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Why investing in the ETF indexed to MSCI ex Controversial Weapons?

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When THEAM launched Parworld Track ex-Controversial Weapons Indexed funds in 2013, it became the first index manager in Europe to adopt the MSCI ex-Controversial Weapons index as the benchmark of a line of open-ended funds.

In a recent article published in the supplement FTfm of the Financial Times on March 27th, 2017, the reporter highlighted a number of data on exposure to controversial weapons via mutual funds sold around the world. Despite investors’ concerns, notably institutional investors but more and more retail investors and foundations, and widespread bans or restriction by international treaties or conventions, a number of funds have exposure to controversial weapons (as defined by those treaties and conventions – described in Exhibit 1).

“More than 6,500 funds sold to retail investors around the world have high exposure to controversial weapons such as cluster munitions, according to new research that has cast doubt over asset managers’ efforts to invest responsibly”… “MSCI, the index provider that carried out the research found that 6678 mutual funds had at least 5% of their portfolio invested in companies that manufacture or distribute these weapons”… “Analysis from Morningstar, the data provider, found that 6% of 100 000 funds sold around the world have holdings in companies that produce controversial weapons.” (source FTfm March 27th, 2017 – article from Aime Williams)

Investors (notably retail) are not always aware of those exposures.

There is a simple way for passive exposure to invest responsibly with ETF indexed to MSCI ex controversial weapons indices.

When THEAM launched Parworld Track ex-Controversial Weapons Indexed funds1 in 2013, it became the first index manager in Europe to adopt the MSCI ex-Controversial Weapons index as the benchmark of a line of open-ended funds. This fits well with BNP Paribas Investment Partners’ broader sustainable investing framework. Since 2010, we have excluded makers of controversial weapons from all managed assets under the BNP Paribas group defense sector policy. This approach is aligned with the April 2013 recommendations of the French Association of Investment Management (AFG) on banning the financing of cluster bombs and anti-personnel mines. The guidelines encourage investment management companies to set up an exclusion policy and use indices excluding the makers of cluster bombs and anti-personnel weapons. The THEAM range of currently 10 ex-Controversial Weapons ETFs listed on Euronext Paris allows investors to gain exposure to the performance of one or more equity markets, while excluding from their portfolios companies involved in cluster bombs and anti-personnel weapons.

ETF Name ETF Isin ETF Mnémo OCR as of end of April 17
BNP Paribas EASY MSCI EMU ex Controversial Weapons NTR LU1291098827 IEEMU 0,25%
BNP Paribas EASY MSCI Europe ex Controversial Weapons NTR LU1291099718 IEEUE 0,25%
BNP Paribas EASY MSCI Europe ex UK ex Controversial Weapons NTR LU1291100664 IEEXU 0,25%
BNP Paribas EASY MSCI Europe Small Caps ex Controversial Weapons NTR LU1291101555 IEESM 0,25%
BNP Paribas EASY MSCI Pacific ex-Japan ex Controversial Weapons NTR LU1291106356 IEPEJ 0,25%
BNP Paribas EASY MSCI North America ex Controversial Weapons NTR LU1291104575 IENAM 0,25%
BNP Paribas EASY MSCI Japan ex Controversial Weapons NTR LU1291102447 IEJAP 0,25%
BNP Paribas EASY MSCI UK ex Controversial Weapons NTR LU1291107917 IEUKD 0,25%
BNP Paribas EASY MSCI World ex Controversial Weapons NTR LU1291108642 IEWRD 0,25%
BNP Paribas EASY MSCI Emerging Markets ex Controversial Weapons NTR LU1291097779 IEEMK 0,35%

Currently MSCI constructs MSCI Global ex Controversial Weapons Indexes for the Standard size‐segment in all MSCI Developed and Emerging Markets. These indexes are free float‐adjusted market capitalization weighted. MSCI ex controversial weapons indexes exclude Nuclear Weapons, Cluster Munitions, Depleted Uranium, Land Mines and Biological or Chemical Weapons – the approach is described in exhibit 2.2

They are highly correlated to the standard MSCI indexes (between 99.93% and 99.99%).

When designing a controversial weapons policy, one area that is often overlooked is that certain funds and ETFs (especially those focused on the defense sector) may be heavily invested in these types of business activities. Using MSCI ESG Research’s Fund Metrics data, MSCI analyzed a universe of 23,482 global mutual funds and ETFs for exposure to controversial weapons through fund holdings. This analysis identified fund holdings with primary or secondary level involvement in any of the potentially controversial weapons, which corresponds to the ‘Minimal Tolerance’ scenario.

