Article
Because they provide a balanced mix of liquidity, diversification, and exposure, sustainable index funds are not only popular with institutional investors. In a panel discussion, Christian Bodmer, Head of Asset Management for Sanitas, and Valerio Schmitz-Esser, Head of Index Solutions for Credit Suisse Asset Management, explained why the products also have a beneficial effect on the companies.
May 5, 2021
Valerio Schmitz-Esser: There are three main reasons. Index funds are broadly diversified, because they invest in hundreds of stocks depending on the benchmark. This minimizes the securities risk. What's more, the products are relatively affordable, not only because of their lower management fees. Transaction costs are also lower, since there is no need for extensive reallocation. Finally, index funds are predictable, as their returns are identical to that of the underlying indices.
Christian Bodmer: As a buy-and-hold investor, we have a long-term investment horizon. This is why we are very conservative when adjusting our strategy. For the reasons that Valerio Schmitz-Esser just mentioned, index funds are the most efficient way for us to reach our investment objectives, including in the area of sustainability.
Schmitz-Esser: We offer more than 100 index funds – all of which are physical replications – that invest in a wide range of regions and asset classes. Twenty-two of those funds already take account of ESG criteria, in other words environmental, social, and governance criteria. In Switzerland, we use the SPI ESG and SBI ESG indices recently launched by the Swiss Exchange as the reference index. Aside from that, we look at the established and broadly diversified MSCI ESG Leaders indices in the case of equity index funds. They cover all of the major regions globally. Their risk/return profile is also comparable to that of the standard indices.
"For institutional investors, the MSCI ESG Leaders index funds strike the right balance of liquidity, diversification, sustainability, and returns."Valerio Schmitz-Esser
Schmitz-Esser: The MSCI Standard index is considered the global benchmark. It is used by many institutional investors such as insurance providers and pension funds. If the ESG index were to stray too far from it, the returns would no longer be within the base index.
Bodmer: We were looking for a way to make our investment portfolio sustainable. To do so, we could have devised our own ESG principles and criteria as a basis for our investments. But why re-invent the wheel when there is already a wide range of attractive solutions? That's why we chose the ESG index funds from Credit Suisse Asset Management, which give us convenient, well-structured access to sustainable investments. When making our choice, we really wanted a dynamic provider in terms of product development and ability to respond to new client needs. Credit Suisse Asset Management fit the bill perfectly here.
Bodmer: Environmental aspects have long been a priority for Sanitas. However, as a service provider, we have only limited options for improvement in this area. By investing our assets sustainably, we are focusing on where we can have the biggest impact and make a difference. This isn't just something that top management has said we have to do: There is widespread support for this approach within the company. This makes a noticeable difference.
Bodmer: Our investment success is an important source of revenue, which of course affects the premiums to some extent. We feel it is our responsibility to future generations to promote sustainability and move with the times. While it's not yet possible to measure the positive effects directly, they do exist. This is not just a passing phase. Our customers also want us to exert our influence.
Bodmer: We do make an impact by investing in ESG index funds. It is an indirect impact, namely via the cost of capital. If people stop buying companies because they fail to meet ESG criteria, the companies will have to pay more to borrow money on the market, so their costs go up. This cost of capital mechanism should lead to a change in behavior. Alongside the ESG index funds, we also have sustainable investments in other asset classes.
Schmitz-Esser: With our green bond index funds, we also offer a solution that uses the proceeds from issues to fund environmental projects. So their impact is very direct. For institutional investors who want to make core investments on the basis of sustainable criteria, however, the MSCI ESG Leaders index funds are a better choice, because they strike the right balance of liquidity, diversification, sustainability, and returns.
"By investing our assets sustainably, we want to lead the way and make an impact."Christian Bodmer
Schmitz-Esser: In the case of passive sustainable investments, there are various options to exclude companies who have a poor track record in sustainability. Certain concepts and products exclude up to 75% of the securities in an index. As a rule, this drives down diversification and increases the risk. An investment of this kind is a suitable addition to a portfolio or for philanthropic investors. Furthermore, the MSCI ESG Leaders indices also set the bar very high. Of 1,600 securities, they exclude 50% of market capitalization. This is already very strict for most institutional investors when it comes to their core portfolio.
