FTSE 4-not-so-good?

Written by Rebecca O'Connor on 20th Oct 2015

HSBC makes up 6.5% of the UK FTSE4Good index, Royal Dutch Shell 4% and Vodafone 4%, to which an ethical investor may respond: “Come again?”

A high profile investigation into money-laundering at HSBC’s Geneva office found links to drug cartels and terrorists. Meanwhile, Shell has only just pulled out of an attempt to drill the Arctic, not because it decided it was wrong, but because the site wasn’t “a gusher”. Vodafone, meanwhile, was accused of aggressive tax avoidance. You might think these activities alone would be enough to warrant exclusion from an index labelled “good”. Not so.

FTSE ranks companies with Environmental and Social Governance (ESG) ratings from 0 to 5, with 5 being the highest. Companies with a FTSE ESG Rating of 3.3 and above will be added to the Index.

The FTSE4Good criteria is well-researched and transparent, but it focuses on improvements and ESG practices, which can easily be (mis)used by large companies to offset the impact of ill-gotten gains from their bread and butter business, resulting in the bizarre pre-eminence of the likes of Shell in the index.

The index has been developed in close consultation with a broad range of stakeholders including NGOs, governmental bodies, consultants, academics, the investment community and the corporate sector. But this diffuse consultation has resulted in a lack of conviction – it only excludes two sectors: tobacco and weapons systems. The index imposes no requirement that a company must only engage in activities with positive social and environmental benefits, as you might expect given the name.

And it is influential. Many so-called “ethical” funds use the FTSE4Good to decide where to invest, and market this fact alongside soft-focus pictures of happy parents throwing their laughing children up in the air. Your average investor who wishes to make their well-meaning decision in 15 minutes is unlikely to drill down as far as the top-ten holdings, and will instead take the marketing on face value.

And yet it is still hard to be too critical, because any attempt to filter out harmful activities from the investment universe should be encouraged and the FTSE4Good plays an important part in the wider shift of capital flows from bad to good.