As of February 2017, the most frequently restricted controversial weapon categories among MSCI ESG Research clients were Landmines, Cluster Munitions, and Biological and Chemical Weapons. The next most commonly restricted categories are Nuclear Weapons (which may or may not be considered controversial based on region, i.e. U.S.-based investors often do not consider them to be controversial), and Depleted Uranium. Investors taking a very conservative approach will likely exclude all types of potentially controversial weapons.

Exclusion commitments by definition narrow the pool of issuers eligible for investment. By far, the type of controversial weapon that had the most companies flagged for involvement was Nuclear Weapons (accounting for 2.55% of the weight of the MSCI ACWI IMI), followed by Cluster Munitions, Land Mines, and Depleted Uranium.

As of February 1, 2017, MSCI ESG Research had not identified any publically traded company with involvement in Biological / Chemical Weapons, Weapons that utilize Non-Detectible Fragments, Blinding Lasers Weapons, or Incendiary Weapons.

 

Weight of the excluded stocks in the MSCI Indices as of May 12th, 2017

MSCI World ex CW MSCI Emerging Markets ex CW MSCI North America ex CW
0.68% 0.31% 1.06%

As a conclusion, there is a simple way to invest responsibly with ETF exposed to MSCI ex controversial weapons indexes while respecting international convention and treaties and avoiding any reputational risks. The high correlation of the MSCI ex controversial weapons indexes with the standard indices is an additional benefit of this approach which is a first step in responsible investments.

Exhibit 1: Weapon Categories and Related Treaty – The ones most frequently identified by advocates and concerned investors are those that have been subject to widespread ban or restriction by international treaty or convention

Weapon Category Convention / Treaty
Chemical Weapons Chemical Weapons Convention
Biological Weapons Biological Weapons Convention
Cluster Munitions Cluster Munitions Convention
Landmines Mine Ban Treaty
Weapons Utilizing Non-Detectable Fragments Convention on Certain Conventional Weapons, Protocol I
White Phosphorous Convention on Certain Conventional Weapons, Protocol III
Blinding Laser Weapons Convention on Certain Conventional Weapons, Protocol IV
Nuclear Weapons Nuclear Non-Proliferation Treaty
Depleted Uranium N/A

The weapons all have one or more of the following characteristics:

– The weapon is indiscriminate, i.e. there is an increased risk of civilian casualties

– The weapon can be classified as a weapon of mass destruction with a single incident resulting in a large number of deaths

– The weapon is considered to be excessively injurious, i.e. it causes an inordinate amount of pain and suffering

– The weapon may have long term health impacts on the populations in areas where they are used

However, institutional investors may take different approaches, prioritizing the exclusion of some weapons makers over others in their investment strategy. These differences may be shaped by legal restrictions, mandate language, or organizational priorities.

 

Exhibit 2: Involvement Levels Explained

The graphic illustrates MSCI ESG Research’s approach to classifying different types of ties to controversial weapons. Companies with the closest ties, i.e. those that manufacture the weapons themselves, are at the bottom of the pyramid. Moving from bottom to top, each tier represents a degree of removal from the weapons themselves. See the MSCI ESG Research Business Involvement Screening Research methodology document for further details.

Table1

The investments in the funds are subject to market fluctuations and the risks inherent in investments in securities. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay, the funds described being at risk of capital loss. For a Complete description and definition of risks, please consult the last available prospectus and KIID of the funds. Investors considering subscribing to a fund should read carefully its most recent prospectus and KIID that can be downloaded free of charge from our site www.easy.bnpparibas.fr

  • 1. Parworld Track ex-Controversial Weapons Indexed funds is a Sub-fund of the Sicav BNP PARIBAS Parworld UCITS V SICAV registered under Luxembourg law.
  • 2. BNP Paribas EASY MSCI EMU ex Controversial Weapons NTR, BNP Paribas EASY MSCI Europe ex Controversial Weapons NTR, BNP Paribas EASY MSCI Europe ex UK ex Controversial Weapons NTR, BNP Paribas EASY MSCI Europe Small Caps ex Controversial Weapons NTR, BNP Paribas EASY MSCI Pacific ex-Japan ex Controversial Weapons NTR, BNP Paribas EASY MSCI North America ex Controversial Weapons NTR, BNP Paribas EASY MSCI Japan ex Controversial Weapons NTR, BNP Paribas EASY MSCI UK ex Controversial Weapons NTR, BNP Paribas EASY MSCI World ex Controversial Weapons NTR, BNP Paribas EASY MSCI Emerging Markets ex Controversial Weapons NTR are Sub-funds of the Sicav BNP PARIBAS EASY UCITS V SICAV registered under Luxembourg law.

On the same subject:

Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management Holding.