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In response to feedback from numerous investors, MSCI will begin fine-tuning its ESG Leaders methodology in December 2020. The climate-risk profile will be improved while comparability among the individual ESG indices will be enhanced. This means that our sustainable Credit Suisse Equity Index Funds, which replicate the ESG Leaders indices, will also become more climate-friendly and generally more sustainable.
November 13, 2020
Since the “Fridays for Future” movement was founded in August 2018, regular climate strikes have been held all over the globe. The objective is clear: to uncover climate policy abuses and ramp up climate protection efforts. Even COVID-19 and its widespread ramifications haven’t managed to overshadow the issue. On the contrary: around the world, calls for long-term reductions in CO2 emissions are getting louder and louder. This trend has also taken hold among many investors, with funds offering ESG integration and a lower greenhouse gas footprint gaining ground on their competitors. The index provider MSCI has therefore decided to take greater account of CO2 emissions in its ESG Leaders methodology and to apply stricter criteria when it comes to excluding companies engaging in controversial business activities.
When Credit Suisse Index Solutions launched its sustainable funds, it decided to use the MSCI ESG Leaders indices as a basis. These broadly diversified indices cover all regions and exhibit comparable risk-return profiles in relation to their parent indices. This is mostly the result of a best-in-class approach that leaves the weighting of individual sectors unchanged. Only securities that successfully go through the multistage selection process are included in the MSCI sustainability indices (see chart 1).
To make the ESG Leaders indices more climate-neutral and promote standardization, MSCI will be introducing new exclusion criteria for the ESG Leaders indices, beginning in December 2020. Carbon emissions in particular should be reduced as much as possible.
1. Further development of the methodology with a view to making targeted reductions in CO2 emissions in the benchmark. Companies will be excluded as soon as the following activities exceed 5% of their total turnover:
a. Mining and sale of thermal coal
b. Power generated from thermal coal
c. Unconventional oil and gas extraction¹
2. Improved screening of controversial business activities
To reduce CO2 emissions, a new threshold of 5% will apply to thermal coal (mining, sale, and use to generate power) and to the unconventional extraction of oil and gas. Companies that generate a higher percentage of their total sales from such business areas will be automatically excluded from the ESG Leaders indices. The chart below shows how the new methodology can be used to reduce CO2 emissions, sales from CO2-intensive activities, and the index weighting of companies that generate revenue from fossil fuels and thermal coal relative to the parent index (see Chart 2).
Chart 2: Simulated CO2 emissions and revenue after adjusting the methodology
Sources: MSCI, Credit Suisse, October 2020
Historical performance information and financial market scenarios are not reliable indicators of current or future results.
The enhanced focus on climate-friendly companies is not the only change effective from December 2020. The leeway in connection with controversial business areas is narrowing as well (see table 1).
Income from the sale of tobacco products may now only account for 5% of company turnover. Revenue generated by civilian firearms must be below the threshold of 15% of total income. Owing to the enhanced focus on CO2 emissions and stricter ESG guidelines, the number of companies contained in the ESG indices has shrunk by approximately 2%.
Table 1: Improved screening of controversial business areas
Sources: MSCI, Credit Suisse, October 2020
Historical performance information and financial market scenarios are not reliable indicators of current or future results.
Although some companies have been eliminated from the ESG Leaders indices due to the new requirements and the exclusion of CO2-intensive sectors, there has not been a significant shift in the risk-return profile (see table 2). While the weighting of the newly excluded companies in the index is relatively low (less than 2%, based on the MSCI World Index2), companies that generate high CO2 emissions are usually concentrated in just a few sectors. Companies that are part of the same sector generally also exhibit similar risk/return profiles. Because the new ESG Leaders indices are still sector-neutral in relation to the parent indices, the weighting of the excluded companies will be replaced by another company from the same sector.
Historical performance information and financial market scenarios are not reliable indicators of current or future results.
Unlike strategies that focus exclusively on climate change, we continue to follow the ESG Leaders methodology. On the one hand, it takes into account a wide range of sustainability aspects, while on the other hand, the ESG Leaders methodology exhibits a very low tracking error compared to the standard index.
The changes being introduced in December 2020 will make it even easier for investors to invest in companies that fight climate change and avoid controversial business activities. Past experience has shown that this often comes with an attractive return, as demonstrated by our Credit Suisse Index Funds, which exhibit a high degree of diversification and thus an optimal risk/return profile. The strong growth of our ESG offering (20 funds that cover all major asset classes and regions, and inflows exceeding CHF 8 bn within three years) proves that the ESG Leaders methodology has established itself as a standard among institutional investors.
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1. In the oil and gas industry, the term “unconventional oil” refers to oil that is extracted using methods other than traditional vertical drill hole extraction. Examples of such methods include directional drilling and hydraulic fracturing (commonly known as “fracking”). This extraction method generally requires more water and energy than conventional oil extraction and is therefore a contentious issue because of the environmental pollution it causes.
2. Status: May 2020.
3. An ex post tracking error is calculated on the basis of historical returns. A low level of error indicates that the portfolio performance is close to the performance of the benchmark.
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