Building a sustainable portfolio

In recent years, ETF investors are increasingly asking: how can I build a diversified portfolio that is aligned with my clients’ additional goals and aspirations in sustainability and how does it compare to the current portfolio?

Understanding your current portfolio’s sustainability

The truth is that for many investors, their existing portfolio already holds some sustainable companies that are going to adapt their business practices in response to climate change, ones that are adapting their business practices to increase boardroom diversity, or simply companies that are managing governance issues.

Consider the following illustrative example: an investor owns a diversified portfolio with a 60/40 growth/defensive mix, which includes a blend of domestic and developed market equities exposures alongside a blend of domestic and international bonds. Using indices as proxies for each asset category, that portfolio could look like this:

Portfolio 1: Hypothetical Original Portfolio

Portfolio 1: Hypothetical Original Portfolio allocation

This information should not be relied upon as research, investment advice or a recommendation regarding the Funds or any security in particular. This information is strictly for illustrative and educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.

Understanding Sustainable Portfolio solutions

We can broadly group portfolio solutions on the sustainability spectrum into the categories of ‘Avoid’ and ‘Advance’ as a way of navigating the various sustainable investing styles:

  • ‘Avoid’ is about minimising or eliminating exposure to certain companies or sectors associated with negative ESG characteristics that could pose reputational or other related risks, or which violate the asset owner’s values.
  • ‘Advance’ is about increasing exposure to positive ESG characteristics. This might include using ESG scores as an additional layer in the traditional investment process or focusing on a specific outcome

For more information visit our Sustainable Investing Hub

iShares offers a broad range of index ESG exposures that investors can use as sustainable portfolio building blocks. The following is a list of Australian domiciled sustainable exposures currently available:

Fund

Type

Benchmark

Sustainable investing style

iShares Core Corporate Bond ETF

ETF

Bloomberg AusBond Credit 0+ Yr Index

Avoid*

iShares Yield Plus ETF

ETF

Bloomberg AusBond Credit and FRN Ex Big 4 Banks Index

Avoid*

iShares ESG Australian Bond Index Fund

Managed Fund

Bloomberg Barclays MSCI Australian Socially Responsible (SRI) and ESG-weighted Index

Advance

iShares ESG Global Bond Index Fund

Managed Fund

Bloomberg Barclays MSCI Global Aggregate SRI Select ex-Fossil Fuels index (AUD hedged)

Advance

iShares Core MSCI World ex Australia ESG Leaders (AUD Hedged) ETF

ETF

MSCI World Ex Australia Custom ESG Leaders Index 100% Hedged to AUD

Advance

iShares Core MSCI World ex Australia ESG Leaders ETF

ETF

MSCI World Ex Australia Custom ESG Leaders Index

Advance

iShares Core MSCI Australia ESG Leaders ETF

ETF

MSCI Australia IMI Custom ESG Leaders Index

Advance

* The fund tracks a non ESG Benchmark but incorporates Blackrock baseline screens.

Seeking greater portfolio sustainability

For the purpose of illustration, we have built an equivalent 60:40 portfolio to our prior example, using the indices as proxies for the Australian domiciled sustainability-focused exposures.  Consider the following example:

Portfolio 2: Sustainable Portfolio Example

Portfolio 2: Sustainable Portfolio Example allocation

This information should not be relied upon as research, investment advice or a recommendation regarding the Funds or any security in particular. This information is strictly for illustrative and educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.

Comparing the example Portfolios

ESG Improvement

When we examine these two portfolios side by side, it is apparent that the new, more sustainable comparable portfolio achieves an improvement in MSCI ESG Quality1 Score and a reduction in carbon intensity (shown below).

MSCI ESG Quality Rating

 

Portfolios side-by-side

 

Original Portfolio

Sustainable Portfolio

MSCI ESG Quality Rating

A (average)

AA (leader)

MSCI ESG Quality Score

5.90

7.89

ESG Coverage (%)

82

95

Carbon Emissions Intensity (tonnes CO2/$m sales)

168

103

Source: MSCI, Aladdin, risk and holdings as at 30 July 2021, ESG data as at 16 August 2021.

Performance and portfolio characteristics

The new ESG portfolio maintains an asset allocation and characteristics that are not unlike the original portfolio. Correlation and tracking error are measures often used to demonstrate the similarity or difference in two exposures, and in this instance, the sustainable portfolio has a relatively high correlation (0.99) and low expected tracking error (1.3%) to the original portfolio.2

Portfolio differences

Correlation

0.99

Tracking Error (%)

1.3

Expected Risk Original Portfolio (%)

7.7

Expected Risk Sustainable Portfolio (%)

7.6

Source: BlackRock, Aladdin ®. Data as at 30/07/2021. Data presented is hypothetical, subject to change and not representative of any funds or investments. Sample portfolios are for illustrative purposes only, and do not represent a recommendation of any security or asset allocation strategy. This analysis serves as a general summary, which is not exhaustive and should not be construed as investment advice

In terms of investment performance, assuming that the portfolios are rebalanced quarterly to the weights shown above and going as far back as the benchmark performance data is available, the sustainable portfolio demonstrates a higher level of returns than the traditional index portfolio. The following is a chart of the cumulative returns on each of the two portfolios:

Comparison graph of portfolio 1 & 2

Source: BlackRock, MPI, Morningstar. Time Period: 06/01/15 - 07/30/21. Data Frequency: month. Currency: AUD.
Past performance does not guarantee futures results. Sample portfolio data shown is for illustrative purposes only and not an actual portfolio. The sample portfolio analysis presented does not represent a recommendation of any security or asset allocation strategy. The sample portfolios returns are based on market offering levels and may vary from the actual performance. Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index.

Concluding remarks

Investment decisions often involve balancing different trade-offs. For instance, a drawback of eliminating exposures to certain companies is that one could be reducing the diversification of their portfolio. This perspective needs to be weighed against the positives, such as the potential for higher quality attributes of companies earning high ESG scores, and the opportunities presented by the transition to a green economy.

Moreover, incorporating an ESG lens into the investment decision-making process can help bolster portfolio management and governance, by taking a more holistic view of risks and opportunities facing a company, beyond the scope of traditional financial analysis. 

The investor would need to consider the various trade-offs, but it is important to reiterate:  the average portfolio is already impacted by sustainable trends. The question is whether, when constructing a portfolio, the investor maximizes the opportunities and manages the risks to adapt to a changing world.