KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

KEEP IT BROAD: AN APPROACH TO ESGSTRATEGIC TILTING
Neeraj Kumar, Veronique Menou, Stuart Doole, Laura Nishikawa

February 2017

FEBRUARY 2017

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

CONTENTS
Keep it Broad: An Approach to ESG Strategic Tilting .......................... 1
Executive Summary............................................................................ 3
Section 1: Understanding the Motivations, Objectives and Constraintsof ESG Investing ................................................................................. 5
Understanding investor motivations .................................................................. 5
Key Considerations for ESG Investing ................................................................. 7
Identifying the challenges of ESG integration for universal owners .................. 9

Section 2: Constructing the MSCI ESG UNiversal Index .................... 10
Defining a minimal common core among institutional investors for exclusions........................................................................................................................... 10
Tilting securities’ weight ................................................................................... 12
Index characterictics ......................................................................................... 12

Conclusion ....................................................................................... 18

FEBRUARY 2017

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

EXECUTIVE SUMMARYHOW CAN UNIVERSAL OWNERS INTEGRATE ESG PRINCIPLES WHILE MAINTAINING A BROAD
AND DIVERSIFIED INVESTMENT UNIVERSE?
Institutional investors are increasingly looking for ways to integrate ESG considerations into
their investment decisions. By doing so, they may aim to mitigate long-term risks, generatehigher risk-adjusted performance and/or align investments with broader societal objectives. As
ESG investment guidelines become more commonplace among asset owners, and as many
continue to build capabilities in engagement and risk management, we have seen a small but
growing set of institutional investors focus on long-termism by adopting investment strategies
that explicitly build in their holistic views of the future.
Historically, investors have relied on either exclusionary or selection-based ESG index
strategies, whereby companies would be screened out from an investment universe due totheir involvement in controversial activities or selected due to strong ESG performance against
sector peers. However, both approaches reduce the investable universe and have proven to bechallenging for the largest asset owners, often referred to as universal owners, whose
portfolios span the entire equity market. Additionally, approaches that exclude companies
altogether may preclude opportunities to engage or incentivize progress.
In this paper, we examine a potential strategy to ESG tilting designed to target companies
demonstrating both a robust ESG profile and a positive ESG trend while maintaining minimal
exclusions. Such a strategy can be illustrated by the MSCI ESG Universal Index. We start bydefining an investable universe minus a core set of exclusions that include involvement incontroversial weapons and violations of international norms. We then utilize both static anddynamic ESG performance indicators to weight the remaining stocks in a way that preserves
diversification and balances the concerns of universal owners.
Our findings highlight that the MSCI ESG Universal Index, which is designed to represent thereturns of this strategy, demonstrated an annualized outperformance of 20 bps and a risk
reduction of 30 bps compared to the parent MSCI ACWI Index for the period ranging from
November 2009 to July 2016 while exhibiting a low tracking error with minimum sector and1
country bets using back-tested data . The index demonstrated a significantly higher ESG profile
overall and across each of the three environmental, social and governance pillars. Finally, thecarbon footprint of the index was reduced by 14%.

1

Simulated or back-tested data is not indicative of current or future returns, which may differ materially. Please see
the disclosures related to back-tested and simulated data at the end of this paper.

FEBRUARY 2017

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

As more investors integrate ESG into their investment process globally, such an index could
potentially be used by asset owners as they determine their strategic asset allocations orimplement their ESG investment strategies.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 4 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

SECTION 1: UNDERSTANDING THE MOTIVATIONS, OBJECTIVESAND CONSTRAINTS OF ESG INVESTINGUNDERSTANDING INVESTOR MOTIVATIONSInstitutional investors are increasingly looking for ways to account for ESG signals in theirinvestment decision-making process. The rise in the number of Principles for Responsible
Investment (PRI) signatories moving from less than 200 (accounting for less than US$ 10
2trillion) in 2006 to more than 1500 (representing more than US$ 60 trillion) in April 2016 is astrong evidence of the trend towards higher ESG awareness.
Institutional investors often pursue different objectives when addressing global environmental
and social issues, including enhancing long-term returns, generating positive societal impact
and/or aligning their investment with their beliefs.

