Indices that integrate environmental, social, and governance (ESG) data are moving from the margins to the mainstream, as investors increasingly seek to align their values with their investments. A new type of ESG index is emerging to facilitate this change in Brazil: the S&P/B3 Brazil ESG Index. Jointly developed by S&P Dow Jones Indices (S&P DJI) and the Brazilian stock exchange (Brasil Bolsa Balcão [B3]), this index not only highlights strong ESG companies—as ESG indices have traditionally done—but it also enables allocation to such companies without requiring investors to take on major risks relative to the market.
THE EVOLUTION OF ESG INDICES
In 1999, S&P DJI launched the first global ESG index, the Dow Jones SustainabilityTM World Index (DJSI World). By including the top 10% of companies, industry by industry, according to their ESG performance, as determined by the Corporate Sustainability Assessment (CSA) conducted by SAM, part of S&P Global, this groundbreaking index encouraged companies to incorporate many ESG factors in their decisions, extending beyond short-term financial considerations.
In the years that followed, other indices, including regional versions of the DJSI World, such as the DJSI Emerging Markets, were launched with this same philosophy in mind: to highlight best-in-class companies and thereby inspire companies to improve their ESG approaches in order to qualify for inclusion in these indices.
Though these indices have been successful and have indeed inspired companies to change in positive ways, aspects of their methodologies present challenges for many investors. Some strategies can be too narrow for investors who want to remain broadly diversified. Though many high-conviction investors use the narrow, best-in-class indices for investment, we saw a need from market participants for ESG indices with returns more in line with the broader market, while providing a more sustainable portfolio of companies. An example of an index that launched in 2019 that typifies this investor-oriented methodology is the S&P 500® ESG Index.
With the launch of the S&P/B3 Brazil ESG Index, Brazil now has an investor-oriented ESG index of its own. This index maintains a large portion of the companies in its underlying index, the S&P Brazil BMI, thereby staying broad and diverse while still screening out companies involved in certain business activities and controversies, as well as those with sustainability profiles that run counter to ESG investors' preferences.
HOW THE INDEX WORKS
The philosophy behind the S&P/B3 Brazil ESG Index is to maintain broad market exposure while aligning with the values of sustainability-focused investors.
The first step is to exclude companies involved in certain business activites contrary to general ESG values. For companies involved in tobacco, controversial weapons, and thermal coal, certain maximum revenue thresholds are set, as defined in the index methodology. If a company generates revenue exceeding these thresholds, it will be excluded at the annual index rebalance that takes place the last business day of April each year. Companies with business practices out of alignment with the United Nations Global Compact (UNGC) are also excluded at the annual rebalance. The exclusion criteria used in Step 1 are provided by Sustainalytics.
Once these exclusions are implemented, an additional screen is applied: companies without S&P DJI ESG Scores are eliminated. Once this is done, the list of companies eligible for the sorting and selection process has been defined.
The remaining companies are then weighted by their ESG scores, subject to certain weighting constraints defined in the methodology. This way, while companies with poor ESG scores can be included, they are given a low weight in the index.