The S&P 500 ESG Index: Defining the Sustainable Core (2024)

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Introduction

The launch of the S&P 500 ESG Index in April 2019 signaled an evolution in sustainable investing. Indices based on environmental, social and governance (ESG) data were no longer simply a means for companies to declare their sustainability credentials or tools to manage tactical investments playing a minor role in investors’ portfolios. The S&P 500 ESG Index and other such indices were built to underlie strategic, long-term mainstream investment products.

For decades, companies that manage their business with various stakeholders and objectives in mind have been included in ESG indices such as the Dow Jones Sustainability Indices. However, these pioneering, best-in-class indices tended to be narrow, including only a small selection of the top ESG performers. This presented challenges to individual and institutional investors who were concerned about the risks inherent in highly concentrated portfolios defined by these indices.

The S&P 500 ESG Index addresses the need for an index that incorporates ESG values while maintaining similar overall industry group weights as the S&P 500. Intentionally broad—including over 300 of the original S&P 500 companies—the S&P 500 ESG Index seeks to reflect many of the attributes of the S&P 500 itself, while providing an improved sustainability profile as a result of an updated ESG Score.

This paper outlines the characteristics of the S&P 500 ESG Index that have appealed to investors, including:

- The easy-to-understand methodology behind the index;
- The historically similar risk-adjusted performance profiles of the S&P 500 ESG Index and the S&P 500;
- How the ESG characteristics of the S&P 500 ESG Index are improved compared with those of the S&P 500; and
- Specific examples demonstrating how the S&P 500 ESG Index methodology sorts and selects companies.

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Company Background

1. Who is S&P Dow Jones Indices (S&P DJI)? S&P Dow Jones Indices (S&P DJI) is the largest global resource for essential index-based concepts, data and research, and is home to iconic financial market indicators, such as the S&P 500^® and the Dow Jones Industrial Average^®. More assets are invested in products based on our indices than products based on indices from any other provider in the world. Since Charles Dow invented the first index in 1884, S&P DJI has been innovating and developing indices across the spectrum of asset classes, helping to define the way investors measure and trade the markets.

2. Who is S&P Global Trucost? S&P Global Trucost is a leader in carbon and environmental data and risk analysis, and it assesses risks relating to climate change, natural resource constraints and broader environmental, social and governance (ESG) factors.

S&P Net Zero 2050 Carbon Budget Indices

3. Can you describe the methodology in short? The indices are based on the concept that all types of financing can replicate the remaining global carbon budget as published by the Intergovernmental Panel on Climate Change (IPCC). In the IPCC’s most recent report, the remaining global carbon budget of 300 GtCO2 in 2020 would be necessary in order to achieve a 1.5°C objective by 2050, with an 83% probability and a starting point of 31.5 GtCO2. Accordingly, there is a starting point (31.5 GtCO2), an endpoint (2050) and a budget (300 GtCO2) to spend between these two points.

In short, starting in 2022, S&P DJI will allocate a carbon budget each year (each new index will reflect a decarbonization trajectory based on the then-current remaining carbon budget) among index constituents based on their emissions. The total index carbon emissions will mirror the trajectory necessary to be carbon neutral at the planet’s level (i.e., in 2022, to meet 1.5°C climate objective, this equates to an initial 25% emissions reduction, followed by a 10.1% reduction each year until 2050).

The market impacts are limited in terms of tracking error and the number of stocks at inception. The tracking error and stock count are anticipated to deviate from the underlying index over time. It becomes increasingly challenging to be carbon neutral if the world and underlying index do not decarbonize, but a decarbonization floor (which is not included in the current methodology) may reduce the impact.

As the carbon budget shrinks with time, new indices may be launched in the future for new entrants that will incorporate a decarbonization pathway using the remaining carbon budget based on then the current IPCC report.

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Introduction

Launched in 2005, the iBoxx Asian Bond Fund (ABF) Pan-Asia is the official benchmark for the Asian Bond Fund 2 (ABF2) initiative of the Executives’ Meeting of East Asia-Pacific (EMEAP) central banks. The initiative was set up to promote the development of local currency bond markets in the region through investments into nine passive local currency bond funds. One of the key objectives of the ABF2 initiative was to provide a cost-effective means of accessing local bond markets to encourage market participation, including the attraction of foreign investment into the region. Another goal of the initiative was to raise investor awareness of the (then) relatively new asset class—and general interest in Asian bonds.

