Almost all of my clients want to do more about climate change. They are sick and tired of watching devastating fires burn wild swathes of land and burning homes here in Washington State and elsewhere. They are disgusted learning of the likelihood of koala bears being added to a list of endangered wildlife facing extinction.
These clients often demonstrate their support through charitable contributions and donations, which at times doesn’t feel like enough. They would like to do more; they want to allocate their investment capital for purpose and profit.
If this describes you, please know that you are not alone. I want to tell you about an interesting development that happened last week.
Last week, BlackRock CEO Larry Fink announced that his firm has made a dramatic change in investment philosophy and now will be emphasizing Environmental, Social, and Governance (ESG) criteria to all their asset allocation and valuation decisions.
For example, BlackRock will be exiting all their investments with greater than 25% of revenues derived from thermal coal. The fundamental rationale behind this major move is that BlackRock views ESG issues, such as climate change, as an investment theme that is as big, or likely bigger, than the baby boom in the 50s. In the past, BlackRock has been very active in the Task Force on Climate-related Financial Disclosure (TCFD) and adopting Sustainability Accounting Standards Board (SASB) methodologies that promote quantifiable disclosures of pertinent ESG related matters.
It is BlackRock’s thesis that increased ESG risks are a secular trend that will force a re-allocation of global capital and create significant relative price changes in financial assets. Here’s what this Wall-Street-speak means in common English: companies that integrate sustainable values into their business models will outperform in the future. Therefore, if you analyze your investments selection through the ESG lens, your portfolios will as well.
While there are implementation issues with this strategy (for instance, BlackRock will still be one of the world’s largest investors in oil & gas), many view it as a step in the right direction. In my eyes, this move is important for several reasons.
BlackRock Is Big.
BlackRock is the world’s largest asset manager, with approximately $7 billion in active and passive assets under management. On its own, BlackRock carries a lot of weight – and people listen. This move represents a major, strategic repositioning for the firm. This is not marketing fluff. BlackRock has already changed their recommended allocations to incorporate ESG criteria. These allocation benchmarks are the basis on which their future investment performance will be measured. The company plans to double the number of ESG products they offer to 150 in the next year. If ESG branded investments become popular, other competitors must follow to stay competitive.
Taking a “Carrot and Stick” Approach to This Issue.
Fink’s primary “carrot” pitch here is that companies that follow ESG criteria will outperform in the future, as sustainability is directly linked to investment returns. I believe that this message is going to have significant practical appeal to many investors.
BlackRocks’ stick is looming visibly in the background. In an open letter to CEOs, Fink states that this year (2020), he is asking companies that “we invest in” to publish disclosures in line with SASB guidelines and disclose climate-related risks in line with TCFD criteria by the end of the year [my emphasis]. In the next paragraph of this letter, he writes: “We [BlackRock] believe that when a company is not effectively addressing a material issue, its directors should be held accountable. Last year BlackRock voted against or withheld votes from 4,800 directors at 2,700 companies. Where we feel companies and boards are not producing effective sustainability disclosures or implementing frameworks for managing these issues, we will hold board members accountable.”
I believe this message is very clear, and CEOs, and their board members, will pay attention.
ESG is not SRI.
Environmental, Social and Governance (ESG) investing is different from Socially Responsible Investing (SRI).
At its core, ESG is about higher long-term investment returns. The thesis is that companies that don’t address looming ESG risks will be unprepared for the future and ultimately underperform. For instance, seaside municipalities that do not have a plan to address the physical infrastructure for rising ocean levels may be a higher investment risk than those that have a plan to address these same risks.
SRI investing, on the other hand, is values-based. Investors who invest on SRI criteria are willing to sacrifice higher returns in order to meet a values driven investment criteria. While both methodologies have merit, between the two, I believe ESG will have much wider investor appeal.
ESG Investments Outperformed in Last 1-year & 2-year Periods.
BlackRock’s ETF (SUSA) that invests in ESG companies outperformed the other comparable ETFs in the “Large Blend “asset class. In this case, I compared the two largest ETFs in the category, Vanguard’s Total Market – VTI and Vanguard’s S&P 500 – VOO. As of 1/17/2020, the one-year performance of SUSA was +27.99% vs. +26.23% for VOO vs. +25.10% for VTI.
The SUSA’s two-year performance of +48.9% bested VTI’s +44.4% and VOO +46.6%.
This is a limited data set, though, and is in part due to a lower exposure to oil stocks which underperformed during this period. The Wall Street Journal has reported that other ESG benchmarks have underperformed at comparable benchmarks over longer periods of time. In any case, I believe that this trend bears watching.
If you have questions about how you should be incorporating ESG thinking into your investment portfolios, call me and we can chat about what may be an appropriate strategy for you.