Updated October 12, 2022 with details on the MSCI ESG optimization process

Plan sponsors may wish to consider whether this investment news has any implications for the investment options available within their plans. Sun Life Assurance Company of Canada purchases units of the funds listed below. They are established as segregated funds under the Insurance Companies Act (Canada).

As we communicated on April 1, 2022, BlackRock Asset Management Canada Ltd. (“BlackRock”) will be making important changes to the LifePath target date funds (LifePath) later this year. BlackRock will replace several underlying funds for LifePath, which provide exposure to broad equity market indices (e.g. S&P/TSX Composite, S&P 500), with funds that provide exposure to MSCI’s Extended ESG Focus indices.

After meeting with BlackRock and reviewing their research, we can now provide additional details, insights and our views on the changes.

The equity index changes are outlined in the table below.

Asset Class

Current Index

New Index

Canadian Equities

S&P/TSX Composite

MSCI Canada IMI ESG Extended Focus

Large Cap U.S. Equities

S&P 500

MSCI USA ESG Extended Focus

Small Cap U.S. Equities

Russell 2000

MSCI USA Small Cap ESG Extended Focus

International Equities

MSCI EAFE

MSCI EAFE ESG Extended Focus

Emerging Markets Equities

MSCI Emerging Markets

MSCI Emerging Markets ESG Extended Focus

BlackRock will continue to manage all funds passively relative to their benchmarks (indices) listed above. There will be no change to the investment management fees and operating expenses are expected to decrease slightly. BlackRock is not changing the target equity allocation in each LifePath fund or the allocations between equity asset classes.  Similarly, BlackRock is not planning to change the fixed income or inflation protection portions (e.g. Real Return Bonds, REITs, commodities, infrastructure) of the LifePath funds at this time. BlackRock expects to review the fixed income exposures in 2023.

About the MSCI ESG Extended Focus Indices

The MSCI ESG Extended Focus indices are diversified by security, sector, and country, similar to the current indices and the MSCI “parent” indices1. MSCI designed the MSCI ESG Extended Focus indices to have a similar risk and return profile to the MSCI parent indices.

The MSCI ESG Extended Focus indices differ from the current indices and the MSCI parent indices in two main ways:

  1. They overweight companies with high MSCI ESG ratings and underweight companies with low MSCI ESG ratings.
  2. They exclude companies that are involved in tobacco, controversial weapons, civilian firearms, thermal coal, and the oil sands. Canadian equities will not exclude companies involved in thermal coal and the oil sands. Companies with no MSCI ESG or controversy scores, and companies involved in “severe ESG controversies” will also be excluded.

MSCI designed its ESG ratings to evaluate how exposed a company is to ESG risks and how well it manages those risks.

The process to construct the MSCI ESG Extended Focus indices is depicted here:

The process to construct the MSCI ESG Extended Focus indices

Source: MSCI

As highlighted in step 3 above, MSCI places various constraints on the MSCI ESG Extended Focus indices to limit the expected tracking error relative to the MSCI parent indices. The predicted tracking error is 0.5% for U.S. and EAFE indices and 1.0% for Canada and the Emerging Markets indices. The table below outlines the constraints used for each MSCI ESG Extended Focus Index.

Summary of constraints

Source: MSCI

As indicated in step 4 above, MSCI optimizes the ESG Extended Focus indices to maximize the ESG Quality score. In this step, MSCI uses a quantitative process that considers the market capital weights from the Parent Index, ESG scores and additional optimization constraints to select and weight the constituents of each MSCI ESG Extended Focus index. The MSCI ESG Extended Focus index targets the same risk/return dynamics as the respective parent index. The optimization process currently excludes a total of 2,700 companies from the parent indices for the new ESG indices used by LifePath.

For a deep dive on the MSCI ESG Extended Focus indices, please refer to the index methodology here.

Why MSCI?

MSCI is a leading provider of tools and services for the global investment community. MSCI creates and maintains a series of commonly used stock indices for investors. BlackRock selected MSCI due to its confidence in MSCI’s experience, ESG research and ratings, and the efficient way they can be integrated into the LifePath funds.

BlackRock indicated that MSCI’s ESG optimized indices gave them confidence to invest in ESG exposures that could improve the management of ESG factors, while maintaining the broad exposure and sector diversification within equities.

Why is BlackRock making these changes?

BlackRock has indicated that these changes are a result of both changing consumer and investor preferences, and their investment research. The change also reflects BlackRock’s increased focus on sustainable investing.  

These changes are consistent with the changes BlackRock made in the UK LifePath funds, where they have already substituted broad market indices with ESG indices. However, in the U.S., BlackRock has launched a separate LifePath ESG target date series.

BlackRock expects that the LifePath funds will generate similar (or better) long-term performance after these changes. BlackRock’s research indicates that the MSCI ESG Focus indices have outperformed their corresponding parent indices over the past decade. (Note: performance below includes both actual returns and MSCI back-tested returns).