2

Integration: there is growing research regarding the materiality of ESG in particular3
when focused on industry-relevant issues. Investors are increasingly using ESG
factors as a way to minimize long-term risks and/or to achieve long-term financial
outperformance.

Values: some investors may decide to consider ESG issues as a way to align theirinvestments with their ethical or political believes. They typically use exclusionary
approaches that screen out controversial activities such as tobacco, weapons, alcoholor gambling from their investment universe.

Impact: increasingly investors are contributing to the UN Sustainable Development
Goals and generating positive impact through their investments. They may decide to
direct capital toward companies that can provide solutions to environmental and/or
social challenges and generate positive measurable/quantifiable impact alongside
financial returns.

UNPRI, PRI Brochure 20163

Khan, Serafeim & Yoon 2015. ‘Corporate Sustainability: First Evidence on Materiality’ Harvard Business School
Working Paper No. 15-073. Gunnar Friede, Timo Busch, and Alexander Bassen, ESG and financial performance:
aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 2015.
Richard Hitchens, Sandra McCullagh, and Chris Parks, Finding Alpha in ESG, Credit Suisse. ESG- α Series, 19 June 2015.
Northern Trust, Doing Good and Doing Well – How Quality Can Enhance Your ESG Strategy, 2014

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 5 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

Figure 1 –MSCI ESG Index Research Framework

Source: MSCI ESG Research
Mounting literature suggests that macro societal and environmental trends – ranging fromclimate change and rising sea levels to social inequality and demographic shifts – pose
4
potentially overlooked risks for long-term institutional investors . Traditionally, such risks were5
considered exogenous, but for the universal long term investor, all risks could be consideredendogenous in their portfolios. Whether tied to the negative impact of environmental
externalities or the social costs of aggressive corporate tax avoidance, we observe a growing
awareness that a long-term institutional investor cannot always afford to take short-term gains

4

See for example Investment Leaders Group. 2016. ”Taking the Long View: A Toolkit for Long-Term Sustainable
Investment Mandate; Focusing Capital on the Long Term.” 2015. ”Long Term Portfolio Guide”; Center for International
Finance and Regulation Research Working Paper Series. 2014. ”Benefits (and Pitfalls) of Long Term Investing,” ”LongTerm Investing: What Determines Investment Horizon?”
5

A Universal Owner is defined as a long‐term owner of a diversified investment portfolio that is spread across theentire market or markets. As a result, Universal Owners collectively own a share of the economy and are effectively
tied into this share in the longer term. They depend on the global markets to produce economic growth on asustainable basis and thus manage their longer-term risk through asset allocation and active ownership practices.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 6 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017at the expense of long term costs to the economic system as a whole – they essentially own
both outcomes.
As a result, there may be increasing value for institutional investors in not only understanding
their exposure to ESG headwinds and tailwinds, but also gauging how portfolio companies
strategically place themselves to innovate, adapt, or see their business model go extinct. As
ESG investment guidelines become more commonplace among asset owners in general, and as
many continue to build capabilities in engagement and risk management, we have seen a small
but growing set of institutional investors focus on long-termism by adopting investment
6
strategies that explicitly build in their holistic views of the future.
This paper focuses on the ESG Integration approach and provides an example of a strategy thataims to enhance exposure to those companies demonstrating both a robust ESG profile and apositive ESG trend while maintaining a broad and diversified investment universe.

KEY CONSIDERATIONS FOR ESG INVESTING
Institutional investors across regions typically differ in their investment beliefs, objectives andconstraints when it comes to addressing ESG. However, we see some areas of convergenceamong those that are most advanced in articulating their approach to ESG investing:

Incorporating ESG factors into investment decisions: several institutional investors
explicitly consider ESG factors in their decisions to buy, sell, overweight, or
underweight securities. This may include divesting from companies whose long-term
7
ESG risk profile is considered intolerable, prioritizing investments in ESG leaders and8companies demonstrating improvements, or favoring investments that create long9
term sustainable value. Rarely do such approaches apply a uniform minimum
standard, rather they tend to favor a more nuanced weighting of ESG factors
alongside financial considerations.



