Tracking a sustainable world: The benefits of global ESG index investing
With the amendment of Regulation 28 allowing for greater offshore allocation in pension funds, local investors are increasingly looking for offshore opportunities to diversify their assets. But looking to global markets for increased investment opportunities introduces local investors to a far larger universe – a daunting prospect, especially when adding the additional complexity of environmental, social and governance (ESG) considerations that the global environment offers.
As global markets evolve and investor priorities shift, the integration of ESG principles into investment strategies is becoming increasingly prominent. Not only do South African investors now need to analyse a vast investment landscape within a much larger global universe, but they are also offered the opportunity to invest in a more mature market when it comes to ESG investments, with exposure to advanced technology and green economic progress.
The role of index investing in global exposure
Index funds track specific benchmarks such as the MSCI ACWI or the MSCI World Index, offering a passive investment strategy that eliminates the need for complex and costly active management.
Through the provision of low-cost, diversified solutions, index funds offer transparency, consistent performance and ease of access to broad market segments, making them an efficient way to gain exposure to global opportunities. This approach allows South African investors to participate in international markets with predictable returns aligned to market segments, while minimising the complexity and costs associated with actively managed funds.
Offshore exposure via index investing can create a well-rounded portfolio that captures the growth potential and diversification benefits of global markets while maintaining a disciplined, cost-effective investment strategy.
The global landscape has been an extremely difficult space for active managers to play in, and this is reflected in multiple surveys such as SPIVA Scorecard, which highlights that only 13% of managers have outperformed the benchmark over a 10-year period ending December 2023.
The growth of passive ESG strategies
The growth of passive ESG strategies increasingly is contributing to investors’ portfolios by offering a way to align investments with values and beliefs, while maintaining the benefits of diversification, cost-efficiency and transparency associated with index investing.
However, more expansive ESG investment strategies in the global universe, such as the Old Mutual MSCI World ESG Index Fund, allow investors to gain exposure to global ESG trends through companies that demonstrate strong ESG practices, which can lead to more sustainable long-term performance.
As global awareness of ESG issues continues to rise, these strategies attract more investors who are concerned about the impact of their investments on society and the environment. Additionally, research has shown that companies with robust ESG practices often exhibit lower risk and better operational performance, potentially leading to superior risk-adjusted returns.
For South African investors, integrating passive ESG strategies into their offshore portfolios provides an opportunity to tap into global markets while promoting sustainability, complementing the broader benefits of global diversification and index investing.
Alignment between indexation and ESG investing
Indexation and ESG investing are increasingly aligned, thanks to the development of ESG-specific indices such as the MSCI ESG Leaders Indexes, which are designed to track companies that excel in managing ESG risks and opportunities.
Contrary to popular opinion that passive investors, by their very nature, cannot make ESG investment-related decisions, index investors are in fact ideally placed to commit to long-term ESG positions. Being a passive investor doesn’t mean you have to be an absent landlord, as you can still exercise your active ownership rights through partnering with a stewardship service provider. In this way, passive investors can ensure their voice is heard by voting at all company meetings and engaging these companies on all key ESG issues.
At Old Mutual Investment Group, we have a clear strategy to ensure we actively and responsibly steward our clients’ capital.
Using an ESG methodology to identify risk
For South African investors, exposure to ESG indices like the MSCI World ESG Index offers significant advantages. The MSCI methodology incorporates rigorous screening to identify companies with superior ESG performance relative to their peers. By focusing on companies that manage their environmental impact, operations and governance effectively, ESG indices can deliver higher risk-adjusted returns over time.
The exclusion of companies with poor ESG practices – such as Shell, which faced significant environmental fines following the 2018 Forcados Oil Spill in Nigeria; or Steinhoff, which collapsed due to fraud – demonstrates the risk mitigation that ESG investing offers. By avoiding companies with significant ESG risks, investors can preserve their capital and align with responsible investing principles.
The MSCI World ESG Leaders Index is designed to reflect the sector and country weights of its parent index (MSCI World Index), resulting in a similar performance profile with minimal tracking error. This index includes companies with superior ESG performance, which tend to be more resilient to market fluctuations and adverse events.
The result is reduced volatility and more stable returns. By incorporating ESG factors into their investment decisions, investors can gain exposure to forward-thinking companies that can anticipate and manage potential risks and opportunities more effectively. With increased agility, these companies are more likely to comply with evolving regulations and standards and avoid fines, legal issues and reputational damage, which helps protect investor returns.
The World ESG Leaders index has also performed well (top quartile) against its peer benchmark (see graph below highlighting the three-year rolling returns – net – relative to peers), which represents the average performance of active managers within the Global Large Cap Blend Equity Peer Group.
Source: Morningstar (Global Large Cap Blend Equity)
Risk management is at the heart of ESG index investing. This proactive approach helps investors to access more stable investment returns while reducing exposure to unforeseen financial losses.
Conclusion
For South African investors, the combination of global exposure and ESG investing through indexation offers a powerful strategy for long-term portfolio growth. With the amendment of Regulation 28, the ability to invest offshore opens up new opportunities to access diverse industries, economies and currencies.
Through index funds, investors can achieve cost efficiency, consistent performance and diversified market exposure, while integrating ESG enables them to align their investment goals with their values.
Bernisha Lala
Co-Portfolio Manager
