Legal & General Future World ESG Tilted & Optimised Emerging Markets Index: February 2025 fund update

• Legal & General is one of the UK’s leading providers of responsible passive funds

• We think this fund offers an attractive blend of responsible and passive investing across emerging markets

• It could be a good addition to a broader responsible investment portfolio

• This fund currently features on our Wealth Shortlist of funds chosen by our analysts for their long-term performance potential

How it fits in a portfolio

The Legal & General Future World ESG Tilted & Optimised Emerging Markets Index fund provides broad exposure to a range of mostly large and medium-sized companies in emerging markets, while being mindful of environmental, social and governance (ESG) issues.

Emerging markets are higher risk as they're at an earlier stage of development, so this fund should only be considered for an investment portfolio with a longer investment outlook that can tolerate periods of higher volatility.

An index tracker fund is one of the simplest ways to invest, and we think this fund could be a great low-cost starting point for a portfolio aiming to deliver long-term growth in a responsible way. It could help diversify an investment portfolio already focused on developed markets, like the US or UK, and add a responsible tilt. It could also be a good addition to a portfolio of other tracker funds.

Manager

Legal & General is one of the largest providers of index tracker funds in the UK and has offered index funds to investors for over 30 years. That means it’s got the resources and expertise to track indices as closely as possible, and the scale to keep charges to a minimum.

Each equity index fund at Legal & General has a primary and secondary manager, although in practice it’s a team-based approach. The primary manager for this fund is Shane Padden. He joined Legal & General in 2022 and is responsible for a range of equity index funds. Prior to this, Padden spent three years at Mercer working as an Investment Consultant.

The secondary manager for this fund is Konstantins Golovnovs. He’s responsible for managing a range of UK and global equity funds. Golovnovs joined Legal & General as part of the graduate scheme in 2010 and worked his way up to become a fund manager in the index team.

Process

This fund aims to track the performance of the Solactive L&G Enhanced ESG Emerging Markets Index. There are currently 1,716 companies in the fund versus 1,842 in the index. It’s not always possible to invest in every company in the index and in the same proportion because it's difficult to buy and sell the smallest companies quickly or at low cost, which impacts performance. This is why the fund uses a partial replication approach which helps it closely match the performance of the benchmark.

The fund invests in emerging markets including Taiwan, India and China and across a range of sectors with communications and technology making up the largest portion followed by banks and consumer staples. South Korea isn’t included in all emerging market indices but is included in this fund’s index and makes up around 8% of the fund. It also invests in some smaller companies which feature in the benchmark. These companies can be subject to more extreme share price movements, and this can increase risk.

The fund won't invest in direct violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption) and companies that earn more than 10% of their revenue from tobacco. It excludes companies that are involved in controversial weapons and those that earn a certain amount of revenue from military and assault weapons. The fund's exclusions include companies that earn more than 20% of their revenue from the mining and power generation of thermal coal and those involved in its expansion. It also excludes companies that earn more than 5% of their revenue from the extraction of oil sands.

The index increases investments in companies that score well on a variety of ESG criteria – from the level of carbon emissions generated, to the number of women on the board and the quality of disclosure on executive pay. It also reduces exposure to companies that score poorly on these measures.

The advantage of reducing investments in poorly-scoring companies, rather than selling their shares completely, is that the Legal & General team can engage to help them improve. An increased investment in exchange for improvement on various factors is also a good incentive, so investors' money could make a positive difference.

The fund also adopts a decarbonisation pathway. This means it aims to reduce emissions by 50% compared to the non-ESG benchmark and then achieve at least a 7% reduction in carbon emissions per year until 2050. The goal is to align the fund with the Paris Agreement, which aims to limit the temperature rise caused by global emissions to 1.5°C above pre-industrial times. We think this is a positive step overall, but it increases the fund’s complexity.

Culture

Legal & General has developed its passive fund range over the last three decades. The company manages around £500bn in tracker funds, allowing it to offer a wide range of index-tracking options.

It’s built a team of experienced passive fund specialists and they’re innovative too. If an index doesn’t exist for a sector they’d like to track, they’ll often work with index providers, like Solactive, to create a suitable index for them to track.

The team managing this fund work closely with various risk departments across the business. We believe this provides support and adds challenge where appropriate.