Exercise influence over companies as an active owner: many institutional investors
actively engage in dialogue with companies to enhance long-term value. This may
include targeted unilateral engagement, collaborative engagement with other asset
owners, or informed proxy voting. Exclusionary approaches to ESG investing may

6

See for example, AP4 Low Carbon Strategy, http://www.ap4.se/en/2016/6/ap4-announces-today-a-continuedaction-in-decarbonizing-its-equity-portfolio
7

See for example, Norges Bank exclusion approach, https://www.nbim.no/en/responsibility/exclusion-of-companies/

8

See for example, ABP, https://www.abp.nl/images/responsible-investment-report-2015.pdf

9

See for example, CalPERS, https://www.calpers.ca.gov/page/investments/governance/sustainable-investing© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 7 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

prove challenging to investors focused on engagement, as they may prefer to retain
ownership and use their influence as shareholders to encourage improvements.
Uphold international norms, laws and regulations: divestment policies or exclusion
lists are common among large institutional investors. While adoption of specificscreens may vary (e.g. tobacco, coal, or faith-based divestments), we see someconvergence around divestment from companies that are in breach of global norms
and regulations. This includes product-based divestment – e.g. companies involved in
the production of controversial weapons (cluster munitions, landmines, biological andchemical weapons) – as well as conduct-based divestment – e.g. companies in breachof global norms and standards around human rights, labor rights, the environment,
and corruption.



Demonstrate leadership to promote responsible investment: finally, leading
institutional investors may aim to influence others by setting standards, promoting
collaboration, seeding ESG-informed investment strategies, or publicizing theirinvestment policies and beliefs. In other words, market signaling is an important
objective in its own right, driving an increasing number of institutional investors to
10
consider shifting to ESG-informed policy benchmarks.

Institutional investors also typically balance these objectives against some common
constraints:


Short-term risk: institutional investors may have a different appetite towards shortterm risks and their willingness to deviate from the market benchmark. How muchtracking error they are willing to bear can be a major factor in determining how togain exposure to companies with a robust ESG profile.

Diversification: many large institutional investors consider themselves as universal
owners and are looking for a broad and diversified universe to invest in. Constraints
relating to size and liquidity may be a key component to consider while integrating
ESG.



Reputational risk: investors may face pressure from stakeholders that may affecttheir approaches towards ESG. Minimizing reputational risks associated with
controversial investments may be an important driver for institutional investors.

10

See for example, AP4 Low Carbon Strategy, http://www.ap4.se/en/2016/6/ap4-announces-today-a-continuedaction-in-decarbonizing-its-equity-portfolio© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 8 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

IDENTIFYING THE CHALLENGES OF ESG INTEGRATION FOR UNIVERSALOWNERSHistorically, ESG integration index strategies have either relied on exclusionary approaches
whereby controversial activities and companies would be screened out from an investment
opportunity set, or else selection approaches whereby only the above-average or best-in-classcompanies on ESG criteria would be included. As a result of these approaches, the investment
universe could easily be reduced by more than half. However, for large asset owners whose
portfolios tend to include the entire equity market, these types of strategies may be too
narrow. Additionally, exclusionary approaches tend to focus on the negative impact ofcompanies while increasingly investors we consulted with expressed interest in focusing on thepositives and incentivizing progress.
An alternate approach to enhancing exposure to good ESG performers would be to
strategically tilt the weight of securities with a high ESG rating and upward trend while
maintaining minimal exclusions. Relying on re-weighting techniques rather than exclusion or
selection allows for investment in a broad and diversified universe that is suitable for universal
owners. In addition, re-weighting keeps the door open for engagement with poor ESG
performers.
Typically, ESG investment strategies rely on companies’ current ESG profiles and often fail toreward companies for making progress. Complementing the static ESG profile metric with one
that measures ESG momentum may enable investors to incentivize companies that have
improved their ESG profile. Further, several studies indicated that ESG momentum was
11
associated with financial outperformance, as highlighted in our recent research.

