An overview of the MSCI ESG Leaders Index
These indices are designed to track the performance of companies selected according to strict environmental, social and governance (ESG) criteria. The selection process excludes companies that are involved in certain controversial business activities or have low ESG ratings. For example, companies that generate their revenue from nuclear weapons, as well as tobacco and alcohol companies, are excluded.
The aim of the index construction is to remain as close as possible to the sector weights of the underlying index and to minimize tracking error while taking the sustainability aspect into account. Companies are mainly selected based on their ESG rating, the trend of this rating and their sector-adjusted ESG score.
The downside of a strong focus on sustainability
Supposedly an ideal solution? Supposedly, because the increased sustainability comes at the price of increased concentration risks.
A closer look at the MSCI World ESG Leaders Index shows that the top 10 stocks accounted for almost 30% of the index at the end of April - twice as much as in the underlying parent index. In the US sub-universe of the same index, even more than 40% of the index is concentrated in the largest ten stocks. Microsoft shares alone account for 12% of the MSCI USA ESG Leaders Index.
The risks of concentration
This heavy weighting of individual stocks leads to extremely high concentration risks. The performance of the index as a whole depends to a large extent on the price performance of these few companies. A drastic fall in the price of one of these heavyweights can have a significant negative impact on the overall performance of the index. This means that the diversification that many investors seek in order to spread their risks is not present here. A disproportionate influence of individual companies can result in the index being very volatile and reacting more strongly to specific corporate events rather than being broadly diversified and stable.
In addition, this can lead to the index being less representative of the overall market and losing the benefits of broad market coverage. Investors who invest in the MSCI ESG Leaders Index may therefore inadvertently be taking a higher risk as they have to rely heavily on the performance of a few large companies.
An alternative: sustainable and risk-optimized
With our OLZ funds, we strive both to improve sustainability and to reduce concentration risks. We achieve this through targeted exclusions of non-sustainable stocks and optimization of sustainability metrics (e.g. ESG score or CO2 intensity), combined with our minimum variance approach. Our minimum variance approach aims to optimize the weighting of individual securities in the portfolio in such a way that the overall risk is minimized. This reduces the dependence on individual, heavily weighted securities, which leads to a more balanced and stable performance. This approach ensures better risk diversification and more consistent performance without neglecting sustainability.
Conclusion
At first glance, the MSCI ESG Leaders Index may appear to be a tempting option for sustainable investments. However, the high concentration risks should not be underestimated. For investors looking for both sustainability and systematic risk optimization, funds such as those from OLZ offer a more balanced alternative.
