Boosting the ESG Focus of Our Ex-State-Owned Enterprises Strategies

WisdomTree’s family of ex-state-owned enterprises (ex-SOE) Indexes was designed to represent the performance of emerging markets companies without significant government ownership—which we define as a 20% or more stock ownership stake.

As a result of this state-ownership screening, there were explicit tilts away from poor corporate governance companies and implicit tilts away from companies that score poorly on environmental considerations:

• “G” in ESG – Selecting only private enterprises explicitly mitigates exposure to the governance issues related to state-owned enterprises.

• “E” in ESG – These Indexes tended to reduce weight to sectors that score poorly on environmental concerns because of the high degree of state ownership in Energy and Materials businesses—this created an implicit environmental tilt.

Based on these tilts, the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE) was named the 2019 Mutual Fund Industry & ETF Awards’ ESG/Impact ETF of the Year.¹

WisdomTree believes these Funds already represented best-in-class ESG solutions due to their performance-driven methodologies. But to further solidify their ESG credentials, we added some more considerations. 

Focus on Governance

Screening out state-owned enterprises (SOEs) from our starting universe explicitly improves aggregate governance, as it removes the inherent principal-agent problem detailed below.

A common criticism of SOEs is that political influences force them to employ too many people and pay above-market wages. A real-life example of the principal-agent problem can be seen by contrasting the per-employee revenue numbers of two comparable energy companies: state-owned PetroChina and privately held Exxon Mobil.

Over the past few years, the Chinese government has praised PetroChina for creating jobs despite falling oil prices and the meltdown of the global economy due to the COVID-19 pandemic.² As seen below, Exxon Mobil generated roughly $2.76 million in revenue per employee—almost seven times as much as the $0.42 million generated by PetroChina in 2016.

Implicitly Improving Environmental Exposures

State-owned enterprises tend to be clustered in Financials, Energy, Materials and Utilities. By screening out SOEs, WisdomTree’s ex-SOE Indexes implicitly screen on environmental considerations by removing exposure to Energy and Materials companies. Some of the largest SOEs in the MSCI Emerging Markets Index’s universe include Energy and Materials companies like Vale, Petroleo Brasileiro (i.e., Petrobras) and Gazprom.

Additional ESG Considerations

As additional ESG considerations to the current methodology of its ex-SOE Indexes, WisdomTree will exclude companies involved in controversial weapons, tobacco or thermal coal activities or that are noncompliant with the Global Standards Screening (GSS), as identified by third-party ESG data provider Sustainalytics, from the strategies’ eligible universes.

WisdomTree applied these changes to all its ex-SOE Indexes on January 25 of this year. The broad Emerging Market ex-State-Owned Enterprises Index (EMXSOE) dropped a total of 14 companies, representing 1.57% of its weight. The relatively modest additional impact of the new ESG screens was by design given the environmental and governance considerations already inherent in the strategy. 

The India ex-State-Owned Enterprises Index (INXSOE) had five companies excluded, totaling 7.65% of Index weight. China ex-State-Owned Enterprises Index (CHXSOE) had no additional companies screened.

Conclusion

At a time when many investors are concerned about the ESG characteristics of their portfolios, WisdomTree believes screening SOEs from a broad emerging market universe provides investors with a portfolio with strong governance and environmental characteristics. Adding more  ESG screens on product involvement and noncompliance to GSS further enhances these portfolios.

For those investors looking to add emerging markets exposure to their portfolios, this family of ex-state-owned enterprises strategies can provide the right combination of long-term returns and sustainable exposures.

¹This award is given to the most successful ETF focused on issues related to environmental, social and governance factors or specific ESG objectives. Success is determined by a combination of several factors, such as flows, performance and innovation. The finalists are comprised of individuals and firms who have submitted entries or been nominated via the online submission process, as well as through recommendations from leading market participants. Judges will use the submitted application material, as well as any uploaded supplemental information, to determine which firm, individual or product they believe to be the most suitable and deserving winners for each category.
²“The new state capitalism: Xi Jinping is trying to remake the Chinese economy,” The Economist, 8/15/20.