11

MSCI, “Can ESG add Alpha?”, 2015. MSCI, “Factor Investing and ESG Integration”, 2016

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 9 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

SECTION 2: CONSTRUCTING THE MSCI ESG UNIVERSAL INDEXIn the following section, we present an approach to constructing an index that aims to target
those companies demonstrating both a robust ESG profile and a positive ESG trend while
maintaining minimal exclusions. We illustrate such a strategy using the MSCI ESG Universal as apractical example.
The approach relies on three steps. First, we identify the worst ESG performers, thosecompanies that are likely not acceptable for institutional ESG investors to invest in as a bareminimum. Second, we define a set of simple and transparent metrics aimed at maintaining arobust current ESG profile and a positive trend. Third, we re-weight securities using a
12
combined ESG score to create the MSCI ESG Universal Index.

DEFINING A MINIMAL COMMON CORE AMONG INSTITUTIONAL INVESTORSFOR EXCLUSIONS
Investors typically vary in their definition of unacceptable investments. Some may consider
excluding companies because of their ethical beliefs while others might focus on excluding
companies to avoid reputational risks. In an attempt to limit the number of exclusions, we
focused on identifying a common core among institutional investors for exclusion, which
includes involvement in controversial weapons and violations of international norms. Other
exclusions such as tobacco, alcohol or poorly ESG rated companies (i.e. rating of CCC by MSCI13
ESG Research) were considered and discussed during a consultation with market participants
but not implemented due to a lack of consensus among consultees.
The following exclusions were considered:Controversial weapons: companies with involvement in landmines, cluster munitions,depleted uranium and biological and chemical weapons were excluded from theprospective index universe. In the MSCI ACWI Index, there were seven companies
involved in controversial weapons accounting for 0.57% weight as of September 2016.

12

For more details on the methodology, please refer to “MSCI ESG Universal Index Methodology:
https://www.msci.com/index-methodology
13

For more details on the MSCI ESG Rating methodology, please refer tohttps://www.msci.com/eqb/methodology/meth_docs/Executive_Summary_MSCI_ESG_Ratings_Methodology.pdf© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 10 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

Figure 2 - Companies involved in controversial weapons
Company

Type of involvement

THE BOEING COMPANY•

Cluster Munitions

LOCKHEED MARTIN CORPORATION•

Cluster Munitions

GENERAL DYNAMICS CORPORATION

•
•
•
•
•

Cluster Munitions
Depleted Uranium
Cluster Munitions
Landmines
Cluster Munitions•••

Cluster Munitions
Landmines
Cluster Munitions

HANWHA CORPLARSEN AND TOUBRO LIMITEDTEXTRON INC.
KOREA AEROSPACE INDUSTRIES, LTD.

Source: MSCI ESG Research as of September 2016
International norms: companies having been found in violation of international
norms (i.e. having faced very severe controversies pertaining to ESG issues) in the past
14
three years were excluded. In the MSCI ACWI Index, as of September 2016, there
were 35 securities that faced very severe ESG related controversies accounting for2.55% of the index weight.

Figure 3 – Examples of companies having faced very severe ESG controversies in the past
three years
Name

SectorControversy Type

SEVERSTAL' PAO
BHP BILLITON PLC
SOUTHERN COPPER CORPORATIONROYAL DUTCH SHELL PLC
WAL-MART STORES, INC.
SOCIETE AURIFERE BARRICKBP P.L.C.
VOLKSWAGEN AKTIENGESELLSCHAFTMONSANTO COMPANYPETROCHINA COMPANY LIMITED

Materials
Materials
Materials
EnergyConsumer Staples
Materials
EnergyConsumer Discretionary
Materials
EnergyLabor Rights
Environment & Human Rights
Labor Rights
Environment
Governance & Labor Rights
Human Rights
Environment & Human Rights
Environment & Governance
Environment
GovernanceSource: MSCI ESG Research as of September 2016

14

International norms include the Universal Declaration of Human Rights, the ILO Declaration on Fundamental
Principles and Rights at Work, and the UN Global Compact. For more information on the definition of controversies,
please refer to https://www.msci.com/documents/10199/acbe7c8a-a4e4-49de-9cf8-5e957245b86b© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 11 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

