Mainstreaming ESG in the Australian Equities MarketMay 30, 2019
Australia, May. 30 2019 — The Australian listed equity market has two characteristics not to be overlooked when constructing a domestic index: its relatively small number of stocks and relatively large exposures to a few specific sectors. These factors alone often mean that the application of a specific indexing methodology can produce more pronounced effects compared with the equivalent approach being applied to a global universe.
Australian Listed Equities
- Number of Constituents
The S&P/ASX 200’s relatively low number of companies imply that each company has a larger-than-average weight in the index for a given size. Therefore, any exclusionary indexing approach could cause relatively larger levels of tracking error and index volatility compared with more diversified benchmarks.
This indeed turns out to be the case. The S&P 500 ESG Index—an index with more constituents of lower average index weights—had a marginally higher standard deviation than the benchmark over five years, at only 0.03%, compared with the S&P/ASX 200 ESG Index’s larger 0.23% margin (see Exhibit 1). The Australian benchmark also had a higher five-year tracking error than its U.S. counterpart.
Companies in the S&P ESG Indices are selected for inclusion, targeting 75% of the eligible universe’s weight, at the GICS® industry group level. However, by looking at the sector-level proportions of benchmark market caps covered in the ESG index compared with the 75% target, some sectors over- or undershoot the target by a significant margin.
These margins in all but two sectors are larger for the S&P/ASX 200 ESG Index than for the S&P 500 ESG Index, which may be expected given the relatively higher weights of the average stock in the Australian index. The marginal inclusion of comparatively smaller-weighted stocks, on average, would likely leave the final industry group market capitalization closer to the 75% target. The same result can also be expected when considering coverage at the sector level (see Exhibit 2).
- Sector Concentrations
Any index benchmarked to the S&P/ASX 200 would also be sensitive to how its methodology treats companies in the Financials (32.10%), Materials (18.12%), Health Care (8.40%), and Industrials (8.22%) sectors due to their significant weights.
The S&P/ASX 200 ESG Index’s sector weights differ slightly from their weights in the benchmark due to the exclusions made when defining the index’s eligible universe. The two largest sector weight differences are found within the Health Care and Financials sectors.
- In April 2019, Health Care had a 2.26% larger sector weight in the S&P/ASX 200 ESG Index compared with benchmark.
- In contrast, Financials was underweight in the S&P/ASX 200 ESG Index by 2.81 (see Exhibit 3).
The S&P/ASX 200 ESG Index – Index Performance
Despite some of the nuances of the Australian listed equities market described above, the S&P/ASX 200 ESG Index achieves its objective. The index…