Creating the fund

The first step in creating the fund is to take the list of the largest companies in the developed market and establish what proportion each company is of the total market value of all of those companies. For example, a company the size of Apple might be 2.5% of this total, so before making the adjustments, £2.50 of every £100 would go into buying shares of Apple.

We then remove any companies that are involved in the manufacture of controversial weapons or have has very severe recent ESG controversy.

Controversial weapons

MSCI define the following types of weapons as being controversial:

‘Involved’ companies will do one or several of the following:

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Environmental, Social or Governance (ESG) controversies

MSCI assesses the impact of a company’s actions to establish if there had been a negative ESG impact.

This can include environmental damage, alleged violations of existing laws, and violations of global norms, such as the UN Global Compact on Human Rights, labour, environment, and anti-corruption.

MSCI group these into 5 main themes and 28 specific areas that they look at:

Environment	Human rights & community	Labour rights & supply chain	Customers	Governance
Biodiversity and land use	Impact on local communities	Labour management relations	Product safety & quality	Bribery & fraud
Toxic emissions & waste	Human rights concerns	Health & Safey	Anticompetitive practices	Governance structures
Energy & climate change	Civil liberties	Collective bargaining & unions	Customer relations	Controversial investments
Water stress	Other	Discrimination & workforce diversity	Privacy & data security	Other
Operational waste (non-hazardous)		Child labour	Marketing & data security
Supply chain management		Supply chain labour standards	Other
Other		Other

A very severe controversy is generally one that would impact over 1,000 people or cause widespread environmental damage. MSCI gives a colour coded rating to companies from green meaning no controversies, to red where a company is involved in one or more very severe controversies.

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How MSCI calculates the ESG ratings

MSCI employs over 200 full time analysts who conduct detailed research into companies’ ESG policies giving each company an overall score. MSCI takes over 1,000 data points relating to the themes in the table above.

They use a wide range of sources for this data – from the companies’ own reports, government publications, scientific research, and reports from international institutions like the United Nations and World Bank.

Companies are scored on both how much risk is associated with the business, as well as how they are managing their risks.

For example, a company in a polluting industry will have a higher level of risk, but if they have very effective processes for managing the risk and plans in place for reducing their pollution compared to others they would receive a higher score.

This data is then compared against other similar companies’ data, eg steel makers will be compared against other steel makers. The best companies in each industry are awarded an AAA rating, the worst a CCC rating. This means that the ratings given to firms in different industries is not directly comparable.

Companies are monitored by MSCI on an ongoing basis, including daily monitoring of controversies and governance events. New information is reflected in reports updated weekly and significant changes to scores can result in the company being reviewed, and the rating changed. Companies receive an in-depth review at least annually.

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How MSCI uses these ratings to change the make-up of the Ethical Fund

The amount invested in each company will be tilted up or down depending on their current ESG score, and the trend of their score. Therefore, more money is invested in those with high and improving scores. This gives incentives for companies to improve their behaviour. In the example above, if Apple was to have a high ESG score it might have its share of the fund increased from 2.5% to 2.7%.

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Different types of ESG, ethical and impact investing

Ethical investment is a broad topic that covers a wide range of potential investment styles such as:

• Impact investing – investing in companies because they have specific ESG benefits such as solar power producers.
• Positive screening – creating a concentrated fund which only invests in the highest scoring companies.
• Negative screening – excluding specific companies or entire industries.

A key consideration with The People’s Pension is to offer a good quality, low cost scheme for all our 5 million plus members.

As part of that, we offer a small well governed fund range that we hope is able to meet the needs of most members.

When we’re choosing a fund to make available within the Scheme’s fund range we have to consider the costs our members will face and the value that fund offers.

As well as the expected performance and risks associated with the fund, a further challenge we face is that with millions of members, trying to offer investments that are able to meet all members’ personal requirements within the fund governance framework is difficult.

As the fund needs to invest in a wide range of industry sectors and geographic locations to ensure the fund is sufficiently diversified, there are inevitably some companies which members may be opposed to investing in.