The S&P 500^® ESG Leaders Index seeks to provide a measurement of U.S. equities while incorporating ESG (Environment, Social, and Governance) factors.¹ The index maintains similar industry weights to the S&P 500 while implementing stricter ESG eligibility criteria.A common misconception is that all ESG indices remove or underweight sectors deemed environmentally damaging, such as Energy or Utilities. However, removing entire sectors may result in a shift in weight toward other sectors, potentially creating sector bias and concentration risk. Rather than excluding sectors, the S&P 500 ESG Leaders Index selects companies that perform highest when considering specific ESG metrics.Exhibit 1 illustrates how the S&P 500 ESG Leaders Index maintains low active share in relation to the benchmark index, in each sector, with the sector active share at 6.41%, highlighting broad sector neutrality. However, using ESG metrics as the criteria to determine index inclusion will naturally result in deviations from the underlying index. This is particularly evident when a sector has several constituents deemed ineligible or a company with a high float market cap (FMC) is excluded. Typically, the more a methodology integrates stricter sustainability criteria, the greater the active share.The S&P 500 ESG Leaders Index methodology selects constituents on a relative basis¹ within each GICS^® industry group, resulting in low active share within sectors. However, in certain instances, sectors may be over- or underweighted relative to the underlying index, causing deviation. This is illustrated by the active share at the index level reaching 41.15%, which is driven by both disparity in index constituents with the S&P 500, as mentioned previously, as well as weights (see Exhibit 1).
The index selection process targets 50% of uncapped FMC from each GICS industry group in the S&P 500, selecting companies in decreasing order using S&P Global ESG Scores (see Exhibit 2). However, specific exclusions (such as exclusions based on specified business activities) may prevent an industry group from meeting the 50% target. This could be a result of the industry lacking enough eligible constituents or the FMC weight of eligible constituent weights not reaching the target.
If this happens, excess industry weight is distributed proportionately among the remaining index constituents. If eligible constituents with higher FMC weighting are selected, any additional weight allocation may result in a sector overweight (see Exhibit 3). To prevent single-stock concentration, a constituent cap¹ is integrated as per the S&P 500 ESG Leaders Indices methodology.
The S&P 500 ESG Leaders Index has provided a measurement of U.S. equities with an ESG lens and maintained similar industry group weights as the S&P 500. By utilizing index construction to maintain broad sector neutrality, the index historically reduced the impact of sector-driven performance, increased the impact of stock selection and produced low tracking error versus the S&P 500.³ Consequently, the success of the index is not solely measured through its performance but also by how closely its industry group weights—and, by extension, sector weights— remain similar to the S&P 500.¹ See Rowton, Stephanie and Maria Sanchez, “The S&P 500 ESG Index: 5 Years of Defining Core Through an ESG Lens,” S&P Dow Jones Indices LLC, Aug. 7, 2024.² A maximum single-company weight cap (5%, company weight in the S&P 500 ESG Index) is applied to the final index constituents.³ Beyhan, Maya, “Understanding the Outperformance of the S&P 500 ESG Leaders Index through a Sectoral Lens,” S&P Dow Jones Indices’ Indexology^® Blog, Oct. 24, 2024.More By This Author:S&P/ASX 200 High Dividend Index: Q3 2024 Performance Attribution
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