Traditional vs. ESG Focus

Source: BlackRock Sustainable Investing, March 2022

BlackRock’s research also suggests that sustainable indices may provide better resilience in market downturns. The figure below depicts the percentage of sustainable indices that have outperformed traditional market indices in recent market downturns. 

Source: BlackRock Sustainable Investing as of December 31, 2020

Most recently, MSCI compared the performance of its top quintile ESG rated European companies with those of its bottom quintile at the onset of the Russian invasion of Ukraine. Top ESG-rated companies demonstrated more resilience. 

Europe Top ESG / Europe Bottom ESG

Source: MSCI

You can find more information from BlackRock hereabout evolving lifepath index offering and hereabout sustainability resilience research.

Our View

The long-term performance of the LifePath funds will primarily be driven by the “glidepath” (i.e. mix of equity and debt over time) and the asset mix. Neither of these return drivers will be affected. We don’t expect the replacement of traditional indices with MSCI ESG Extended Focus indices to have a significant impact on performance over the long term.

The changes are consistent with Sun Life GRS’s belief that sustainable investing is not just about creating new products, but that all investments should integrate ESG issues. ESG factors may identify risks and provide return opportunities over the long term. Most research on ESG and performance suggests that ESG inclusion is at least neutral, if not beneficial, to long term performance. The MSCI ESG Extended Focus were incepted in 2018 and don’t have as long of a track record as other traditional indices.

The systematic “values” or “norms” based exclusion of certain industries and controversial companies will naturally create a range of reactions from plan sponsors and members. The number of hard exclusions (currently under 200 companies) is relatively small in comparison to the nearly 5,100 companies in the parent indices. Currently, tobacco and thermal coal screens comprise the majority of the exclusions.

The performance difference between the MSCI ESG Extended indices and Parent MSCI indices have been relatively small (under +/-0.50% difference between each MSCI ESG Extended Focus Index and the respective parent index, for the 5-year period ending June 30, 2022).

While we have no major concerns with the changes, due to their significance, GRS Investment Solutions has placed the LifePath target date series on our Watch List, under “Additional Monitoring” (the least severe category). We’ll continue to work with BlackRock to monitor the transition and the impact of these changes to clients. We’ll provide further updates as necessary.

Some plan sponsors have asked us to comment on why the Canadian LifePath target date funds have more closely followed the UK LifePath funds (and not the US, where BlackRock launched a brand new ESG target date series). In general, the U.S. has been slower to adopt ESG factors as a key investment consideration, unlike other jurisdictions. The Department of Labor issued a statement in 2021, noting that their prior rules led to investor confusion and had a “chilling” effect on the appropriate integration of ESG. Canada more closely aligns with Europe on ESG integration in retirement savings plans. We think BlackRock’s evolution of their current target date series reflects Canada’s approach to ESG.

Over the coming months, the GRS Investment Solutions team is happy to support plan sponsors and their investment advisors in understanding these changes further.

A few sponsors have indicated that they wish to review their target date fund offering to ensure they continue to meet the needs of members. While target date funds are generally designed to be a “set it and forget it” option for members, we believe it’s prudent for sponsors to review their investment options periodically, including target date funds, which are often the default investment option. It’s worth noting that all other platform target date funds integrate ESG considerations to some extent. To our knowledge, there is no other fully passive target date fund series offered in the CAP space in Canada.

Sun Life’s GRS Proprietary ESG framework has the following ESG evaluations for target date fund series available on the Core investment platform:

  • BlackRock LifePath: ESG Leader (Passive)
  • MFS LifePlan: ESG Leader
  • Sun Life Granite (including Target Date & Multi-Risk Target Date): ESG Developing Leader
  • Fidelity ClearPath: Not currently considered an ESG Leader/ESG Developing Leader

When will the changes occur?

BlackRock expects to begin transitioning the LifePath target date funds to MSCI ESG Extended Focus index funds in Q4 2022. Due to the size of the assets involved, the transition may take up to 10 months to complete. BlackRock confirmed that they will complete the transition over two tax years (2022 and 2023 – see info below).

How will members be impacted?

The changes within the funds underlying LifePath do not require any actions from your members. Given the significance of the changes, we’ll be communicating these changes and the rationale for them directly to plan members. Members will be notified through the Message Centre on their secure mysunlife.ca account on July 18. As well, we will send an email to all impacted members in August.

For more details refer to the plan member communication.

If your members have money in a non-registered plan, they will likely experience a capital gain or loss when the changes occur, due to the trading activity that will occur in the underlying funds. Sun Life will report any capital gains or losses on the tax slips we produce for plan members. BlackRock expects the changes to impact capital gains and losses in 2022 and 2023. Members must report capital gains or losses on their tax return in the year the changes occur.

Questions?

Please contact your Sun Life Group Retirement Services representative.

1 Parent indices are the broad market indices that the MSCI ESG Focus indices are based upon. For example, the MSCI Canada Index is the parent index for the MSCI IMI Canada ESG Extended Focus Index.