Legal & General Future World ESG UK Index: February 2023 fund update

• Legal & General is one of the UK’s leading providers of responsible passive funds
• We think this fund offers an attractive blend of responsible and passive investing across the UK market
• It could be a good addition to a broader responsible investment portfolio
• This fund was recently added to our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Legal & General Future World ESG UK Index fund is a good option for broad exposure to the UK stock market, while being mindful of environmental, social and governance (ESG) issues.

The UK is home to successful businesses that make money domestically, as well as across the globe.

An index tracker fund is one of the simplest ways to invest, and we think this fund could be a great 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 tracker funds.

Manager

Legal & General has been running index tracker funds longer than most. It’s also one of the largest providers of tracker funds and has the biggest index team in the UK. That 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 Legal & General has a primary and secondary manager, though in practice the team as a whole helps to manage each fund. Jason Forster is the primary manager responsible for this fund. Forster heads up the team responsible for the fund management of the UK. He was formerly responsible for the development of the in-house index fund management system before becoming a fund manager in 2002. The secondary manager for this fund is Konstantins Golovnovs. Golovnovs is responsible for managing a range funds with both UK and global equity mandates. He moved into his current role in index funds in 2011.

Process

This fund aims to track the performance of the Solactive L&G Enhanced ESG UK Index. It's made up of around 340 companies spread across the UK market, including in the consumer staples, financials and energy sectors. The fund invests in the same companies as the index, which is known as full replication. This helps the fund closely match the performance of the benchmark.

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. It also reduces exposure to companies that score poorly on these measures. The fund also invests in smaller companies in line with the benchmark, which are usually subject to more extreme price movements, and this can increase risk.

The advantage of reducing investments in poorly-scoring companies, rather than selling their shares completely, is that the Legal & General team 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 as at 2021 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

Legal & General has continued to develop their passive fund range over the last 30 years. It has just over £470bn 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 UK Index, so they can track it.

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 Legal & General’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

Legal & General Investment Management (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.

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 22-strong 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 0.10%. This is more expensive than some other UK 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’s tracked the Solactive L&G Enhanced ESG UK Index since launch in April 2019. During that time, it’s delivered a return of 8.86% versus 13.28%* for the index.

As you would expect from an index tracker fund, it’s fallen behind the benchmark because of the costs involved in running the fund. However, the techniques used by the managers have helped to keep performance close to the index and reduced the tracking difference.

Due to the exclusions and tilting mechanism, we would expect the fund’s performance to differ slightly from the broader UK stock market. For example, the fund’s lower exposure to oil & gas has held back performance over the last year as this sector performed strongly.

Many UK companies earn money from and operate in countries across the globe. So, while they’re listed in the UK, they aren’t just reliant on the strength of the UK economy to thrive. This means that the UK market can be sensitive to geopolitical developments.

It’s no secret that rising energy costs, constrained food supplies and global supply chain disruptions has pushed inflation in the UK to 40-year highs in recent months. This will continue to have a knock-on impact on consumer spending, which could put further strain on UK businesses going forward.

The fund has a relatively short track record, but Legal & General’s 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.

Past performance is not a guide to the future. *Source: Lipper IM to 31/01/2023. The period between 31 January 2020 and 31 January 2021 reflects the performance of the I Class version of the fund. Performance from 31 January 2021 onwards reflects the performance of the C class version of the fund. This is due to when each share class was launched.

**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 UK Index fund, including charges

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