Legal & General Future World ESG Emerging Markets Index: April 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 emerging markets
• 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 Emerging Markets Index fund is a good option for broad exposure to a range of large and medium-sized companies in emerging markets, while being mindful of environmental, social and governance (ESG) issues.

These markets are higher risk as they’re at an earlier stage of development, so this fund should only be considered for a portfolio with a longer investment outlook that can tolerate periods of higher volatility.

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 responsible 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. Shane Padden is the primary manager responsible for this fund. Padden is responsible for a range of LGIM’s Equity Index portfolios and joined LGIM in 2022 from Mercer where he spent 3 years as an Investment Consultant. The secondary manager is Konstantins Golovnovs who is responsible for managing a range funds with both UK and global equity mandates. He joined LGIM’s graduate scheme in September 2010, completing rotations in the Index Funds, Active Equities, LDI and Solutions front office teams.

Process

This fund aims to track the performance of the Solactive L&G Enhanced ESG Emerging Markets Index. It’s made up of around 1,500 companies spread across emerging markets including Taiwan, India and China. The fund also has a greater weighting to the technology and financial sectors versus the non-ESG FTSE emerging markets index. This fund also has an allocation to South Korea which is not available in the FTSE Emerging Markets index, though it is in other non-ESG emerging indices.

It’s not always possible to invest in every company in the Index and in the same proportion because it’s difficult to buy and sell the smallest companies quickly or at low cost, which impacts performance. This is why the fund adopts a partial replication approach which helps it 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. It also reduces exposure to companies that score poorly on these measures. The fund also invests in smaller companies which feature in the benchmark, these companies can be 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 of 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 Emerging Markets 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 0.20%. This is more expensive than some other emerging markets 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 Emerging Markets Index since launch in April 2022. During that time, it’s delivered a return of -2.96% versus -3.14%* for the index. 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 emerging stock markets including an allocation away from sectors like oil and gas.

The consumer goods sector in emerging markets has been particularly resilient over the last year as demand for basic necessities and household goods remain steady. In recent years these markets have also had to contend with the COVID-19 pandemic, war, and other geopolitical risks.

Despite these challenges, these sectors remain promising for investors willing to accept the higher level of risk and volatility associated with emerging markets.

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 24/04/2023.

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

Find out more about L&G Future World ESG Emerging Markets Index including charges

L&G Future World ESG Emerging Markets Index Key Investor Information