Asset owners turn to bespoke index strategies for ESG plays

The rising trend of custom indices among asset owners reflects a growing need for precision and alignment in investment portfolios. These products enable investors to optimise risk allocation and enhance performance, according to financial experts.
Asset owners turn to bespoke index strategies for ESG plays

Asset owners worldwide are increasingly recognising the value of custom index investment products to tailor their portfolios and align with specific investment strategies.

APG Asset Management recently introduced a bespoke index designed to boost responsible real estate bets. The $665 billion Dutch pension fund manager’s innovative index was designed to cater to the growing demand for environmental, social and governance (ESG) customisation and to allow clients to align their portfolios with specific sustainability preferences.

Rutger van der Lubbe,

"Our clients focus on costs, which makes an index product attractive to them. We saw that as a reason not to simply offer a passive index strategy but instead to leverage our leadership in responsible investing to create what we believe offers a superior investment solution: an index that incorporates ESG factors," Rutger van der Lubbe, head of global real estate investment strategy at APG told AsianInvestor.

Likewise, Korea’s National Pension Service, one of the largest pension funds globally, has developed a custom index to target niche real estate investments, signalling its desire to optimise returns in specific segments of the market.

California Public Employees' Retirement System (CalPERS), New York State Common Retirement Fund (NYSCRF), Canada Pension Plan Investment Board (CPPIB), and the Government Pension Investment Fund (GPIF) of Japan are among the notable institutions that have also embraced custom index strategies.


Felix Gotz,
Scientific Beta

Institutional investors require indices that closely reflect their investment beliefs, objectives, and constraints, which leads them to partner with index providers to build dedicated indices for their investment mandate, according to Felix Goltz, research director at Scientific Beta, a provider of a smart factor and ESG/climate index platform.

“For example, a pension fund needs an index that incorporates their definition of sustainability when excluding or tilting stocks. Institutional investors may also have specific goals in terms of factor exposures or risk controls that deviate from what is offered in off-the-shelf indices,” Goltz told AsianInvestor.

These bespoke investment needs are driving the trend of large institutions adopting indices that are tailored to their objectives, he said.

The use of custom indices is not a new phenomenon according to Jean de Kock, investment consulting director for Asia at Mercer.

Jean de Kock,

“If the practice is becoming more popular, it is likely a function of both increasing accessibility—such as lower cost of creating a custom index—and a sign of increasing sophistication amongst clients that want to better navigate their exposure to specific risk factors, whether that be on a country, sector, style or extra-financial basis,” de Kock told AsianInvestor.

The use of a customised benchmark allows asset managers to be far more targeted with where they are taking active risk, while aligning with their clients’ investment beliefs or constraints, he said.

“Traditional market cap weighted indices may not represent the most appropriate anchor for active risk budgets, which can contribute to misalignments between the manager and client. Conversely, bespoke indices can enhance the alignment without impairing the manager’s potential to add value,” de Kock said.


The adoption of custom indices offers numerous benefits to investors according to Jason Zeall, associate director of Asia investments at WTW.

“One of the key benefits of custom indexing is that investors can have a benchmark that is personalised to the investor’s unique circumstances, such as risk tolerance, goals and preferences,” Zeall told AsianInvestor.

Jason Zeall,

To an extent, this allows investors to own more allocations based on what they want and then own less of what they do not want.

“Often, tracking a market cap benchmark requires owning securities that may not be the best but the investor is still forced to invest in these securities for the purposes of minimising tracking error,” he said.

Custom indices provide the flexibility to incorporate “elements of subjectiveness” which can be the case when it comes to ESG considerations, said Zeall.

“Investors, who may not necessarily agree with the indices’ definition of ESG, may want to customise an index that suits their own definitions rather than just accept what is on-the-shelf.”

However, leveraging custom indices also carries potential risks. Investors making active calls at the index level may face challenges in achieving consistent outperformance compared to market benchmarks, he said.

“It is difficult to conclude that this would lead to additional performance. It is already difficult for fund managers to create consistent alpha based on active calls—allocation or securities selection decisions— and hence it would be hard to see why investors making the active calls themselves at the index level, would create outperformance over the market benchmark.”

Scientific Beta’s Goltz agrees that adapting indices could result in a lack of robustness. Furthermore, ad hoc adaptations in one area of index design may have unintended consequences in another area.

“For example, inclusion of additional sustainability criteria might alter financial risks of an index or dilute the original sustainability objectives. Index providers need to identify such issues and help investors to navigate the trade-offs between competing objectives in index design,” said Goltz.

Therefore, it is crucial for index providers to assess the robustness of specifications and apply a rigorous research framework when developing indices, he said.

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