Interest in ESG investments is believed to be driven by at least three main factors. First, the Covid-19 pandemic has demonstrated that acting mainly for the benefit of society brings measurable benefits from the perspective of companies operating in the changing business environment. Entities that act responsibly are appreciated by both employees and customers. The second important factor is the interest of millennials in such investments. This is associated with the effect of a new generation of informed consumers entering the market for whom environmental protection, safe and stable working conditions and high management standards are important. The third factor, i.e. the rate of return on capital invested, is of key importance from the investment perspective. According to the available data, in 2020 three out of four balanced equity funds beat the market ratios, and 25 out of 26 ESG index funds beat the broad market funds. One spectacular example is the rate of return achieved by the MSCI Emerging Markets ESG Leaders index over the past 10 years. The index grew by 150%, while the MSCI Emerging Markets index, i.e. the index of all emerging market companies, has gained 59% in the same period. There is no doubt that these are the key factors that appeal to investors seeking attractive forms of investing their capital.
Tomasz K. Wiśniewski PhD
Deputy Head of the Information Products and Indices Department of Giełda Papierów Wartościowych w Warszawie S.A. (the Warsaw Stock Exchange)
In response to investors’ needs, an increase in the offer of sustainable products has recently been observed. In the first quarter of the year, the largest investment funds launched 33 new products compared with 29 products launched in the first quarter of the previous year. The most active fund in this area is Lyxor, which released 18 balanced ETF funds on the European market, followed by Amundi and iShares, which released 16 and 13 new funds, respectively.
European ESG ETF inflows - % of overall European ETF inflows
Q1 2020 data is zero due to net outflows from ETFs that quarter
Source: Morningstar
The activities of stock exchanges themselves which are involved in promoting sustainable financing are also important in this context. To achieve this purpose, the stock exchanges publish indices of companies which take ESG factors into account in their operations. Globally, there are more than 1000 ESG-related indices which are quickly becoming underlying instruments for financial instruments such as ETFs (currently the most popular instruments on the markets) or investment certificates and derivative instruments (forward contracts and options), which are gaining popularity with investors.
The first ESG indices were published in the United States. Dow Jones, which started to publish SI (Sustainability Index) in September 1999, should be considered the pioneer in this field. A year later, Calvert started to publish its ESG index, and in July 2001 the British firm FTSE published its first FTSE4Good index.
The Warsaw Stock Exchange also follows this trend. The RESPECT Index was introduced in 2009, and the WIG-ESG index has been published since September 2019.
The RESPECT Index was based on an annual verification of the compliance of public companies with certain ESG standards. Companies characterized by high standards of reporting and communication with investors qualified for participation in the RESPECT Index. Their compliance with the prescribed criteria was verified based on an analysis of penalties imposed by the Polish Financial Services Authority and the content of the companies’ websites. To be included in the index, the companies had to complete a questionnaire on ESG issues the results of which were verified by an independent auditor. Over ten years, the number of companies participating in the RESPECT Index has grown from 16 in the first edition to 32 in the twelfth edition. In this period, the rate of return on this index gained 55 percent, while WIG (the broad market index) gained 45 percent. The main aim of the first ESG index published by the WSE was to promote socially responsible business and educate companies in this area. The RESPECT Index clearly achieved this aim, which is confirmed by the fact that the number of participants almost doubled between the first and the last edition.
The WIG-ESG index, which was launched in September 2019, is primarily an underlying instrument for any investment strategy. This means that a stock market investor interested in building a portfolio of companies that meet high ESG standards can purchase a unit in an investment fund whose structure corresponds to the WIG-ESG basket, without having to invest in shares of individual companies. The rate of return on such an investment will reflect the rate of return on the index.
Źródło: Giełda Papierów Wartościowych.
According to its adopted principles, WIG-ESG includes all companies participating in the WIG20 and WIG40 indices. A company’s position in the index depends on the ESG ranking based on reports prepared by Sustainalytics, an international scoring company. In this case, the companies are evaluated based on publicly available information. This model has been functioning for many years and it is accepted by both investment companies and entities which calculate the indices. The following information is analysed in the scoring process: annual reports of companies, reports containing non-financial information, information provided on websites and information communicated by companies to their stakeholders. Reports published by companies in accordance with the Best Practices for WSE-Listed Companies are also assessed. The more rules a company applies, the higher its score and position in the index. This means that the whole process of company evaluation does not require their involvement or possible costs.
The WIG-ESG index also gives the companies an important advantage in their relations with investors. The criteria applied are based on international standards thus facilitating communication with international investors who use such standards. The evaluation criteria and scoring principles are transparent and predictable, which is important both for companies and investors. As a result, the companies know what actions need to be taken to achieve higher scores, and the investors know the roadmap for achieving the companies’ targets based on their published strategies. Ambitious plans of companies in the ESG area and their implementation result in increased interest and a higher level of investment in particular companies. Therefore, taking the ESG issues into account in the investment process is becoming a new standard on global capital markets.
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