Indeed, as an investment practice, the past twelve months have seen an unprecedented and exponential growth in global demand for sustainable investment solutions. “Climate change has become a defining factor in companies” long-term prospects’ wrote BlackRock CEO Larry Fink in his annual letter at the start of 2020.1 Evidence is building that the addition of sustainable investment is one of necessity with the style acting as a powerful risk management framework to portfolios, a notion increasingly supported and reinforced by regulators. Nowhere is this more pertinent than for UK pension schemes where regulation, member pressure and investment options are driving the shift to sustainable investing.2 As of 1 October 2019, Trustees of schemes with over 100 members were required to update their Statement of Investment Principles (SIP), in relation to financially material considerations which the trustees should recognise when making investment decisions, including environmental, societal and governance (ESG) factors. And by 1 October 2020, Trustees need to amend their SIPs to include information on their policies regarding how asset managers’ performance and remuneration are reviewed in line with trustees’ policies. Accordingly, a number of schemes and consultants are trying to get ahead of the game with regards to reporting ESG considerations in their portfolios. Some have also implemented their own ESG and climate change policies to ensure they are compliant with the new regulations. In this regard, as the industry pivots towards the adoption of ESG solutions, the universe of dedicated sustainable investment funds continues to swell. Last year saw a combined total of US$20.6 billion in European and US mutual funds and exchange-traded funds (ETFs), up from US$5.5 billion in 2018.3 In the first quarter of 2020 alone, US$14.0 billion of assets have allocated to sustainable funds, already surpassing well over half of last year’s total.4 The increasing breadth of product offerings in both open-ended funds and ETFs has been crucial in allowing investors affordable access, where previous integration of ESG had historically been associated with higher costs.5
Investors rightly deem portfolio resilience to be a critical component to their late cycle portfolio construction, a premise now accelerated more than ever as we enter a period of unprecedented global economic uncertainty. The COVID-19 pandemic, itself a medical, social and monetary goliath, is playing out in damaging tandem with a global reduction in oil pricing, which saw a dramatic world-wide asset value reduction in Q1. But in this regard, we believe reducing exposure to companies who cannot adapt their business models to a low carbon environment has helped protect ESG performance in the short term.
Whilst ESG funds have indeed suffered, falling 12% this year to date, which is just half the decrease of the S&P 500 for the same period.6 They are faring better than their conventional fund competitors and are overrepresented in the top quartiles of their peer groups, in terms of their performance.7 This period marks the first and sternest downturn the sustainable market has faced.
Our view is that strong performance on key sustainability metrics is often viewed as a proxy for operational excellence. Companies with high ESG scores tend to have a lower cost of capital, higher profitability and lower exposure to tail risks.8 We believe the breadth and quality of ESG data have improved enough to make ESG analysis an integral part of the investment process. We believe capturing, analysing and actioning this level of demand requires significant investment in people, infrastructure and data, and it is critical that investment managers develop measurement tools to deepen their understanding of material risks. BlackRock’s commitment to working with clients on these issues, as well as developing solutions in the space, is steadfast as attention has moved towards identifying drivers of longterm returns associated with environmental, social and governance issues to achieve sustainable investment returns. In this regard, there is more focus than ever to build and embed sustainability into the investment and risk processes to meet the needs of clients, enabling them to navigate periods of uncertainty and protecting their financial future. For example, BlackRock has created a Carbon Beta Tool to stress-test issuers and portfolios for different carbon pricing scenarios.1 In 2020 the business will continue to build additional tools, including one to analyse physical climate risks and one that produces material investment signals by analysing the sustainability-related characteristics of companies.
Sion Cole, Head of BlackRock’s Fiduciary Management Business, says of the increasing move towards ESG strategies, “Implementing these changes into the portfolio can be a daunting task for trustees who are looking to adopt ESG tilts into their investment principles and manage a more sustainable investment strategy. We think that one way of achieving this is to delegate the implementation to a fiduciary manager. They will have the tools and depth of expertise to analyse the huge amounts of data and apply this in a way that is consistent with the Trustees’ beliefs, whilst also being aligned to the investment objectives of the scheme”. One thing is for sure though and that is that whilst the current economic uncertainty looks set to continue in the near term, we believe sustainability will endure to form an integral tenant of our long-term investment approach.
1 A fundamental Reshaping of Finance Larry Fink Letter CEO, BlackRock, Jan 2020 https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
2 The Role of ESG in UK Pension Schemes, BlackRock, July 2019
3 Money moving into environmental funds shatters previous record, CNBC, January 2020
4 ESG packed on the Assets in Q1, ETF Trends, April 2020
5 BlackRock Investment Institute Sustainable Investing, BlackRock, May 2018
6 Older ESG Funds Outperform Their Newer Rivals in Market Tumult, Bloomberg, March 2020
7 Sustainable Equity Funds Are Outperforming in Bear Market, Morningstar, March 2020
8 The Journal of Portfolio Management, MSCI, July 2019
This article was featured in Pensions Aspects magazine June 2020 edition.
Last update: 19 January 2021