Sustainable is both attainable and explainable

May 21, 2020

The economic outage to contain the spread of Covid-19 has forced companies and whole industries to rapidly adapt to sharp falls in demand and a more uncertain future. The emergency response to the pandemic has led many of us to reassess how we lead our daily lives and has prompted wide-ranging behavioral changes – some welcome, some forced – that will likely endure even after life returns to normal.

We may commute less, socialize online more, shift some of our consumption online, and hold more cash for a rainy day than before. These behavioral changes will likely accelerate many preexisting structural trends, challenging some business models and revenues, while boosting others.

One investing trend that is clearly receiving a boost as investors come to terms with the coronavirus shock is sustainable investing. Sustainability has delivered better risk-adjusted performance throughout the crisis than the broad market and, looking at indices over nearly a decade, exhibits similar, if not better, results than found in traditional equity investments in Canada, other developed markets and emerging markets (see the chart below). This has attracted inflows but the assets under management in sustainable funds remains small. In Canada, sustainability has doubled from just over C$5 billion in 2014 to over C$10 billion today, according to data from Bloomberg and the Investment Funds Institute of Canada (see the second chart below).

Sharpe ratio for ESG best-in-class vs. traditional indexes, 2011-2020

Chart: Sharpe ratio for ESG best-in-class vs. traditional indexes, 2011-2020

Source: BlackRock Investment Institute, with data from Refinitiv Datastream and MSCI, as of 13 May 2020.
Notes: The data covers the period from 1 January 2011 to 13 May 2020. Returns are annualized gross total returns in local currency. Indexes used are the MSCI World ESG Leaders Index, MSCI Emerging Markets ESG Leaders Index, MSCI Canada ESG Leaders Index (“ESG leaders" bars), MSCI World Index, MSCI Emerging Markets Index, and MSCI Canada Index (“traditional” bars). We use the US. and Canadian 3-month treasury bill as the risk-free proxy for developed markets and Canada, respectively. We assume a risk-free rate of zero for emerging markets. Past performance is not a reliable indicator of future results. It Is not possible to invest directly in an index.

AUM of Canadian sustainable investing funds, 2014-2019

Chart: AUM of Canadian sustainable investing funds, 2014-2019

Source: BIackRock Investment Institute, with data from Bloomberg and the Investment Funds Institute of Canada, as of December 2019.
Notes: The chart shows the total assets under management for Canadian- domiciled sustainable mutual funds and ETFs.

Unsurprisingly, investors are closely following how companies are managed during the coronavirus and how they treat their employees, customers and the communities within which they operate. Increasingly, this “social license to operate” extends to the public policy sphere. Corporations, especially those receiving relief funds to manage cash-flow and liquidity problems, face greater scrutiny from regulators and policymakers on a wide-range of sustainability concerns: balance-sheet management, dividend payments, share repurchases, climate change-related disclosures and executive pay. Canada’s Large Employer Emergency Financing Facility announced early last week imposes many of these same constraints on businesses that receive federal support.

Investors are not only looking to hold companies with strong environmental, social and governance scores for their operational excellence and to potentially align their values with their investing goals, but there is also evidence that the trend to divest companies with large carbon footprints is also gaining momentum. This has serious implications for Canadian energy companies. Just last week, the world’s largest sovereign wealth fund in Norway announced that it will divest and blacklist four of Canada’s largest energy producers (Suncor, Canadian Natural Resources, Cenovus, and Imperial Oil) for not meeting its emissions criteria. A Stanford study published in the August 2018 edition of “Science” ranked Canada’s oil output the fourth most carbon-intensive of 90 countries surveyed. This move adds fuel to the fire for a Canadian oil industry already plagued by numerous acute and structural challenges: a lack of takeaway capacity made potentially worse on Monday when U.S. presidential hopeful Joe Biden pledged to block the Keystone XL pipeline project, increasing pressure on governments globally to tackle climate change, and tightening access to capital.

Flows into sustainable assets are still in their early days, and we believe that the full consequences of a shift to sustainable investing are not yet in market prices. The trend to sustainable investing may have even been accelerated by the pandemic. This implies a return advantage may be gained over the long transition as we note in our report: Sustainability: the tectonic shift transforming investing.

Kurt Reiman
Kurt Reiman
Senior Strategist for North America, BlackRock
Kurt Reiman, Managing Director, is a member of the BlackRock Investment Institute (BII) and Senior Strategist for North America. In this role, Kurt contributes to the ...