The main question likely in investors' minds is, "What took them so long?"
And it did take them a while: KLD has been working on a global index on and off since 1999. The project was derailed by the market downturn in 2001, according to the company, and was taken up again in earnest a couple years ago.
"In many ways I guess we can say that the delay was beneficial in the sense that the research we're working with is better than it's ever been, and the methodology for the index is more advanced than that which we were working with several years ago," says Thomas Kuh, managing director of KLD Indexes.
Peter Kinder, KLD's president, says that two big changes have taken place in the institutional market that made the time particularly right for the launch of the new index family. Institutional investors, he says, are now big believers in global investing. They are also expressing a lot more interest in investing according to environmental, social and governance criteria than they have before, Kinder says. He cites as a sign of the changes in attitudes that have taken place the UN-sponsored Principles of Responsible Investment that were developed by a panel of the world's largest institutional investors and which have been signed by nearly 250 asset holders, investment managers and service providers in the field of finance. All together, those firms represent more than $10 trillion in assets under management.
The new benchmark index, the KLD Global Sustainability Index, is derived from the companies representing the top 75% of the market capitalization of each sector of the S&P/Citigroup Broad Market Index. One of the key features of the index is that it is sector neutral—the sector weightings of the KLD index approximate the sector weightings of the S&P/Citigroup BMI.
"One of the things we've consistently heard over the years is that to the extent that SRI indexes have tracking error relative to an underlying market benchmark, it's always considered to be a bit of a problem. Obviously some tracking error can be tolerated, but what we decided to do, taking that criticism into account, is eliminate that part of the tracking error that's associated with sector variances. So it removes some of the systemic risk that a lot of SRI indexes have," Kuh explains.
Rather than applying screens to eliminate undesirable companies, as KLD has done with many of its previous indexes, components are rated according to 14 different ESG criteria and then ranked within their regional sector peer group. The scoring system favors companies that have good environmental records; serve or benefit their communities and society in general; hold high labor standards for their own employees and those of the companies and firms in their supply chains; produce safe and high-quality products; and, display ethical and exemplary management. Ideally, the stocks in the top 50% of the identified selection pool of each regional sector are selected for inclusion in the index.
Twenty-three developed markets are included in the indexes. Although the index is sector-neutral with regard to the S&P/Citigroup BMI, its methodology does not require it to reflect the weightings of the various countries. Country indexes are not calculated, but the index family does include four subindexes. The benchmark index itself had 686 components at launch; in comparison, the Dow Jones Sustainability World Index has roughly 310. The KLD Global Sustainability World Index includes 210 components in the Asia Pacific subindex, 200 in the Europe subindex and 276 in the North America subindex. KLD also calculates the KLD Global Sustainability Ex-U.S. Index, which has 485 components.
The benchmark's top 10 holdings include Microsoft, Royal Dutch Shell, BP, HSBC Holdings, Procter & Gamble, Cisco Systems, Johnson & Johnson, IBM, Vodafone Group and Novartis AG.
Northern Funds has already filed to create an index mutual fund based on the benchmark index.