Indexology^® Blog

The S&P 500^® ESG Index celebrated its fifth birthday on Jan. 28, 2024. Over the past five years, the index has become an important piece of the sustainable indexing puzzle for investors looking to leverage the strength of the S&P 500 while incorporating meaningful and measurable sustainability-focused enhancements.

Traditionally, five-year celebrations are marked by gifting something made from wood. As a symbol, wood represents strength, stability and the ability to withstand challenges. It embodies the vitality needed to overcome obstacles and adapt to changing circumstances. In many ways, this is appropriate symbolism for an index that has been designed to help investors address the challenges and changing circumstances in an evolving world.

Let’s celebrate this milestone with a quick look back at the past five years of the S&P 500 ESG Index.

From the Beginning

The launch of the S&P 500 ESG Index on Jan. 28, 2019, signaled an evolution in sustainable investing. The index filled an important gap for investors seeking to incorporate ESG values while maintaining similar overall characteristics to the widely known and utilized S&P 500 (see Exhibit 1).

Evolving Sustainability Landscape

Adapting to the ever-changing landscape of sustainable indexing has been essential over the lifespan of the S&P 500 ESG Index. Several refinements have been made to the index methodology to reflect the evolving sentiments of a sustainability-minded investor. These views have been voiced in the results of several market consultations that led to a revised and expanded list of exclusions based on a company’s involvement in certain business activities (see Exhibit 2). The consultations also addressed several other relevant updates, including more frequent eligibility checks for business involvement activities³ and UNGC exclusions.⁴ Most recently, S&P Dow Jones Indices consulted the market on two key sustainability enhancements, which resulted in the change from the Sustainalytics Product Involvement to the S&P Global Business Involvement Screens and the change from the S&P DJI ESG Scores to the S&P Global ESG Scores.⁵

With these enhancements, the S&P 500 ESG Index has retained its main objective, which is to maintain similar overall industry group weights to the S&P 500, while enhancing the overall sustainability profile of the index with an average ESG Score improvement of 7.65% over its five-year lifespan.⁷

Five-Year Performance

As seen in Exhibit 3, the S&P 500 ESG Index has outperformed the S&P 500 not only over its five years of live history, but over the shorter-term one-year and three-year periods as well. One might assume that this outperformance has come at the expense of an increased risk profile for the index, but as we can see in Exhibit 4 that is not the case. The risk/performance profile of the S&P 500 ESG index was significantly better than the S&P 500 over both the three- and five-year timeframes.

Performance Perspective

One of the main criticisms around sustainability investment strategies is that the over (or under) performance is simply a result of over (or under) weights to particular sectors. In Exhibit 5, it is clear that it is not true for the S&P 500 ESG Index, which has maintained similar sector exposure to the S&P 500 since its launch. This is further evidenced by examining the performance attribution of the S&P 500 ESG Index. Exhibit 6 highlights that the excess returns have been primarily driven by stock selection rather than differences in sector exposure. This is by design, as the methodology lends itself to a broadly sector-neutral outcome. Thus, the outperformance was not all necessarily due to significant overexposure to Information Technology and underexposure to Energy, as some might assume.

Conclusion

The five years of live history for the S&P 500 ESG Index is indeed something to celebrate, and we look forward to watching our sustainable indexing star continue to shine.

¹ Illustration reflects the current use of the S&P DJI ESG Scores in the index methodology. On Jan. 23, 2024, S&P Dow Jones Indices announced the results of a consultation which disclosed the transitioning of the S&P DJI ESG Scores to the S&P Global ESG Scores. The changes will be implemented as of the market open on May 1, 2024. For more information on the S&P Global ESG Scores, please refer to the S&P Global ESG Scores Methodology.

² In cases where risks are presented, S&P Global releases a Media and Stakeholder Analysis (MSA) which includes a range of issues such as economic crime and corruption, fraud, illegal commercial practices, human rights issues, labor disputes, workplace safety, catastrophic accidents and environmental disasters. The Index Committee reviews constituents flagged by S&P Global’s MSA to evaluate the potential impact of controversial company activities on the composition of the indices. If the Index Committee decides to remove a company, that company is ineligible for re-entry for at least one full calendar year, beginning with the subsequent rebalancing.

³ Index constituents are reviewed on a quarterly basis for ongoing eligibility under the Business Activities exclusion criteria. Companies determined to be ineligible are removed from the index, effective after the close of the last business day of July, October and January. The reference date for this review is the last business day of the previous month. No constituent will be added to the index as a result of any deletion that may take place. Changes to Sustainalytics coverage are not considered as part of this review.

