Legal & General Future World ESG UK Index: February 2024 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 the UK market

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

• This fund is on the 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 UK Index fund is a good option for broad exposure to the UK stock market, while being mindful of environmental, social and governance (ESG) issues. The companies that the fund invests in vary in terms of their size and the sectors in which they operate.

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 a portfolio that is heavily invested in other areas around the world and add a responsible tilt. It could also be a good addition to a portfolio of other tracker funds.

Manager

Legal & General are one of the largest providers of index tracker funds in the UK and have offered index funds to investors for over three decades. They have one of the best resourced and most experienced teams in tracker fund management. This enables them to track indices as tightly as possible and keep costs low for investors.

Each equity index fund at Legal & General has a primary and secondary manager, although in practice it is very much a team-based approach. The primary manager for this fund is Jason Forster. He heads up the team responsible for the fund management of the UK. Forster was formerly responsible for the development of the in-house index fund management system before becoming a fund manager in 2002. The secondary manager for this fund is Konstantins Golovnovs. He is responsible for managing a range of funds with both UK and global equity mandates. Golovnovs moved into his current role in index funds in 2011.

Process

This fund aims to track the performance of the Solactive L&G Enhanced ESG UK Index. It does this by investing in every company in the index and in the same proportion. This is known as full replication and helps the fund closely match the performance of the benchmark.

The fund is made up of nearly 300 companies spread across the UK market, mainly in the consumer, financials and energy sectors. It also invests in smaller companies in line with the benchmark, which are usually subject to more extreme price movements, and this can increase risk.

The fund won't invest in persistent violators of the UN Global Compact Principles (a UN pact on human rights, labour, the environment and anti-corruption) or companies involved in tobacco and controversial weapons. The fund’s exclusions include companies that earn more than 20% of their revenues from the mining and extraction of thermal coal, as well as companies that derive more than 20% of their revenues from thermal coal power generation and 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% relative to the unadjusted benchmark and thereafter 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 continued to develop their passive fund range over the last 30 years. It has just over £470bn invested in this part of the business, 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 in the case of the Future World ESG UK Index, so they can track it.

The team running 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 portfolio 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 are impressed with the extent to which they have woven ESG into their culture. Being a primarily 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.

The Future World range incorporates LGIM’s ‘Climate Impact Pledge’, which is their commitment to assess and engage with around 1,000 of the world’s largest companies on how well they manage the implications of climate change. Companies that consistently show a lack of awareness of climate change, and do not 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 their annual Active Ownership report.

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.

Cost

The fund has an ongoing annual charge of 0.15%, but we've secured HL clients an ongoing saving of 0.05%. This means you pay a net ongoing charge of 0.10%. This is more expensive than some other UK trackers, but we think it's a reasonable price to pay given the additional ESG analysis that takes place. Our platform fee of up to 0.45% per year also applies.

Performance

Since the fund launched in April 2019, it’s delivered a return of 9.18%* versus 11.47% for the Solactive L&G Enhanced ESG UK Index. Remember, past performance isn’t a guide to future returns. As you would expect from an index tracker fund, it’s fallen behind the benchmark over the long term because of the costs involved in running the fund.

Over the last 12 months, the fund returned 0.33% compared to the benchmark’s return of -0.39%. The techniques used by the managers have helped to keep performance close to the index and reduced the tracking difference.

Due to the exclusions and tilting mechanism, we would expect the fund’s performance to differ slightly from the broader UK stock market. For example, the fund’s lower exposure to utilities and oil & gas has held back performance over the year as these sectors have performed well.

The cost-of-living crisis and fears of a recession have impacted investors’ confidence in the UK over the year. However, price pressures have eased quicker than expected and inflation has dropped sharply. UK inflation slowed to 3.9% in November which is the lowest level it’s been since September 2021. It has more than halved the level it was this time last year.

Interest rates rose to 15-year highs in August but have been held at 5.25% ever since, with the expectation that there will be cuts later in 2024. Despite the optimism of interest rate cuts, the UK still faces challenges. The UK economy is estimated to have grown by 0.1% in 2023, which is the lowest annual growth since 2009 excluding the year 2020 which was affected by the pandemic.

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.

The period between 31 January 2020 and 31 January 2021 reflects the performance of the I Class version of the fund. Performance from 31 January 2021 onwards reflects the performance of the C class version of the fund. This is due to when each share class was launched. The benchmark changed from the Solactive L&G ESG UK Index to the Solactive L&G Enhanced ESG UK Index on the 15 January 2021.

**N/A = performance data for this period is not available due to when the fund was launched.