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Blog Posts — January 18, 2019

Gauging the Impact of ESG Exclusions

Negative or exclusionary screening is the most popular environmental, social and governance (ESG) strategy among asset owners and managers.1

The launch of the STOXX® Europe 600 ESG-X Index last November aimed to satisfy investors’ need for a market-cap-weighted benchmark that is in line with the typical exclusion criteria of their responsible-investing policy. The ESG-screened version of the popular STOXX® Europe 600 Index excludes companies based on norms (United Nations Global Compact principles) and products (controversial weapons, tobacco and thermal coal).

Such exclusionary approaches usually tend to introduce differences in performance and hamper diversification relative to the benchmark. They can also create unforeseen biases and unintended risk, as well as tracking error and additional management costs. All these pose practical challenges for the investor.

To assess precisely what the cost and impact of these exclusionary screens is on portfolio returns and risk profile, a new research paper2 from STOXX analyses in depth the performance of the STOXX Europe 600 ESG-X Index versus the STOXX Europe 600 Index.

Nearly matching results

In data going back to 2012, the STOXX Europe 600 ESG-X Index’s exclusion criteria resulted in the underweighting of a number of sectors, Anand Venkataraman, Head of Product Management at STOXX, and Willem John Keogh, Senior Product Development Manager, found in the analysis. These are oil and gas, banks, industrial goods and services, personal and household services, health care, basic resources, utilities, and automobiles and parts.

Overall, the paper finds that the exclusions added nearly 23 basis points in annualized returns over the STOXX Europe 600 Index since 2012, while increasing the annualized volatility by 6 points. The results don’t diverge statistically from those of the benchmark in a significant way, Venkataraman and Keogh write.

Factor-based performance attribution

Furthermore, the analysts carried out a historical factor-based performance attribution analysis of the ESG-X index versus its benchmark, using Axioma Portfolio Analytics.

Neither the specific returns contribution of 0.098%, nor the overall factor contribution of 0.105%, nor any of the broad factors (style, country, industry, currency and market) contributed statistically to the active portfolio’s returns in a significant way, according to the authors.

“We may therefore conclude that the performance of the ESG-X is statistically not significantly different from that of the STOXX Europe 600 Index,” they write.

A deeper look into sub-factors such as leverage, medium-term momentum volatility and industry appeared to have no significant positive or negative cumulative contribution bias, with few exceptions.

“As such, the exclusion of stocks does not seem to have either destroyed index performance or altered its risk profile as compared to the benchmark,” the authors added.

The STOXX Europe 600 ESG-X Index delivers a risk-return profile that is very similar to that of the STOXX Europe 600 Index, without any strong biases or exposures resulting from the exclusions. The finding is important for investors familiar with the STOXX Europe 600 Index who seek to easily implement and adopt the ESG-X index as an ESG-screened benchmark for their responsible investing approaches.

New futures on ESG-screened index

The STOXX Europe 600 ESG-X is the first ESG exclusion-screened version of a flagship index, a liquid market-cap-weighted benchmark for the European market. The STOXX Europe 600 ESG-X shares its benchmark’s rules, sector composition and methodology – including the same transparent free-float market-cap weighting scheme.

The introduction in February this year of futures contracts on the STOXX Europe 600 ESG-X Index, EURO STOXX 50® Low Carbon Index and STOXX® Europe Climate Impact Ex Global Compact Controversial Weapons & Tobacco Index at Eurex is likely to further facilitate the implementation of passive ESG screen strategies and help lower the cost of portfolio trading.

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Eurosif, ‘European SRI Study 2018,’ Nov. 19, 2018.
2  Venkataraman, A., Keogh, W.J., ‘STOXX® Europe 600 ESG-X Index – Analysing ESG Exclusions,’ STOXX, December 2018.