⁴ As a result of market consultation that was finalized Jan. 23, 2024, S&P DJI is revising the Quarterly Eligibility Review process in relevant indices, so UNGC eligibility is always reviewed in March, June, September and December, in line with the schedule of the Global Standards Screening dataset. This will ensure a timely removal of those companies classified as Non-Compliant with UNGC eligibility requirements regardless of the rebalancing schedule of the specific index. For more information on the results of this consultation, please visit UNGC Quarterly Eligibility Review Methodology Updates

⁵ Both enhancements will be implemented to align with the annual rebalance of the S&P 500 ESG index which is effective after the close of the last business day of April. For more information, please reference Transitioning S&P Sustainability Indices to S&P Global ESG Scores and Business Involvement Screens (spglobal.com)

⁶ For more information on the market consultations that resulted in these changes, please visit Historical Announcements – Client Resource Center | S&P Dow Jones Indices (spglobal.com)

⁷ The index has achieved an average S&P DJI ESG Score improvement of 7.65% (at the index level) from Jan. 27, 2020-Jan. 29, 2024, representing an average of 21.47% of the overall ESG improvement potential, given the sustainability characteristics of the starting universe.

American political consultant James Carville once commented that he’d like to be resurrected as the bond market because, “you can intimidate everyone.”  As of July 2023, the global bond market comprises about USD 135 trillion of securities, of which rated corporate debt represents USD 23 trillion.¹ U.S. corporate debt makes up roughly half of the global total, and as Exhibit 1 illustrates, the 1980s were a turning point in the U.S., as companies increasingly switched away from seeking bank loans for financing needs and toward leveraging the growing debt capital markets.

The composition of bond holders has also evolved. Most evidently, direct retail ownership of corporates and U.S. Treasuries has near halved, from 20% of outstanding issuance in 2010 to 11% as of Q2 2023. Meanwhile, assets in U.S. bond mutual funds have almost doubled. This has been part of a broader trend of “professionalization” or disintermediation, which saw households gravitate away from direct security ownership and toward mutual funds during the bull market of the 1990s.

In contrast to the equity markets, where index-based funds have come to represent almost half of invested capital, about three-quarters of bond fund assets were still actively managed at year-end 2023, as we observe in Exhibit 3. This is partly because fixed income index funds have a shorter history than their equity cousins: a bond index fund didn’t exist until 1986, and the first bond ETF wasn’t launched until 2002—both lagging their equity equivalents by a decade or so.

However, passive investing in the bond markets could catch up. Just as in equities, it appears difficult for active managers to outperform over the long term. Meanwhile, since 2010, the proportion of global mutual fund and ETF assets that are passively managed has in fact grown faster in bonds than in equities.

If the transformative trajectory of passive investing in equity markets is any guide for fixed income, the stage may now be set for a remarkable future for passive fixed income management. To assess whether (and why) bond markets might continue to catch up, we invite you to dive into our in-depth analysis here.

¹ Refers to the amount of global and U.S. corporate debt rated by S&P Global Ratings as of July 2023. For more information, please see Limbach, Sarah, Gunter, Evan M., and Singh, Vaishali, “Credit Trends: Global State of Play: Debt Growth Diverging By Credit Quality,” Sept. 6, 2023.

The S&P High Yield Dividend Aristocrats^® includes large-, mid-, and small-cap companies in the U.S. that have raised their dividends for at least 20 consecutive years. The index recently concluded its annual reconstitution on Jan. 31, 2024, which brought 18 new members into this accomplished group. Accounting for the three deletions, the index’s total count increased from 121 to 136, which enhances its overall diversification and liquidity. This blog will examine the additions and deletions through a size and sector lens and provide a look at the laudable track record of constituents’ dividend increases.

Exhibit 2 details how the reconstitution affected the S&P High Yield Dividend Aristocrats from a size perspective. Pre-reconstitution, the index had 77, 31 and 13 constituents in the S&P 500^®, S&P MidCap 400^® and S&P SmallCap 600^®, respectively. The 15 net additions included 12 net additions from the S&P 500, 4 additions from the S&P MidCap 400, and 1 net deduction from the S&P SmallCap 600. Post-reconstitution, there are 89, 35 and 12 constituents from the S&P 500, S&P MidCap400 and S&P SmallCap 600, respectively.

As Exhibit 3 displays, Utilities and Industrials were the biggest beneficiaries of the reconstitution, with their net counts increasing by 7 and 4, respectively. Industrials now comprises 30 constituents, 8 more than the next-highest sectors by count: Financials and Utilities, each with 22. After losing two constituents, Consumer Staples dropped to the third-highest sector by count, with 19. The lone constituent in the Communication Services sector, John Wiley & Sons, was removed from the index, resulting in Communication Services being the only GICS^® sector without representation in the index.

A Long History of Dividend Growth

Exhibit 4 summarizes the number of constituents that have increased their dividends in five-year increments. Notably, over one-half of constituents have increased their dividends for 35 years or longer, and over 36% have achieved this feat for 45 years or longer. These track records are certainly commendable and demonstrate these companies’ historically consistent ability and willingness to return increasing amounts of shareholder capital across multiple decades.

The S&P 500^® Dividend Aristocrats^® seeks to track an elite group of companies that have raised their dividends for a minimum of 25 consecutive years. This index has just concluded its annual reconstitution, which was effective at the market close on Jan. 31, 2024. Fastenal has been added, while Walgreens is out, which keeps the membership list at 67 stocks.