Employees are also encouraged to participate in Legal & General’s share save scheme which should encourage them to be more engaged with the growth of the company. In addition, a portion of fund managers’ bonuses are invested into the funds they manage. By doing this, their interests are further aligned with the investors in the fund.

ESG Integration

Legal & General Investment Management (LGIM) is predominantly a passive investor, but we’re impressed with the extent to which they’ve woven Environmental, Social and Governance (ESG) matters into their culture. Being a mostly passive fund house hasn’t stopped them being innovative when it comes to ESG. In May 2019, the firm launched its ‘Future World’ range of funds, which this fund is part of.

The Future World range incorporates LGIM’s ‘Climate Impact Pledge’, which is their commitment to assess and engage with the world’s largest companies on how well they manage the implications of climate change. Engagement is carried out with reference to comprehensive ‘sector guides’, which outline best practice and LGIM’s expectations for companies in each key sector. Companies that consistently show a lack of awareness of climate change, and don’t respond positively to engagement, are sold from the Future World funds.

In 2019, LGIM established its Global Research and Engagement Platform, which brings together representatives from the investment and stewardship teams, in order to unify their engagement efforts. Engagement is conducted in line with the firm’s comprehensive engagement policy. A detailed description of the firm’s engagement and voting activity (including case studies) is available in its annual Active Ownership report. Quarterly Engagement reports are also available.

LGIM’s Stewardship team is responsible for exercising voting rights globally, both for LGIM’s active and index funds. Voting decisions are publicly available through a tool which allows a user to search for any company to find out how LGIM voted, and a detailed rationale is provided for votes against management and abstentions.

The FCA (Financial Conduct Authority) recently launched its Sustainability Disclosure Requirements (SDR), which include anti-greenwashing, naming and labelling rules. It includes four labels to help investors find funds that have a specific sustainability goal. This fund doesn’t have a sustainability investment label as it doesn’t have a specific sustainability objective. However, the fund and the index it tracks apply ESG criteria as described above. Therefore it added ‘Tilted and Optimised’ to its name in December 2024 to reflect how it incorporates ESG into its process.

While the fund has a decarbonisation pathway, emerging markets tend to be more carbon intense than their more developed peers. It means this is one of the most carbon intense funds under HL’s research coverage. The companies within the fund may face increased scrutiny from investors and regulators, as well as higher costs associated with carbon emissions management and potential carbon pricing mechanisms, potentially impacting the fund’s performance.

Cost

The fund has an ongoing annual charge of 0.20%. This is more expensive than some other emerging market tracker funds, but we think it's a reasonable price to pay given the additional ESG analysis that takes place. Our platform charge of up to 0.45% per annum also applies, except in the Junior ISA, where no platform charge applies.

Performance

Since the fund launched in April 2022, it’s done a good job of tracking its benchmark, returning 9.18%* during this time. As expected from an index tracker fund, it’s fallen behind the benchmark over the long term because of the costs involved in running the fund. However, the tools used by the managers have helped to keep performance close to the index.

Over the past 12 months, the fund has risen 9.95%. Taiwan’s stock market was one of the best performing emerging markets, driven by advancements in Artificial Intelligence (AI). This was led by Taiwan Semiconductor Manufacturing (TSMC), the world’s largest chip manufacturer, which has seen huge growth due to the strong demand for chips essential for the development of AI. TSMC is the largest company in the index, making up around 9%.

China’s stock market also performed well, with most of its gains coming later in the year. China has struggled in recent years as its economy hasn’t recovered as many had expected since its COVID-19 lockdown and there have been ongoing concerns around its property sector. But the Chinese stock market rallied in the second half of 2024 when the government announced stimulus measures aimed at boosting its economy.

On the other hand, Brazil was one of the worst performing emerging markets last year, with high interest rates weighing heavily on the country. South Korea’s stock market also fell in value. There’s been a lot of political uncertainty in South Korea and its economy grew less than expected in 2024.

Due to the exclusions and tilting mechanism, we expect the fund’s performance to differ slightly from non-ESG emerging markets. Over the last year, energy companies in emerging markets struggled so having less invested in the energy sector benefitted the fund.

The fund has a relatively short track record, but Legal & General’s team has a longer one managing a range of other tracker funds. Their size, experience and expertise running index tracker funds gives us confidence the fund will track its index tightly and efficiently over the long term, although there are no guarantees.