Understanding the FlexShares STOXX® Partnership

Posted by FlexShares on Aug 21, 2017 8:30:00 AM

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STOXX® Limited is a family of indexes created out of a joint venture between Dow Jones, Deutsche Boerse Group and SIX Swiss Exchange. Their indexes are widely used in Europe and globally, including in many ETFs. STOXX® licenses its indexes globally for commercial use.

STOXX® and FlexShares

At FlexShares, we utilize STOXX® indexes in three of our ETFs, including:

  • FlexShares STOXX® Global Broad Infrastructure Index Fund (NFRA), which focuses on global stocks in the infrastructure space.

The other two ETFs using STOXX® indexes are our ESG funds:

  • FlexShares STOXX® U.S. ESG Impact Index Fund (ESG)
  • FlexShares STOXX® Global ESG Impact Index Fund (ESGG)

STOXX® and our ESG methodology

The investable universe for ESG and ESGG is the STOXX® Global 1800 index. The index is comprised of 600 European stocks, 600 American stocks, and 600 Asian/Pacific region stocks. This breakout is represented by the STOXX® Europe 600 Index, the STOXX® North America 600 Index, and the STOXX® Asia/Pacific 600 Index, respectively. [1]

From this investable universe, STOXX® uses a representative sampling strategy to form the two passively managed benchmarks used for the ESG and ESGG funds.

The STOXX® U.S. ESG Impact Index, the benchmark for ESG, offers broad U.S. market exposure with a tilt toward companies that score well for a set of ESG key performance indicators (KPIs). [2] KPIs typically include such measures as gender equality and diversity programs, training hours per employee, publishing environmental consumption figures, and level of board independence, quality, or diversity.

The STOXX® Global ESG Impact Index, the benchmark for ESGG, uses a similar set of KPIs to screen STOXX® 1800 constituents globally. [3]

FlexShares engaged STOXX® to analyze ESG KPIs to see if indicators that lead to long-term value creation for shareholders could be identified. STOXX®'s research identified potential Key Performance Indicators (KPIs) in each of the environmental, social, and governance buckets that were most influential in determining risk and return. These critical KPIs serve as the backbone of STOXX®'s proprietary ESG index methodology, which is central to our ESG process at FlexShares. [4]

Our approach

Using the STOXX® ESG indexes as a base, we follow a rigorous process in selecting the holdings for ESG and ESGG.

We believe that ESG integration takes the risks and opportunities of ESG factors into account and integrates them into the more traditional financial analysis of potential portfolio names. These factors involve asking questions such as:

  • Does the company have a scalable/quantitative process?
  • Do the names exhibit positive risk/return vs. simply using a market cap weighted approach?
  • Are we focusing on the KPIs that exhibit a substantive or material impact on the long-term sustainability of a firm's business model along with its share price performance?
  • Does the company improve the overall diversification of the portfolio?

Diversification controls are designed to provide a diversified portfolio, but also keeping an eye that it is not overly skewed toward any particular stocks, sectors, or countries. These controls are designed to provide a fund that:

  • Sector/style neutral.
  • Sector allocation is not greater than +/- 5% of the benchmark index.
  • Country allocation is not greater than +/- 1% of the benchmark index.
  • Tracking error is not greater than 3%, versus both the S&P 500 and the Russell 1000 for the ESG fund, and not greater than 2% versus the MSCI World Index for ESGG. Tracking error is defined as how closely a fund or portfolio follows the index to which it is benchmarked.

With the help of our index partners at STOXX®, we feel we have the right benchmarks from which to base our approach to ESG investing.

Written in conjunction with Roger Wohlner utilizing Contently. Roger is an experienced financial writer whose work has appeared on Investopedia, US News, Morningstar Magazine and MSN Money.

[1] Stoxx.com, “STOXX® Global 1800," https://www.stoxx.com/index-details?symbol=SXW1E

[2] Stoxx.com, "STOXX® USA ESG Impact," https://www.stoxx.com/index-details?symbol=SXEIMUGV

[3] Stoxx.com, "STOXX® Global ESG Impact," https://www.stoxx.com/index-details?symbol=SXEIMGGV

[4] FlexShares.com, "Why ESG May Finally Gain Traction," https://www.flexshares.com/etf/documents/white-papers/case-for-esg-investing.pdf

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FlexShares STOXX® US ESG Impact Index Fund (ESG) and the FlexShares STOXX® Global ESG Impact Index Fund (ESGG) are passively managed and use a representative sampling strategy to track their underlying index respectively. Use of a representative sampling strategy creates tracking risk where the Fund's performance could vary substantially from the performance of the underlying index. The Funds are subject to environmental, social and governance (ESG) Investment Risk, which is the risk that because the methodology of the Underlying Indices selects and assigns weights to securities of issuers for non-financial reasons, the Funds may underperform the broader equity market or other funds that do not utilize ESG criteria when selecting investments. The Funds are also at increased risk of industry concentration, where it may be more than 25% invested in the assets of a single industry. For ESGG, investments in foreign market securities involve certain risks such as currency volatility, political and social instability and reduced market liquidity. The Funds may also invest in derivative instruments. Changes in the value of the derivative may not correlate with the underlying asset, rate or index and the Funds could lose more than the principal amount invested.

The STOXX® USA ESG Impact Index and the STOXX® Global ESG Impact Index are the intellectual property (including registered trademarks) of STOXX® Limited, Zurich, Switzerland and/or its licensors ("Licensors"), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by STOXX® and its Licensors and neither of the Licensors shall have any liability with respect thereto.

FlexShares STOXX® Global Broad Infrastructure Index Fund (NFRA) is subject to infrastructure-related companies risk and MLP risk. Risks associated with infrastructure-related companies include: realized revenue volume may be significantly lower than projected and/or there will be costs overruns; infrastructure project sponsors will alter their terms making a project no longer economical; macroeconomic factors such as low gross domestic product ("GDP") growth or high nominal interest rates will raise the average cost of infrastructure funding; government regulation may affect rates charged to infrastructure customers; government budgetary constraints will impact infrastructure projects; and special tariffs will be imposed.

The STOXX® Global Infrastructure Index is the intellectual property (including registered trademarks) of STOXX® Limited, Zurich, Switzerland and/or its licensors ("Licensors"), which is used under license. The securities based on the Index are in no way sponsored, endorsed, sold or promoted by STOXX® and its Licensors and neither of the Licensors shall have any liability with respect thereto.

Tags: Funds

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