The S&P500 is one of the oldest index funds around, and underlies many investment products. The index tracks the stock of 500 of the largest U.S. companies across industries. As demand for ESG screened investment products continues to grow, there’s now a new alternative index that excludes nuclear weapon producers, but only excluding controversial weapons from the mainstream indices can really be the answer.
To be eligible for inclusion in the standard S&P500 index, a company has to meet a set of quantitative criteria, such as a market cap of at least USD 5.3 billion. Factors like sector representation are also taken into account, as the index is meant to cover all industries. And that means all industries: for the S&P500 it doesn’t matter whether a company produces organic pineapples or nuclear weapons, as long as it meets the quantitative criteria that the index is based on.
But since May this year, it has a new sibling: the S&P500 ESG. This index follows and tries to replicate the results of the standard S&P500 closely, but incorporates a range of ESG factors evaluating companies to include. Most notably, companies that produce tobacco, companies not in compliance with the UN Global Compact, and companies that produce controversial weapon are excluded from the index.
This means that companies involved in cluster munitions, anti-personnel landmines, biological, chemical and nuclear weapons, depleted uranium weapons and white phosphorus weapons will not be included in the index.
The creation of the new S&P500 ESG (and a family of similar indices such as the S&P Europe 350 ESG) is a logical move. Financial institutions from around the world are increasingly looking to exclude producers of nuclear weapons and other inherently destructive sectors from their investments. The Don’t Bank on the Bomb reports alone show 63 financial institutions that have taken steps to that effect. But some financial institutions have indicated they find it difficult to also exclude controversial weapons from their index funds, and especially from third party index funds. The new S&P ESG index series will likely be widely used to build index-linked ESG products, and can also function as a benchmark for such products.
It’s just not good enough
However, the creation of dedicated ESG indices is not good enough, and will not completely answer to the growing demands from the financial sector for controversial weapons free products.
In February 2019, Swiss Sustainable Finance launched an open letter calling on global index providers to exclude controversial weapons from their mainstream indices “in order to align their products with what has become standard practice or expectation among institutional and individual investors”. The open letter was signed by more than 140 asset owners, managers and other financial institutions. It was sent to major index providers FTSE Russel, Morningstar, MSCI, STOXX and S&P Dow Jones Indices.
S&P responded to the open letter on IPE , saying that “its philosophy was to offer choice to investors”, a politely phrased No to the 140 signatories of the SSF open letter.
But as long as including nuclear weapons remains the mainstream option, S&P500 will continue to miss the mark. Because the 140 signatories were not asking for more separate ESG indices, but for controversial weapons to be excluded from the mainstream index options. For example, when asked for a response by IPE, the CEO of Danish pension provider PKA said “By joining forces with other investors around the globe we can hopefully get this message through and make index providers once and for all exclude controversial weapons from mainstream indices.”