ESG As A ‘Conversation’ With Companies

June 03, 2019

Mona NaqviLate last month, S&P Dow Jones Indices added its own twist to socially responsible investing by launching its own house-brand environmental, social and governance (ESG) index series.

Based on well-known S&P DJ vanilla indexes, the new ESG benchmarks include single-country and regional indexes, as well as indexes for developed and regional markets. Notably, there's also an ESG version of the signature S&P 500 Index.

It's SPDJI's first set of benchmarks using the firm's new in-house ESG scoring system, but S&P DJI pioneered the ESG indexing space back in 1999, when it launched the Dow Jones Sustainability Index.

In advance of IMN's Global Indexing & ETFs Conference later this month, we sat down with Mona Naqvi, senior director of ESG Indices for S&P Dow Jones Indices, to learn more about the benchmarks and how they work. Naqvi is a speaker at the event, where she'll be on the "Cashing In On ESG-Aware Portfolios" panel.

ETF.com: What do you think investors often overlook or miss when they're evaluating different ESG-related indexes and products?

Mona Naqvi: One of the biggest oversights when investors evaluate anything ESG is when they review the quality and robustness of underlying data. There are so many different data sources these days that it can be quite difficult for investors to deploy the necessary resources and time to do the due diligence required to unpack the methodologies and guarantee the robustness of the whole data collection.

One reason for that is low disclosure from companies, though that's improved significantly over the years. Not all companies report, and even those who do don’t necessarily do it perfectly.

A lot of ESG data providers even leave some estimates blank for companies or apply industry averages, which, at the end of the day, can yield rather inaccurate results when it comes to [building] products, particularly if you're advocating for divestment or even reweighting companies accordingly.

ETF.com: What does S&P DJ do differently, then?

Naqvi: Our scores, which are calculated by SAM [a unit of RobecoSAM that specializes in producing ESG data], actually go beyond simply collecting public disclosure. We engage companies directly through an annual survey, the Corporate Sustainability Assessment. That allows us to have a more in-depth assessment of corporate sustainability performance.

We also require that all the sponsors substantiate with robust supporting evidence, which gives us unparalleled insight into how companies are managing material issues, beyond simply what they might choose to publicly disclose.

ETF.com: So you're not just taking what they say at face value. You're double-checking their homework, so to speak.

Naqvi: Exactly. It gives us an opportunity to really get in the weeds and have a conversation with the company, to understand not just the issues they think are important, but how they're managing them.

Often, that's a level of detail that companies exclude from their public reporting, but that they're more than happy to share in a conversation with us. It also allows us to ask questions of emerging importance in the ESG space, so we can stay on trend and relevant with the most timely issues, long before companies are publicly disclosing them.

ETF.com: What sort of issues do you mean?

Naqvi: For example, starting in 2016, some surveys included company tax avoidance and what-not. That was an interesting development, because it led to conversations with companies that have not necessarily considered this an issue before. Now they've started to either change company policy or disclose new results.

ETF.com: So, just by the nature of you having these conversations with companies, you're directing them to realize this is an important issue?

Naqvi: Yes. We launched the world's first global sustainability benchmark in 1999. And we used a similar methodology and partnership with SAM back then. If you look over the 20 years we've been doing this, the issues that have emerged in the ESG space correlate with the types of issues we're pushing for.

ETF.com: Is there a concern that companies may be misreporting or misrepresenting themselves as they answer these surveys so as to look better? How do you account for that?

Naqvi: We require that any responses are fully substantiated with robust evidence. In some cases, that requires auditor documentation and assurance. The whole scoring methodology is itself audited and quality control checked.

Back when we launched the Dow Jones Sustainability Index, there was, by design, a self-selection bias in the companies that responded. Fast-forward to today, we made some adjustments to the methodology. For example, we no longer penalize companies for not responding to particular questions, which gave them a negative score before; now, only if a question is responded to by more than 50% of a company's industry peers, and it goes unanswered, will it have the potential to negatively impact the scoring.

ETf.com: How does this data create a different kind of sustainability index?

Naqvi: Our index targets the top 75% of market capitalization within each [GICS] industry group in the parent index, ranked by these new ESG scores. We also exclude any company involved in the production of tobacco, controversial weapons, or which have a low UN Global Compact score; also, any companies in the bottom 25% of ESG rankings for our global universe of constituents.

So we end up with a broadly sector-neutral approach that ends up mirroring the risk/return profile of the parent index. We're really dispelling the myth of an ESG performance trade-off. That's a compelling case for using ESG in the core of a portfolio, and not just at the periphery.

ETF.com: One of the sure bets in ESG investing is there's always a new crisis that’ll come up. Take the Facebook privacy scandals, for example; or a weather-related event, like a flood or hurricane. How do your indexes handle ESG-related events that might suddenly arise and negatively impact constituents?

Naqvi: On our behalf, SAM is continuously monitoring company controversies through its "media & stakeholder analysis." This is informed by real-time news monitoring to look for specific issues.

If the specific controversy has a material impact on the score, we have an index governing committee that has the discretion to remove any companies from the index in between rebalancing dates. That helps us ensure the scores and indexes remain timely and relevant.

Contact Lara Crigger at [email protected]

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