An index integrating environmental, social and governance (ESG) screens has been announced by Northern Trust, allowing investors in emerging markets to 'filter out' companies with less satisfactory criteria.
Northern Trust partnered with MSCI ESG Research's and Institutional Shareholder Services' (ISS) ESG screens to create the MSCI Emerging Markets Custom ESG Index. A pooled fund passively managed to this index has also been launched.
Allocation by institutional investors to emerging markets has increased by 30 per cent in the last three years, according to research by EIRIS. Developed-world investors want to allocate more to emerging markets nations, which own 70 per cent of the world's currency reserves, according to Northern Trust.
However, investors are concerned emerging market companies lack "executive independence and scrutiny of management", said John Krieg, managing director for Northern Trust's asset management arm in Europe, the Middle East and Africa.
"This challenge led us to examine how we could develop a passive investment vehicle that could filter out companies with less satisfactory governance criteria, while still enabling access to emerging markets," he said.
Northern Trust says the index's four-step process involves screens being applied to the MSCI EM Index universe, followed by a sequence of checks on governance and executive independence.
Any constituents lacking sufficient independence across ownership, board representation, key corporate committees and audit and remuneration committees are filtered out, Northern Trust stated.
"Northern Trust's Emerging Markets Custom ESG Equity Index Fund offers investors a means of applying both common exclusion screens and a filter for the potential negative effects of such majority control, allowing investors access to this growing asset class whilst meeting their governance needs," Northern Trust said.
According to a 2012 Northern Trust study, 44 per cent of institutional investors incorporate ESG considerations into investment planning. This follows research from the Global Sustainable Investment Alliance, indicating 22 per cent of globally invested assets incorporate ESG criteria.
In addition, approximately $13.6 trillion of assets, 22 per cent of the available total, is now invested incorporating ESG principles, according to the Global Sustainable Investment Alliance 6 (GSIA).
"Research shows that good corporate governance matters and the addition of the governance screen should improve the quality of the companies in the index from an ESG perspective," said Thomas Kuh, executive director of MSCI ESG Indices.
Generally, the development and maintenance of human and corporate rights rises in line with a nation's wealth, Northern Trust says, so lower ESG standards should be expected in emerging markets.
"The question for foreign investors in emerging markets is how much they should demand greater ESG analysis today - either to ameliorate their investment strategy or comply with their governance policy," Northern Trust stated.