Schmitz-Esser: Exclusion and best-in-class are proven methods that work in accordance with market economy models and do not just rely on bans. So they do have an impact. It's comparable to CO2 emissions trading: Carbon emissions are not directly prohibited. By forcing companies to pay for their emissions, there is an incentive for them to do business more sustainably.
Bodmer: I think the days of investors doing something just to get some peace and quiet are over. There is widespread urgency to take action. But the method chosen depends on the guidelines for the individual investors. For us, the ESG index funds are the right choice.
Bodmer: No. There are even studies proving that sustainable investments outperform in the longer term, because the companies have a lower cost of capital or because "green" products are generally more successful. Overall, we expect performance to be in line with the benchmark indices. In the long run, we feel certain that sustainability will pay off. By contrast, we cannot exclude too many stocks, because that's bad for diversification and drives up the risk.
Schmitz-Esser: Much research has been done on the correlation between ESG criteria and financial performance. For instance, a meta study comprising 2,200 studies concluded that, in 90% of cases, there was a neutral or even positive correlation between the sustainability practices of a company and its performance. So good performance and sustainable investing are not mutually exclusive. We have analyzed our products as well and found that in Europe, Japan, and especially in the emerging markets, we outperformed the benchmark indices with the ESG Leaders indices. Outperformance in the emerging markets was even 3%, which was due mainly to the companies' better corporate governance. The ESG indices lagged somewhat behind only in the US, where some technology stocks were excluded due to ESG issues.
Schmitz-Esser: You can't avoid the topic any longer in Switzerland and Europe, whether you are an institutional or private investor. Everyone must deal with the sustainability issue. This is why demand is so high, including for ESG index funds.
Index funds track a benchmark index as accurately as possible. They perform accordingly and are broadly diversified. The latter reduces the risk of the funds. Thanks to this passive approach, the products offer a transparent, cost-effective investment option. Unlike exchange traded funds (ETF), which are also passive, index funds can be purchased or sold only once per day at net asset value (NAV) directly with the fund provider.
Head of Index Solutions for Credit Suisse Asset Management
Valerio Schmitz-Esser, Managing Director, has more than 23 years of professional and executive experience in quantitative finance, index research, and portfolio management. Valerio was appointed Head of Index Solutions at Credit Suisse Asset Management in March 2010. Valerio joined Credit Suisse in 2000 as an index portfolio manager. From 2002 to 2010, he held several team lead positions in quantitative portfolio management at Credit Suisse Asset Management. From 1996 to 2000, Valerio was a research assistant at the Chair of Corporate Finance and Governance at the University of Fribourg. Valerio holds a PhD from the University of Fribourg in Switzerland and is a CFA charterholder.
Head of Asset Management for Sanitas
Credit Suisse Asset Management ESG index funds
Index Solutions at Credit Suisse Asset Management currently offers 22 sustainable index funds that cover a broad ESG investment spectrum. The basis in Switzerland are the new SPI ESG and SBI ESG indices; in other regions it is the ESG Leaders indices from MSCI. These are based on the MSCI World Index, which comprises some 1,600 stocks. From this pool, the most sustainable stocks per sector are chosen in a multi-step process based on the exclusion and best-in-class principles. Excluded are controversial industries such as tobacco, alcohol and weapons, nuclear and coal-based energy, and oil and gas drilling methods that are particularly detrimental to the environment. Companies with a negative track record due to unethical conduct or poor corporate governance are also excluded, as are companies with a low ESG rating. Of the remaining companies, those companies with the best ESG rating in their sector are chosen for the index. As a result, the ESG Leaders index contains just 50% of the standard index. Because the sectors are weighted equally, however, comparability is still possible.