TILTING SECURITIES’ WEIGHTIn an attempt to increase the index’s exposure to high ESG performers we decided to moveaway from a free float market cap weighted index and tilt securities’ weights based on both
ESG rating and ESG trend. The rationale for using both signals combined was to maximize theweight of those companies maintaining a strong current ESG profile and having improved their
ESG performance.
 ESG rating: using MSCI ESG Ratings, which measures the ability of an issuer to manage
key medium- to long-term risks and opportunities arising from ESG factors relative toindustry peers, we assign an ESG score to each company in the parent universe.
o Leaders (AAA and AA) = 2
o Neutral(A, BBB, BB) = 1
o Laggards(B and CCC) = 0.75
 ESG trend: using MSCI ESG Trend, which indicates the ESG rating change from priorperiod to current, we assign an ESG trend score to each company in the parent
universe.
o Positive Trend = 1.25
o Flat Trend = 1
o Negative Trend = 0.75
 Combined ESG score: combining both ESG rating and ESG trend we assign an ESG
score to each company: ESG combined score = ESG rating score * ESG trend score. The
combined ESG Score is winsorized between 2 and 0.5. Winsorization is required toprevent drop in weight of a AAA rated company and increase in weight of a CCC
rated company. For example –o If the ESG Rating of the company changes from B to A then company’s
Combined ESG score = 1 ( for ESG rating of A) * 1.25 ( for Positive Trend ) =1.25.
o If the ESG Rating of the company stays stable at B then company’s combined
ESG score = 0.75 ( for ESG rating of A) * 1 ( for Flat Trend ) = 0.75.
o If the ESG Rating of the company changes from AA to AAA then company’s
combined ESG score = 2 ( for ESG rating of AA) * 1.25 ( for Positive Trend ) =2.5. Since the Combined ESG score is greater than 2.5, it is winsorized to 2.
In an attempt to fully represent the effect of ESG signals, we decided not to include any
constraint on sector, country or region weights. Nor did we apply optimization techniques tomaintain a low tracking error to the parent index.

INDEX CHARACTERICTICS
Overall, the resulting MSCI ESG Universal Index demonstrated superior risk/returns
characteristics within a reasonable tracking error during the back tested time period of Nov.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 12 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 20172009 through Sept. 2016. At the same time, it demonstrated notable improvement in the ESG
profile relative to the parent benchmark. The MSCI ESG Universal Index is an example of anindex that can be used by large asset owners at a policy level for the purpose of strategic asset
allocation or at an investment strategy implementation level in accordance with their ESG
integration goals.
In figure 4, we show using back tested data that the MSCI ESG Universal Index outperformed
15
the MSCI ACWI Index by 20 bps per annum over a seven year period . The MSCI ESG Universal
Index also outperformed the MSCI ACWI Index on risk-adjusted basis with an Information Ratioof 0.17 during that same period. The active exposures on factors, countries and sectors
contributed to the overall outperformance of the MSCI ESG Universal Index while remaining of
16
modest magnitude.
Figure 4 - Performance of MSCI ACWI ESG Universal Simulated History Index
Key Metrics
MSCI ACWI Index

MSCI ACWI ESG
Universal Index

8.1
14.1
0.58
0.56
0.0
0.0
NaN
1.00
2447
2.1
1.9
16.3
2.6

8.3
13.9
0.60
0.58
0.2
1.0
0.17
0.98
1849
9.4
2.0
16.4
2.7

Total Return* (%)
Total Risk (%)
Return/Risk
Sharpe Ratio
Active Return (%)
Tracking Error (%)
Information Ratio
Historical Beta
No of Stocks***
Turnover** (%)
Price To Book***Price to Earnings***
Dividend Yield*** (%)
Period: 30-Nov-2009 to 30-Sep-2016* Gross returns annualized in USD** Annualized one-way index turnover over index reviews since 26th Nov 2014*** Monthly averages
The definitions of all statistical parameters are available in the Appendix

Source: MSCI
15

Reference period is limited by data availability for certain ESG metrics.

