ESG index fund composition subjectivity

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jsaver
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ESG index fund composition subjectivity

Post by jsaver » Wed Sep 11, 2019 1:55 pm

My wife and I own two ESG funds. I know most Bogleheads aren’t fans of these funds. I realize owning these funds may leave us with less money in the future to do good with. I'm just sharing something I learned looking into these funds with regards to their different composition and why this is.

Okay, so the funds we own:

1. Fidelity International Sustainability Index Fund (FNIDX) which "seeks to provide investment results that correspond to the total return of the MSCI ACWI (All Country World Index) ex USA ESG Index."

2. Vanguard ESG International Stock ETF (VSGX) which "seeks to track the performance of the FTSE Global All Cap ex US Choice Index."

One thing that jumped out at me right away is some notable differences in composition between the funds. For example, FNIDX holds Total S.A. while VSGX does not, and conversely, VSGX holds Nestlé S.A., while FNIDX does not. I wanted to know why.

About the indexes:
The MSCI ESG Leaders Indexes are constructed by applying a Best‐in‐Class selection process to companies in the regional indexes that make up MSCI ACWI, a global equity index consisting of developed and emerging market countries. The ESG Leaders Indexes target sector and region weights consistent with those of the underlying indexes to limit the systematic risk introduced by the ESG selection process. The methodology aims to include securities of companies with the highest ESG ratings representing 50% of the market capitalization in each sector and region of the parent Index. Companies that are not existing constituents of the ESG Leaders Indexes must have an MSCI ESG Rating of 'BB' or above and the MSCI ESG Controversies Score of 3 or above to be eligible. In addition, companies showing involvement in alcohol, gambling, tobacco, nuclear power and weapons are excluded from the Indexes. The selection universe for the ESG Leaders Indexes is the constituents of the MSCI Global Investable Market Indexes.

-- MSCI ACWI EX USA ESG LEADERS INDEX (USD) pdf.
and
The FTSE Global All Cap ex US Choice Index excludes stocks of companies that FTSE Group determines engage in the following activities: (i) companies that produce adult entertainment; (ii) companies that produce alcoholic beverages; (iii) companies that produce tobacco products; (iv) companies that (a) produce or (b) produce specific and critical parts or services for, nuclear weapon systems, chemical or biological weapons, cluster munitions, and anti-personnel mines; (v) companies that produce other weapons for military use; (vi) companies that produce firearms or ammunition for non-military use; (vii) companies that own proved or probable reserves in coal, oil, or gas; (viii) companies that provide gambling services; and (ix) companies that generate revenues from nuclear power production or related activities (including equipment, construction, and uranium). The index methodology also excludes the stocks of companies that, as FTSE Group determines, do not meet the labor, human rights, environmental, and anticorruption standards as defined by the United Nations Global Compact Principles, as well as companies that do not meet certain diversity criteria.

-- VSGX prospectus.
So Total S.A. isn't part of VSGX because its index excludes petroleum companies. That's pretty objective. The two indices simply have some differences in the categories of companies they objectively exclude.

But why is Nestlé S.A. missing from FNIDX? Since it's not among any of its index's excluded categories, it must be due to the ESG rating/score.This is where things get very subjective and squishy. I found this evaluation by MSCI of Nestlé S.A:
Nestle S.A. is involved in controversies related to its Labor Rights, Customers, Environment and Human Rights impacts. It faces significant concerns related to Supply Chain Labor Standards, Child Labor, Anticompetitive Practices, Marketing & Advertising, and Water Stress.

-- https://www.smart-und-fair-fonds.de/med ... ort_3_.pdf
Other than this PDF mirrored on a random German web site, I can't find anything specific to Nestlé's (or any other company's for that matter) MSCI ESG score. There's plenty of methodology papers on the MSCI site about how the ESG index is derived, but the raw data feeding the index is publicly unavailable. I can imagine why this is, but it doesn't make the MSCI ESG rating very transparent.

Meanwhile, the FTSE ESG index appears to be less squishy than the MSCI ETF index since it doesn't use these arbitrary scores, but rather companies that do not meet "standards as defined by the United Nations Global Compact Principles."

I'm not thrilled by the subjective aspect of ESG investing in FNIDX. I'd like access to the MSCI ESG scores and raw data as an investor in FNIDX. But it is what it is. At the end of the day, we own a very small bit less Nestlé and Total than we otherwise would.

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nisiprius
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Re: ESG index fund composition subjectivity

Post by nisiprius » Wed Sep 11, 2019 8:24 pm

Don't forget to consider what, if anything, the index providers and/or the mutual fund managers are doing in order to try to influence corporate behavior. Typically, they try to talk to corporate management--tell them what they could do to get included in the index, for example, and sell them on the idea of doing what's necessary for inclusion.
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pdavi21
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Re: ESG index fund composition subjectivity

Post by pdavi21 » Wed Sep 11, 2019 8:39 pm

Nestle got African babies hooked on baby formula. Not sure if people are still mad about that or not though.

I wouldn't say that Bogleheads dislike ESG funds. I would more say many believe they are less than optimal because they are slightly actively managed. Really they probably are pretty close to total market funds in performance.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

retiringwhen
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Re: ESG index fund composition subjectivity

Post by retiringwhen » Wed Sep 11, 2019 8:52 pm

This discussion is part of why I don't do ESG. The various funds and indices have some pretty esoteric ideas of what ESG entails and only slightly overlap with what I feel is important.

Much of the Goodness in the ESG model is around Corporate Governance. It is interesting to note that Vanguard takes an active approach in addressing Governance issues with ALL companies they have proxy voting rights in. Obviously they spend more time with some than others, but I believe it is interesting to note that they do it regardless of the ESG score of the company or their inclusion in the ESG indices.

Since I am a total market investor, the only way I tilt for ESG is to buy small amounts of companies I want to support or see succeed.

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jsaver
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Re: ESG index fund composition subjectivity

Post by jsaver » Wed Sep 11, 2019 9:03 pm

nisiprius wrote:
Wed Sep 11, 2019 8:24 pm
Don't forget to consider what, if anything, the index providers and/or the mutual fund managers are doing in order to try to influence corporate behavior. Typically, they try to talk to corporate management--tell them what they could do to get included in the index, for example, and sell them on the idea of doing what's necessary for inclusion.
If that influences corporate behavior for the better then that seems like a good thing. But how would I even know if it's not in the prospectus?

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jsaver
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Re: ESG index fund composition subjectivity

Post by jsaver » Wed Sep 11, 2019 9:13 pm

retiringwhen wrote:
Wed Sep 11, 2019 8:52 pm
This discussion is part of why I don't do ESG. The various funds and indices have some pretty esoteric ideas of what ESG entails and only slightly overlap with what I feel is important.

Much of the Goodness in the ESG model is around Corporate Governance. It is interesting to note that Vanguard takes an active approach in addressing Governance issues with ALL companies they have proxy voting rights in. Obviously they spend more time with some than others, but I believe it is interesting to note that they do it regardless of the ESG score of the company or their inclusion in the ESG indices.

Since I am a total market investor, the only way I tilt for ESG is to buy small amounts of companies I want to support or see succeed.
That's good to know about Vanguard.

What we ultimately decided is that both of these funds objectively exclude some sectors in which we're happy to reduce our ownership. They also both exclude some sectors we're neutral about. On the more subjective part of the two funds (the ESG ratings), both have false negatives (include companies we'd like to see excluded) but are less likely to have false positives (exclude companies that are doing good).

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