Legal & General Future World ESG Developed Index: June 2023 Update

How it fits in a portfolio

The Legal & General Future World ESG Developed Index fund is a good option for broad exposure to a range of large and medium-sized companies in developed markets, while being mindful of environmental, social and governance (ESG) issues. While the fund predominately invests in larger companies, it also invests in some smaller companies in line with the benchmark. These are usually subject to more extreme price movements, which can increase risk.

An index tracker fund is one of the simplest ways to invest, and we think this fund could be a low-cost starting point for a portfolio aiming to deliver long-term growth in a responsible way. It could also be a good addition to a portfolio of other responsible tracker funds.

Manager

Legal & General Investment Management (LGIM) has been running index tracker funds longer than most and is one of the largest providers of this type of fund. It also has one of the biggest index teams in the UK, which comprises of 25 fund managers who are supported by two analysts. This means it’s got the resources and expertise to track indices closely, and the scale to keep charges to a minimum.

Each equity index fund at LGIM has a primary and secondary manager, though in practice the entire team helps manage each fund. Alongside the wider team, Sacha Mirza is the primary manager responsible for this fund. Mirza joined LGIM in 2013 after previously working at UBS for 10 years and has significant index tracker fund management experience. The secondary manager for this fund is Robert Dowling who joined LGIM in 2010 after working for State Street Global Advisors as a fund manager, specialising in Asia-Pacific and global emerging markets.

Process

This fund aims to track the performance of the Solactive L&G Enhanced ESG Developed Index. It's made up of over 1400 companies across global developed markets, such as the US, Japan and the UK, and is diversified across lots of sectors, including technology, industrials and financials.

The team would preferably invest in every company in the index and in the same proportion. However, this is not always possible because it's difficult to buy and sell the smallest companies quickly or at low cost, which could ultimately impact performance. This is known as partial replication and helps to closely match the performance of the index.

The index increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay. If companies score poorly on these measures the index reduces exposure.

The advantage of reducing companies that score poorly, rather than selling their shares completely, is that because the team still own some shares, they can engage to help them improve. An increased investment in exchange for improvement on various factors is also a good incentive, so investors' money makes a positive difference.

The fund won't invest in persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption) or companies involved in tobacco and controversial weapons (such as cluster munitions, anti-personnel mines and chemical and biological weapons). The fund’s exclusions include companies that earn more than 20% of their revenues from the mining and extraction of thermal coal, as well as companies that derive more than 20% of their revenues from thermal coal power generation and oil sands.

The fund also adopts a decarbonisation pathway. This means it aims to reduce emissions by 50% relative to the unadjusted benchmark and thereafter achieve at least a 7% reduction in carbon emissions per year until 2050. The goal is to align the fund with the Paris Agreement, which aims to limit the temperature rise caused by global emissions to 1.5°C above pre-industrial times. We think this is a positive step overall, but it increases the fund’s complexity.

Culture

LGIM has continued to develop their passive fund range over the last 30 years. At the end of December 2022, it had around £445bn invested in this part of the business, allowing it to offer a wide range of index-tracking options.

It’s built a team of experienced passive fund specialists and they’re innovative too. If an index doesn’t exist for a sector they’d like to track, they’ll often work with index providers (like Solactive in the case of the Future World ESG Developed Index) to create a suitable index for them to track.

The team running this fund work closely with various risk departments across the business. We believe this provides support and adds challenge where appropriate.

Employees are also encouraged to participate in LGIM's share save scheme which should encourage them to be more engaged with the growth of the company. In addition, a portion of portfolio managers’ bonuses are invested into the funds they manage. By doing this, their interests are further aligned with the investors in the fund.

ESG Integration

LGIM is predominantly a passive investor, but we are impressed with the extent to which they have woven ESG into their culture. Being a primarily passive fund house hasn’t stopped them being innovative when it comes to ESG. In May 2019, the firm launched its ‘Future World’ range of funds.

The Future World range incorporates LGIM’s ‘Climate Impact Pledge’, which is their commitment to assess and engage with around 1000 of the world’s largest companies on how well they manage the implications of climate change. Companies that consistently show a lack of awareness of climate change, and do not respond positively to engagement, are sold from the Future World funds.

In 2019, LGIM established its Global Research and Engagement Platform, which brings together representatives from the investment and stewardship teams, in order to unify their engagement efforts. Engagement is conducted in line with the firm’s comprehensive engagement policy. A detailed description of the firm’s engagement and voting activity (including case studies) is available in their annual Active Ownership report.

The stewardship team is responsible for exercising voting rights globally, both for LGIM’s active and index funds. Voting decisions are publicly available through an industry-leading tool which allows a user to search for any company to find out how LGIM voted.

Cost

The fund has an ongoing annual charge of 0.15%. This is more expensive than some other global market trackers, but we think it's a reasonable price to pay given the additional ESG analysis that takes place. Our platform charge of up to 0.45% per annum also applies.

Performance

The fund launched in April 2019 and tracks the Solactive L&G Enhanced ESG Developed Index. Over this time, the fund has tracked the index closely. As is typical of index tracker funds, you would expect the fund to fall behind the index, because of the costs involved in running the fund. This is the case for most index funds, but the fund managers apply techniques to help keep performance as close to the index as they can, reducing the overall tracking difference.

While the fund has a relatively short track record, the team has a longer one managing a range of other tracker funds. Their size, experience and expertise running index tracker funds gives us confidence the fund will track its index tightly and efficiently over the long term, although there are no guarantees.

If we compared the fund against the broader global stock market, the fund’s exclusion list and tilting mechanism could cause performance to be different. For example, over the last 12 months the oil & gas sector has struggled to perform, which, given the fund has lower exposure to this part of the market, has helped performance.

In the wider market, more ‘growth’ orientated sectors, like technology, have led market returns. Inflation levels have started to peak and in many countries around the world there are hopes that central banks will stop hiking rates and potentially begin to lower them. This could be good news for these types of sectors.

Past performance is not a guide to the future. Source: Lipper IM to 31/05/2023.

*N/A = performance data for this period is not available due to when the fund or index was launched.

More on Legal & General Future World ESG Developed Index, including charges

Legal & General Future World ESG Developed Index Key Investor Information