16

This analysis used back tested data. Back-tested performance is not actual performance, but is hypothetical. There
are frequently material differences between back tested performance results and actual results subsequently achievedby any investment strategy. Such results are not indicative of future results or performance, which may also differ
materially. Please see the disclosures at the end of this paper related to back tested or simulated data.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 13 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

Figure 5 - Relative Performance of MSCI ACWI ESG Universal Index vs. MSCI ACWI Index

Source: MSCI

Overall, the ESG Universal Index retained the style characteristics of the MSCI ACWI Index. The
active style factor exposures are very small (smaller than +/-0.1 standard deviations). While
the active factor exposures are small, we can see in figure 6 that when analyzed under MSCIGEMLT model, the MSCI ESG Universal Index was over weighted on ‘Profitability’, ‘Investment
Quality’ and underweight on ‘Earning Variability’. The MSCI ESG Universal Index was also lessweighted in volatile stocks (under weighted on Residual Volatility) compared to the MSCI ACWI
Index (underweight on Residual Volatility). We can see in figure 8 that both exposures i.e.,
overweight on quality factors and underweight on volatile stocks contributed positively to theoutperformance of MSCI ESG Universal Index.
17

In terms of sector exposures, except in the case of the GICS® Energy Sector, the MSCI ESG
Universal Index’s maintained very similar exposure compared to the MSCI ACWI Index (figure6). Since the MSCI ESG Rating is a sector relative metric, sector exposures were maintained
after reweighting of constituents.
In terms of geographical exposure (figure 7), the size of active exposures were more
pronounced. The MSCI ESG Universal Index was underweight in MSCI Emerging Markets (EM)17

The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI andStandard & Poor’s. “Global Industry Classification Standard (GICS)” is a service mark of MSCI and Standard & Poor’s.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 14 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017securities before 2012 since a large proportion of companies in the MSCI EM Index were notincluded in MSCI ESG Rating coverage universe. The overall weight of EM stocks increased in
the MSCI ESG Universal Index from June 2012 through September 2016. The active exposure tocountries was relatively small; the MSCI ESG Universal Index maintained small overweight inUnited Kingdom securities and underweight in USA securities.
Figure 6 - Relative Style and Industry Exposure of ESG Universal Index Dec 2009 – Sept. 2016

Source: MSCI
Figure 7 - Relative Region and Country Exposure of the MSCI ESG Universal Index

Source: MSCI

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 15 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

Figure 8 - Performance Attribution of MSCI ESG Universal Index under MSCI GEM LT Model

Index:
Period:MSCI ACWI ESG Universal Index
30-Nov-2009 to 30-Sep-2016

Annualized Gross Returns

Total
Return (%)
Risk (% Std Dev)

8.33
13.89

BenchmarkActive

8.15
14.07

0.17
1.00

Currency
Selection

Cash
EquityActiveEquityTrading

Transaction
Cost

-0.34
0.37

0
0

0.52
0.91

N/A
N/A

N/A
N/A

Explicit
Currency

Implicit
Currency

World
EquityCountries

Industries

Risk Indices

Asset
Selection

0
0

-0.34
0.37

0.00
0.00

0.27
0.55

0.27
0.34

0.21
0.37

-0.23
0.52

BtoP

Earn. Yield

Size

Mid Cap

Momentum

LT Reversal

Beta

Res. Vol.

-0.05
0.06

0.00
0.03

-0.05
0.09

-0.03
0.05

-0.05
0.08

0.00
0.03

-0.04
0.21

0.18
0.12

Leverage

Earn. Qlty

Inv. Qlty

Profitability

Earn. Var.

Div. Yield

GrowthLiquidity

-0.01
0.02

0.00
0.01

0.05
0.03

0.06
0.05

0.06
0.06

0.04
0.04

0.00
0.01

0.06
0.05

Source: MSCI
From an ESG perspective, the MSCI ESG Universal Index demonstrated an enhanced ESG
profile compared to the MSCI ACWI Index as of September 30, 2016:

Higher exposure in ESG leaders: MSCI ESG Universal Index included 36.7% of ESG
leaders as opposed to 20.8% in the MSCI ACWI Index. In addition, the MSCI ESG
Universal Index demonstrated better performance on each of the underlying E, S and
G pillars.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 16 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

Figure 9 – ESG Performance Comparison, MSCI ACWI vs. MSCI ESG Universal, Sept 30th, 2016

Source: MSCIHigher exposure to companies with a positive ESG trend: MSCI ESG Universal Index
included 20.8% of upgrade as opposed to 18.1 % in the MSCI ACWI Index. It was alsoless exposed to companies that experienced an ESG downgrade, which accounted for
8.3% of the MSCI ESG Universal index vs 10.3% for the MSCI ACWI Index.

