MSCI Launches ESG Index Series that Aims to Be More Inclusive

MSCI has launched an index series geared to environmental, social and governance (ESG) investing that will enable institutional investors to better integrate ESG factors into their investing process.

The MSCI ESG universal indexes aim to help such large investors be more inclusionary and universal in their approach to ESG investing, so that they have a broader universe of equity investments to draw from without giving up their ESG focus. These indices will move away from a market capitalization weighting for equities to one that takes stock of their ESG profile so as to better weigh ESG performance.

The MSCI index will only exclude such companies that it deems to have violated international standards on matters such as human rights or the environment, as well as those it considers to be involved with “controversial weapons,” such as biological and chemical weapons.

Diana Tidd, MSCI’s global head of index, said, “The MSCI ESG Universal Indexes offer the world’s largest asset owners a scalable way to integrate ESG into their investment decision-making processes. Asset owners can use the MSCI ESG Universal Indexes to facilitate asset allocation or to help implement investment strategies in accordance with their ESG goals.”

For more stories like this, sign up for the CIO Alert newsletter. 

Globally, the MSCI ESG indexes serve as a benchmark for more than $56 billion in investments, according to the New York investment-index firm. So how does incorporating ESG factors impact investment performance? Cambridge Associates, a Boston-based global investing firm, finds that investors that incorporated ESG factors in their investments in emerging market stocks came out ahead of those that didn’t weigh such factors.

For instance, MSCI’s emerging markets ESG index beat MSCI’s emerging markets index by a total of 12% over a three-year period (beginning June 2013, when MSCI launched the emerging markets ESG index), and more than half of this outperformance is based on ESG factors.

Chris Varco, senior investment director for mission-related investing at Cambridge Associates, said: “Using these criteria to help pick stocks in emerging markets really helps to separate the wheat from the chaff. Of the 367 basis points of annualised outperformance achieved by the MSCI emerging markets ESG index, some 199 basis points were attributable to ESG factors after we accounted for the contribution of other factors such as country, currency, sector and style.”

The sector factor contributed to 107 basis points of the outperformance, while style accounted for 63 basis points and currency for four basis points. The country factor however, lowered the ESG index’s overall return by five basis points. Another factor that positively impacted the performance of the MSCI emerging markets ESG index is that government enterprises, which figure more prominently in the MSCI emerging markets index, don’t have a big presence in the ESG index. These government enterprises are not solely focused on generating a good shareholder return and their returns are also impacted by other factors.

Cambridge also finds that the impact on quantitative returns from the incorporation of ESG factors is not so positive for investments in developed countries. Over an approximate six-year period, for instance, the MSCI world ESG index turned in a lower return, by 10 basis points, than the MSCI world index. According to Cambridge, this comes about as the ESG index excluded some large capitalization US companies such as Amazon, Apple, Home Depot and Facebook.

That doesn’t mean that the incorporation of ESG factors is always a negative for returns in the case of developed country investments. Active investors who have used such factors alongside financial analysis have done better than the MSCI world index in recent years, Cambridge report.

– By Poonkulali Thangavelu

South Dakota and Michigan are the latest states to announce changes to their state pension systems as a result of lowered expected investment and funding concerns.

In South Dakota, Gov. Dennis Daugaard on February 9 signed into law a bill that changed the cost-of-living-adjustment requirement formula for the $10.5 billion South Dakota Retirement System (SDRS).

Under the new formula, the retirement system’s COLA will not exceed 3.5% and will not be less than 0.5% a year, provided the retirement system is 100% funded. However, if the funding ratio falls below 100%, the retirement system’s board can enact a “restricted COLA maximum” so the funding ratio can increase back to 100%.

Previously, the South Dakota COLA formula was linked to the system’s funding ratio. When it was fully funded at 100% or more, the COLA was 3.1%, but when it was less than 80%, the COLA fell to 2.1%. Between 80% and 100%, the fund reverted to a formula based on a combination of the funding ratio and the consumer price index. South Dakota enacted the COLA changes based on an actuarial study done in November 2016 when the fund’s assumed rate of return was reduced to 6.5% from 7.25%.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

The SDRS also plans changes for its participants this spring. A bill will enact a new benefit design for members joining SDRS on or after July 1, 2017. This benefit design does not impact the one for current SDRS members. SDRS will continue as one plan with two benefit designs, according to a release on the SDRS website.

Under the new plan, the retirement age was raised by two years (from 65 to 67 for judicial, and from 55 to 57 for public safety employees) and early retirees will face a 5% per year reduction in benefits. In addition, members who enroll on or after July 1, 2017, will be eligible for a Variable Retirement Account (VRA) that will include an annual contribution of up to 1.5% of compensation; credited with South Dakota Investment Council earnings; available to members at retirement, disability, or death.

These changes were made to address longer life expectancies, increasing market volatility, and “evolving employer workforce objectives. By applying the benefit design changes for future members only, legal issues and retirement planning concerns for Foundation members are avoided,” according to the SDRS website.

Michigan to Reduce Assumed Rate of Return

In Michigan, the state is assuming a reduced expected return rate for its retirement plans and has established a taskforce charged with addressing the unfunded liability for the state’s four retirement plans. A new state budget proposed this month included more funding to the $55.7 billion Michigan Retirement Systems as a result of lowering the pension system’s assumed rate of return to 7.5% from 8%.

The goal of reducing the assumed rate of return, while simultaneously raising state contributions to the four public defined benefit plans the state administers, will reduce risk and “remain on track to eliminate the liability entirely by the year 2038,” according to a statement released by Gov. Rick Snyder.

The unfunded pension liabilities of the four state retirement systems as of Sept. 30, 2015, (the latest available date) were $33.2 billion, according to the Michigan State Office of Budget.

The state’s largest public plan, the $43.2 billion Michigan Public School Employees Retirement System (MPSERS), faced an unfunded liability of $26.7 billion. The new lower 7.5% return target will be implemented over a two-year period for MPSERS, according to the governor’s proposed 2018 budget.

As of Sept. 30, 2015, two of the state’s three pension plans were frozen: the $10.9 billion Michigan State Employees Retirement System had an unfunded liability of $5.8 billion, and the $255 million Michigan Judges Retirement System, with an unfunded liability of $8 million. The $1.3 billion Michigan State Police Retirement System, which was not frozen, had an unfunded liability of $654 million.

- By Chuck Epstein