As an index with limited exposure to credit risk, the iBoxx ABF Pan-Asia is made up of local currency-denominated sovereign and sub-sovereign debt from eight Asian markets, namely China, Hong Kong, Indonesia, Malaysia, Singapore, South Korea, Thailand and the Philippines.

Since inception, the index and the underlying markets have undergone significant changes. In this paper, we will highlight some of the key developments and provide insights into notable changes in the index methodology since its launch in 2005. We will also take a closer look at the performance and demand for Asian local currency bonds in recent years, as well as how Asian bonds could benefit investors in a diversified global portfolio.

Market Development

The size of the local government bond markets in the iBoxx ABF Pan-Asia grew at a compound annual growth rate (CAGR) of 16.2% since 2010. Growth rates between individual bond markets differed, which underscored the disparity across the iBoxx ABF Pan-Asia economies in terms of their development, financial reform, trade dependency and market maturity, as well as the supply and demand of local government debt.

As shown in Exhibit 1, among the eight markets in the index, China registered the fastest growth rate (668%) over the 12-year period ending Dec. 31, 2021, while Singapore logged the slowest growth, at 80%. In the same period, the Hong Kong government bond market expanded at a pace of 598%, but it still remained the smallest in U.S. dollar terms among the ABF markets. Notably, after growing at a CAGR of 9.2% as compared with Singapore’s 5.0% over the same time span, the size of the Philippines government bond market (USD 159.0 billion) marginally exceeded that of Singapore (USD 158.9 billion) as of Dec. 31, 2021.

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In Search of Impact

The rising interest rate cycle and growing importance of sustainability-oriented strategies have been at the forefront of the fixed income market this year. Investors’ focus on sustainable investing has shown no signs of abating, despite the magnitude and speed of rate hikes.

One rapidly growing area in the sustainable finance space is green bonds, often referred to as impact finance. They are defined by the use of their proceeds, which are to be used for specific projects to make a direct impact in an environmentally friendly way, as defined by the International Capital Market Association (ICMA). The market at first was tapped by supranational borrowers such as the European Investment Bank and the World Bank, but now most issuers in this space are corporates (see Exhibit 1).

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1. What is SPIVA^® and why did S&P DJI start putting these reports out 20 years ago?

   Tim: “SPIVA” stands for “S&P Indices Versus Active,” and it is the name for a regular series of research reports that compare the performances of actively managed funds to appropriate benchmarks. The primary role of the SPIVA Scorecards is to help inform a sometimes unfortunately noisy debate over the relative merits of active and passive investing. The scorecards do this by providing data on where (and when) actively managed funds have been performing well (or poorly), over both short- and long-term horizons, in various markets around the world—as well as offering a range of deeper statistics and analysis on active fund performance.

2. How do we ensure that the SPIVA report isn’t biased considering it’s coming from an index provider?

   Tim: One important thing to mention is that we don’t just publish the results when they suit us, instead sticking to a predetermined calendar (which is in most cases semiannual). There have been, and perhaps will be again, years when a majority of actively managed U.S. equity funds outperformed the S&P 500^®. We’ll report it when they do. More generally, the SPIVA Scorecards frequently acknowledge outperformance in individual fund categories: particularly over short-term horizons, there are usually plenty of examples to be found in the range of global reports. I’d add that, from a practical perspective, the scorecards are based on publicly available data, with a fully disclosed methodology—an interested third party can check our results, and sometimes they do.

   Craig: Any analytic effort, SPIVA included, is no better than the data on which it is based, and we source our data carefully. But ours is by no means the first or only study to examine similar data and reach similar conclusions. The first study of active management versus indices of which we’re aware was published 90 years ago. Its conclusion would sound familiar to any reader of our current SPIVA reports: “Statistical tests of the best individual records failed to demonstrate that they exhibited skill, and indicated that they more probably were results of chance.”

3. How has the report evolved over the past 20 years?

   Craig: SPIVA has broadened its coverage considerably. Our first SPIVA report was U.S.-centric, and it covered only 12 comparison categories (large-, mid- and small-cap; growth, value, blend and all styles). Since then, SPIVA has expanded to 9 different geographies, and now reports on the performance of over 100 different active fund categories around the world.