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Rick Redding, IIA

IIA sees impressive growth in ESG indices

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Environmental, social and governance (ESG) lie front and centre in the index world says Rick Redding, the CEO of the not-for-profit Index Industry Association (IIA). “It’s what a lot of people are working on and where a lot of interesting work is being done trying to look at ESG in a much more sophisticated way.”

Last October’s annual global index survey, conducted by the IIA, reported that, fuelled by investor demand, there had been impressive growth and innovation in the ESG sector, up 13.85 per cent across equities and fixed income.

One of the key problems identified by the IIA in building ESG indices is input data. “Unlike a typical market cap index, where all the data is publicly available, it’s difficult to get some of the information,” Redding says.

“While we think about it as a first world issue, it is easier to get some of the data on gender differences or pay data  in the United States but even within the EU it can be difficult.”

The background work to creating an index with ESG filters involves a lot of survey work and interviews to get to the data and that process, Redding says, is key to getting ESG even more reliable and robust in investor minds.

He also observes a difference between the US and Europe in what they want in terms of ESG. 

“In America, we primarily want an exclusionary index, an index without something, whereas a lot of Europeans are looking at it in a better way, looking for companies that are good corporate citizens and that uphold their values. The difficulty is in creating indices that have high scores across a realm of different criteria.”

Three people might agree on the 15 essential criteria that they want to screen for in an ESG index, but the one thing that they each don’t agree on means that there are suddenly three indices – hence the proliferation in ESG indices.

“Indexing helped investors because people coalesce around  benchmarks and mass customisation brings the costs down,” Redding says. “We will need mass customisation in ESG to bring the costs down to where other passive investments are and then ESG will explode globally.”

Greenwashing, nodding in the direction of genuine ESG, is a concern that Redding says has to be acknowledged. “But it isn’t the motivation,” he says. 

“We can always see that and it’s a great way to look at the difficulty of what investors want. The investors are driving the decisions because that is what they are going to build. The more educated people can get around ESG the better the indexes will be.”

The interesting question then is where do you stop the equation, Redding says. A new wormhole opens when asset managers examine companies that appear to be in traditionally dirty industries, such as the oil industry, but have spent more on green research than all the green companies combined.

“Europeans are doing this better because if you just exclude the oil company, you may be missing the fact that it may have the best gender diversity policy. It’s better to say let’s look at companies that score 90 per cent and build a portfolio around that.”

Redding expects that there will be new interest in ESG fixed income indices. “We always think in terms of equities in ESG, but if you are a pension scheme or an endowment, why wouldn’t you want your fixed income run the same way as your equities?” he says. 

The IIA is the only industry body to quantify the index universe and, according to its October 2019 study, there were 2.96 million indexes globally. According to the IIA’s two previous surveys, the total number of indexes rose from 3.29 million in 2017 to 3.73 million in 2018.

While the 2019 figure represented a 20 per cent decrease on the year, much of that was due to the decommissioning of indexes, a process which occurs every year to ensure indexes are not redundant. Previously, this had been offset by the addition of new indexes, but there were a large number of decommissions in both equities and “other” categories in the past year.

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