No exposure to ESG worst performers as defined by involvement in controversial
weapons and companies in breach of international norms.



Lower carbon footprint: MSCI ESG Universal Index was 14% less carbon intensive that
the MSCI ACWI Index.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 17 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

CONCLUSION
As institutional investors search for ways to account for ESG issues in their investment
decision-making process as a way to enhance long-term returns, mitigate long-term risks, oradvance societal objectives, many large asset owners may look to enhance their exposure to
ESG while maintaining a broad and diversified universe in which to invest. In this paper, weoutlined an approach to increase exposure to high ESG performers while maintaining minimal
exclusions.
We defined an index methodology that aims first to identify the minimal core for exclusion
among investors and second, tilt the weight of companies demonstrating leading ESG practices
and positive ESG momentum. The resulting Index demonstrated superior risk/returns
characteristics with a reasonable tracking error using back tested data during a seven year
period. It also demonstrated higher ESG scores both overall and on each E, S and G pillar.
As more investors look to integrate ESG considerations into their investment decisions, newapproaches that thoughtfully balance both short- and long-term ESG and financial
considerations can help make ESG investment strategies more appealing to a broader andincreasingly mainstream audience.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 18 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017CONTACT US
esgclientservice@msci.com

AMERICASABOUT MSCI ESG RESEARCH PRODUCTS ANDSERVICES+ 1 212 804 5299
EUROPE, MIDDLE EAST & AFRICA+ 44 20 7618 2510
ASIA PACIFIC+ 612 9033 9339

MSCI ESG Research products and services areprovided by MSCI ESG Research LLC., and aredesigned to provide in-depth research, ratings
and analysis of environmental, social andgovernance-related business practices tocompanies worldwide. ESG ratings, data andanalysis from MSCI ESG Research LLC. are also
used in the construction of the MSCI ESG
Indexes. MSCI ESG Research LLC. is a
Registered Investment Adviser under theInvestment Advisers Act of 1940 and a
subsidiary of MSCI Inc.

ABOUT MSCIFor more than 40 years, MSCI’s researchbased indexes and analytics have helped theworld’s leading investors build and manage
better portfolios. Clients rely on our offerings
for deeper insights into the drivers of
performance and risk in their portfolios, broad
asset class coverage and innovative research.
Our line of products and services includes
indexes, analytical models, data, real estatebenchmarks and ESG research.
MSCI serves 98 of the top 100 largest money
managers, according to the most recent P&I
ranking.
For more information, visit us atwww.msci.com.

© 2017 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document.