Introducing the Index’s Newest Member: Fastenal Company

Fastenal is the latest company to be added to this prestigious index by raising its dividends for 25 consecutive years. This new S&P 500 Dividend Aristocrat is an industrial distributor that sells items ranging from fasteners to tools and has evolved into a supply chain solution company.

As of Dec. 31, 2023, Fastenal has a gross margin of 45.7%,¹ a return-on-equity of 34.5% and a low debt-to-equity ratio of 7.8%. Fastenal has a dividend yield of 2.3%, which is in line with the 2.4% overall yield of the S&P 500 Dividend Aristocrats.

A Long-Term Member Is out: Walgreens Boots Alliance, Inc.

Walgreens Boots Alliance was dropped from the index after the pharmacy chain reduced its quarterly dividends by 48% to 25 cents per share. The move comes as the company seeks to strengthen its long-term balance sheet and cash position.

Walgreens had been a long-time member of the S&P 500 Dividend Aristocrats, having increased its annual dividends for almost 50 years. However, this index’s stringent methodology requires the 25 years to be consecutive, and rules are rules.

The S&P 500 Dividend Aristocrats Sector Breakdown

These changes did not have a material impact on the overall sector weights. As Exhibit 1 shows, the index retains its relatively large overweights in consistent dividend-paying sectors such as Consumer Staples and Industrials, with large underweights in IT, Communication Services and Consumer Discretionary.

A Long History of Dividend Growth

While one of the longer-standing members of the index was removed, Exhibit 2 shows that more than half of the current constituents in the S&P 500 Dividend Aristocrats have grown their dividends for more than 40 years.

¹ Taylor Ranta Oborski, Fastenal Company Reports 2023 Annual and Fourth Quarter Earnings, Jan. 18, 2024 .

While most dividend strategies underperformed their respective benchmarks in 2023, the S&P Pan Asia Dividend Aristocrats^® impressively outperformed the S&P Pan Asia BMI by approximately 3.50% (see Exhibit 1). Furthermore, despite the outperformance, the S&P Pan Asia Dividend Aristocrats’ valuations and dividend yield remained favorable relative to the benchmark (see Exhibits 3 and 4). This blog will examine these metrics in more detail, in addition to providing a detailed performance attribution for 2023.

As Exhibit 1 shows, the S&P Pan Asia Dividend Aristocrats’ strong 2023 performance further boosted its long-term outperformance versus the S&P Pan Asia BMI. Going back to Dec. 31, 2001, the S&P Pan Asia Dividend Aristocrats has outperformed the S&P Pan Asia BMI on average by 2.35% annually. Additionally, this long-term outperformance has been achieved while also delivering a lower full-period volatility, maximum drawdown and downside capture ratio.

Exhibit 2 displays the 2023 performance attribution for the S&P Pan Asia Dividend Aristocrats and S&P Pan Asia BMI. As shown in the attribution analysis columns, the total outperformance totaled 3.50%, with 7.15% due to the bottom-up stock selection effect and -3.65% from the allocation or sector effect. Information Technology was the largest positive-contributing sector for the S&P Pan Asia Dividend Aristocrats, at 10.20%, with 10.78% from the selection effect and -0.58% due to the allocation effect.

The key differentiator of the S&P Pan Asia Dividend Aristocrats versus its benchmark is the requirement that stocks must increase dividends per share for at least seven consecutive years. This filter, in addition to the payout and dividend yield filter, may bias the index toward selecting higher quality stocks since the ability to consistently grow dividends over the long term can be an indication of financial strength and discipline.

Exhibit 3 displays the valuation comparison and discount of the S&P Pan Asia Dividend Aristocrats versus its benchmark. The index is cheaper on all three metrics shown, with an average discount over the three metrics at approximately 34%. Not shown in the table but important nonetheless, is the return-on-equity (ROE) metric, which measures how efficiently a company utilizes shareholder capital to generate net income. The S&P Pan Asia Dividend Aristocrats has a 9.9% ROE versus 9.1% for the S&P Pan Asia BMI as of Dec. 29, 2023.

As Exhibit 4 shows, the index’s dividend yield has been higher than the Pan Asia BMI’s dividend yield every year since 2009. Furthermore, the average dividend yield for the S&P Pan Asia Dividend Aristocrats was 3.42% versus 2.47% for the S&P Pan Asia BMI over this period. Interestingly, the year-end 2023 dividend yield for the S&P Pan Asia Dividend Aristocrats was 3.71%, 8.40% higher than its historical average versus the S&P Pan Asia BMI’s year-end 2023 dividend yield of 2.57%, only 4% higher than its historical average.

Conclusion

Following a strong year of performance in 2023 thanks to its effective bottom-up stock selection, the S&P Pan Asia Dividend Aristocrats heads into 2024 holding a dividend yield and valuation advantage over its benchmark. For investors seeking an index with these value and dividend yield exposures, in addition to various quality and dividend filters, the S&P Pan Asia Dividend Aristocrats Index is an option to consider.