By Mark Barnes, PhD, Head of Investment Research (Americas)

Investors are increasingly looking for simple ways to align their investments with their personal views on environmental and societal issues. Our analysis, as reviewed in our article on this topic, shows that combining ESG screens with a transparent, rules-based index construction methodology results in indices that are close substitutes for underlying indices with with which investors are most familiar.

This blog is the latest in a series of research articles focusing on global sustainable investing strategies. Our research paper presents six-year case studies for the FTSE Australia 300 Choice and FTSE Developed ex-Australia Choice indices, two market-cap-weighted indices using a rules-based methodology that allows investors to apply strong exclusion guidelines based on ESG values ​​to a broad market index.

Although the Global Choice selection process can have a significant impact on the composition of certain sectors, our research found that the overall long-term effect on index performance was minimal and that Global Choice indices behaved very similar to their underlying benchmarks (with correlations and betas close to 1 over time). These results provide investors with confidence that these indices can serve as close substitutes for their underlying benchmarks while allowing them to express their ESG principles in portfolios.

For illustrative purposes, we present performance statistics for the FTSE Australia 300 Choice Index, which uses the benchmark FTSE Australia 300 Index as its starting universe, for the six-year period ending 31 March 2021. As As stated, the Australia 300 Choice Index lagged the underlying index’s annualized benchmark gain of around 6.75% by a modest 10 basis points, with comparable volatility. The tracking error over this period was 2.45%.

Performance statistics – April 2015 to March 2021 (AUD)

To get a better idea of ​​the stability of the co-movement, we also calculated correlations over a rolling two-year period. As shown below, although the correlation briefly dipped below 0.95 early in the period, it has stabilized around a high of around 0.994 more recently. Our research found similar results for the FTSE Developed ex-Australia Choice Index, which outperformed its market-cap-weighted benchmark by around 98 basis points per year.

Correlation – FTSE Australia 300 Choice Index versus benchmark FTSE Australia 300 Index (24-month rolling window)

The chart below represents the annualized volatility of the Australia 300 Choice Index and the underlying benchmark over a 24 month window. As noted, the characteristics of the two indices are similar enough that the volatility of the Australia 300 Choice Index closely matches that of the benchmark over time. Again, this indicates that the Australia 300 Choice Index is a close substitute for the underlying benchmark.

Annualized volatility – FTSE Australia 300 Choice Index and FTSE Australia 300 benchmark (24 month rolling window)

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.