Inclusion in prominent sustainability stock indexes signals that a company is making headway on emissions and other environmental factors. Perhaps more importantly, at least where the finance team is concerned, it can also boost demand for company stock.
Yet the world of stock indexes remains opaque to many in sustainability. Trellis asked Julia Wilson, who leads issuer relations for sustainability and climate at investment intelligence firm MSCI, for tips on using ESG indexes to accelerate company progress on climate.
Indexes 101
A stock index is essentially a group of companies that meet some kind of criteria. Among the best-known is the S&P 500, which includes leading U.S.-based companies as assessed by market capitalization, profitability and other factors. ESG indexes are specialist groupings based on environmental, social and governance benchmarks, and there are other indexes that focus only on sustainability or climate.
One example criterion is an MSCI benchmark known as the Low Carbon Transition Risk Assessment, which places companies in one of five categories linked to the transition to a low-carbon economy. Companies classed as at risk of “asset stranding” — say a company operating coal power plants — are excluded from a suite of regional MSCI indexes containing businesses that are relatively well-positioned for the transition.
Many other sustainability-related criteria are used to define membership in the countless indexes on offer to investors. S&P, for instance, asks companies to complete its Global Corporate Sustainability Assessment and uses the results to determine membership of the more than 200 sustainability and climate indexes it offers.
Why indexes matter
Trillions of dollars of assets are held in investment vehicles linked to indexes. Exchange traded funds (ETFs), for example, make it easy to invest in the group of companies covered by a specific index.
Inclusion or exclusion is not permanent: Indexes are updated regularly, typically every quarter. A company that’s excluded from an index due to a low rating on an ESG benchmark can gain entry by improving its score.
When this “rebalancing” happens, operators of ETFs and related vehicles may buy stock in the newly added companies. Investors that monitor the indexes may also decide to buy or sell. The collective impact results in a jump in demand for the new entrants. Wilson said that one tech company saw an additional $500 million of its stock added to one class of investment vehicle after joining an MSCI ESG index.
Examples like that illustrate the opportunity for sustainability teams: Resources for projects that reduce emissions and tackle environmental issues can be positioned as also helping gain access to important indexes. It’s a “match made in heaven” when it comes to CFOs and CSOs working together, said Wilson.
What sustainability teams can do
First, determine which indexes your company is part of — a task that, given the number out there, is easier said that done.
One starting point is to figure out which broader indexes a company is in. These can be defined by market capitalization, location and other factors. More specialist sustainability indexes are often based on these broader groupings. For example, the FTSE USA Index contains large and mid-sized U.S.-based companies. Constituents of that index with the highest ESG scores are included in the FTSE4Good USA Index.
Then, do more detailed checks:
- If you know the name of a specific index, MSCI, FTSE Russell and other providers offer tools for checking on constituent companies.
- There are also paid services from MSCI, Bloomberg, Morningstar and others that, given a company name, will list the indexes in which it is included.
- Run these same checks for peer companies to get a sense of where your organization may be behind or ahead.
- Ask finance teams for any lists they may care about.
It’s also worth checking to see how your company scores on specific ESG tests, noted Wilson. Under the MSCI Controversies framework, for example, companies are assigned scores based on the severity of alleged social or environmental problems, such as toxic chemical spills. Poor scores on these screens can automatically exclude companies from certain indexes.
One key thing to remember, added Wilson, is that indexes are dynamic and relative. “It’s not, oh, we made it to AAA, we’re good forever,” she said. “You could be improving your performance in absolute terms, but if your peers are doing so at a faster rate, then you could be etched out.” And, of course, the reverse is true: Every rebalancing is an opportunity for your company to nudge a rival out of the way.