MSCI.COM | PAGE 19 OF 20

KEEP IT BROAD: AN APPROACH TO ESG STRATEGIC TILTING | FEBRUARY 2017

NOTICE ANDDISCLAIMER

This document and all of the information contained in it, including without limitation all text, data, graphs, charts (collectively, the “Information”) is
the property of MSCI Inc. or its subsidiaries (collectively, “MSCI”), or MSCI’s licensors, direct or indirect suppliers or any third party involved in making
or compiling any Information (collectively, with MSCI, the “Information Providers”) and is provided for informational purposes only. The Information
may not be modified, reverse-engineered, reproduced or redisseminated in whole or in part without prior written permission from MSCI.
The Information may not be used to create derivative works or to verify or correct other data or information. For example (but without limitation),the Information may not be used to create indexes, databases, risk models, analytics, software, or in connection with the issuing, offering,sponsoring, managing or marketing of any securities, portfolios, financial products or other investment vehicles utilizing or based on, linked to,
tracking or otherwise derived from the Information or any other MSCI data, information, products or services.
The user of the Information assumes the entire risk of any use it may make or permit to be made of the Information. NONE OF THE INFORMATIONPROVIDERS MAKES ANY EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO THE INFORMATION (OR THE RESULTS TO BE
OBTAINED BY THE USE THEREOF), AND TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, EACH INFORMATION PROVIDER EXPRESSLYDISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS,NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH RESPECT TO ANY OF THE
INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by applicable law, in no event shall any Information Provider have any
liability regarding any of the Information for any direct, indirect, special, punitive, consequential (including lost profits) or any other damages even if
notified of the possibility of such damages. The foregoing shall not exclude or limit any liability that may not by applicable law be excluded or limited,
including without limitation (as applicable), any liability for death or personal injury to the extent that such injury results from the negligence orwillful default of itself, its servants, agents or sub-contractors.
Information containing any historical information, data or analysis should not be taken as an indication or guarantee of any future performance,
analysis, forecast or prediction. Past performance does not guarantee future results.
The Information should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees,
advisors and/or clients when making investment and other business decisions. All Information is impersonal and not tailored to the needs of any
person, entity or group of persons.
None of the Information constitutes an offer to sell (or a solicitation of an offer to buy), any security, financial product or other investment vehicle or
any trading strategy.
It is not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only
available through third party investable instruments (if any) based on that index. MSCI does not issue, sponsor, endorse, market, offer, review orotherwise express any opinion regarding any fund, ETF, derivative or other security, investment, financial product or trading strategy that is based on,linked to or seeks to provide an investment return related to the performance of any MSCI index (collectively, “Index Linked Investments”). MSCI
makes no assurance that any Index Linked Investments will accurately track index performance or provide positive investment returns. MSCI Inc. is
not an investment adviser or fiduciary and MSCI makes no representation regarding the advisability of investing in any Index Linked Investments.
Index returns do not represent the results of actual trading of investible assets/securities. MSCI maintains and calculates indexes, but does not
manage actual assets. Index returns do not reflect payment of any sales charges or fees an investor may pay to purchase the securities underlying theindex or Index Linked Investments. The imposition of these fees and charges would cause the performance of an Index Linked Investment to bedifferent than the MSCI index performance.
The Information may contain back tested data. Back-tested performance is not actual performance, but is hypothetical. There are frequently material
differences between back tested performance results and actual results subsequently achieved by any investment strategy.
Constituents of MSCI equity indexes are listed companies, which are included in or excluded from the indexes according to the application of therelevant index methodologies. Accordingly, constituents in MSCI equity indexes may include MSCI Inc., clients of MSCI or suppliers to MSCI. Inclusionof a security within an MSCI index is not a recommendation by MSCI to buy, sell, or hold such security, nor is it considered to be investment advice.
Data and information produced by various affiliates of MSCI Inc., including MSCI ESG Research Inc. and Barra LLC, may be used in calculating certain
MSCI indexes. More information can be found in the relevant index methodologies on www.msci.com.
MSCI receives compensation in connection with licensing its indexes to third parties. MSCI Inc.’s revenue includes fees based on assets in Index
Linked Investments. Information can be found in MSCI Inc.’s company filings on the Investor Relations section of www.msci.com.
MSCI ESG Research LLc. is a Registered Investment Adviser under the Investment Advisers Act of 1940 and a subsidiary of MSCI Inc. Except withrespect to any applicable products or services from MSCI ESG Research, neither MSCI nor any of its products or services recommends, endorses,
approves or otherwise expresses any opinion regarding any issuer, securities, financial products or instruments or trading strategies and MSCI’s
products or services are not intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment
decision and may not be relied on as such. Issuers mentioned or included in any MSCI ESG Research materials may include MSCI Inc., clients of MSCI
or suppliers to MSCI, and may also purchase research or other products or services from MSCI ESG Research. MSCI ESG Research materials, including
materials utilized in any MSCI ESG Indexes or other products, have not been submitted to, nor received approval from, the United States Securities
and Exchange Commission or any other regulatory body.
Any use of or access to products, services or information of MSCI requires a license from MSCI. MSCI, Barra, RiskMetrics, IPD, FEA, InvestorForce, andother MSCI brands and product names are the trademarks, service marks, or registered trademarks of MSCI or its subsidiaries in the United Statesand other jurisdictions. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and Standard &Poor’s. “Global Industry Classification Standard (GICS)” is a service mark of MSCI and Standard & Poor’s.

© 2015 MSCI Inc. All rights reserved.

MSCI.COM | PAGE 20 OF 20