GLOBAL INSIGHTS - FOR QUALIFIED INVESTORS

Sustainable investing: a “why not” moment

09-May-2018
By BlackRock Investment Institute

We have moved from a “why?” to a “why not?” moment in sustainable investing. Drawing on the insights of BlackRock’s investment professionals, we show why we believe it is feasible to create sustainable portfolios that do not compromise return goals and may even enhance risk-adjusted returns in the long run.

Strong ESG performers tend to exhibit operational excellence — and are more resilient to perils ranging from ethical lapses to climate risks. ESG data are still incomplete, largely self-reported and not always comparable — and we advocate for greater consistency and transparency. Yet breadth and quality have improved enough to make ESG analysis an integral part of the investment process.

Sustainable investing summary

  • We find ESG can be implemented across most asset classes without giving up risk-adjusted returns. ESG and existing quality metrics such as strong balance sheets have a lot in common. This implies ESG-friendly portfolios could underperform in “risk-on” periods — but be more resilient in downturns.
  • New benchmarks and products are making ESG investing more accessible across asset classes and regions. Data are improving, but still patchy: This means it is key to go beyond headline ESG scores for insights. Understanding how and why individual score components can affect returns across countries, industries and companies is key. 
  • Early evidence suggests that focusing on ESG may pay the greatest dividends in emerging markets (EMs). Shareholder protections, natural resources management and labour relations can be critical performance differentiators. A new suite of ESG-friendly EM debt indexes could help steer more capital into ESG leaders over time.
  • BlackRock is engaging with companies on sustainability issues, not to impose our own values, but to advocate for ESG excellence on behalf of clients. We also advocate for more consistent, frequent and standardised reporting of ESG-related metrics with data providers, companies and regulators.

Equity snapshot

Do equity investors need to choose between returns and ESG? Our answer: No. We looked at traditional equity indexes alongside ESG-focused versions. Highlights are outlined in the No sacrifice required? table. Annualized returns since 2012 matched or exceeded the standard index in both developed and emerging markets, with comparable volatility. EMs were the standout.

no-sacrifice-required-chart

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from MSCI, April 2018. Notes: the data covers the period from May 31, 2012, to Feb. 28, 2018. Returns are annualised gross returns in US dollar terms. Number of stocks, price-to-earnings ratio and dividend yield are monthly averages. Indexes used are the MSCI USA Index, MSCI World ex-US Index, MSCI EM Index (“Traditional” columns) and MSCI’s ESG-focused derivations of each (example: MSCI USA ESG Focus Index). The MSCI ESG Focus indexes use back-tested data. They are optimised to maximise ESG exposure within certain constraints (example: a tracking error of 50 basis points and maximum active weight of 2% for each index constituent in the case of the USA ESG Focus).
See important notes in the disclosure below.

ESG comes to EMD

New ESG indexes in EM debt — a collaboration between J.P. Morgan and BlackRock — could prompt greater capital allocation to more ESG-friendly issuers over time, we believe. The Sustainable sovereigns chart shows country weights in the new JESG EMBI Global Index versus its standard counterpart. Gaps in ESG performance across countries lead to meaningful shifts in index weights — and perhaps investment flows. Example:  A large drop in China’s country weight could lead to selling of its bonds as investors adopt the new index.

sustainable-sovereigns-chart

Sources: BlackRock Investment Institute, with data from J.P. Morgan, April 2018. Notes: the chart shows country weights in the JESG EMBI Global Index versus its standard counterpart: the JPMorgan EMBI Global Diversified Index, as of April 19, 2018. The countries with the six largest weights in the JESG EMBI Global are shown, plus China, the country with the largest weighting difference between the two indexes.

Less is more

Subsets of ESG metrics can point to revealing trends. Take self-reported carbon emissions. We find global companies that have reduced their carbon footprints (annual carbon emissions divided by sales) the most every year have outperformed the carbon laggards. See the orange line in the Carbon efficiency chart. Why? Companies that find ways to make more with less tend to be more efficient.

Equity-performance-by-carbon-intensity-chart

Past performance is no guarantee of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, Thomson Reuters Asset4 and MSCI, April 2018. Notes: the analysis above calculates the carbon intensity of global companies in the Asset4 database by dividing their annual carbon emissions by annual sales. Companies are ranked and bucketed in five quintiles based on their year-over-year change in carbon intensity. We then analyse each quintile’s stock price performance versus the MSCI World Index. Most improved means the 20% of companies that posted the greatest annual decline in carbon intensity. Data is from March 2012 through March 2018. The example is for illustrative purposes only.

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Important notes: Unless otherwise noted, index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Data for time periods prior to the index inception date is hypothetical and is provided for informational purposes only to indicate historical performance had the index been available over the relevant time period. Hypothetical data results are based on criteria applied retroactively with the benefit of hindsight and knowledge of factors that may have positively affected its performance, and cannot account for risk factors that may affect the actual portfolio performance. The index sponsor may make methodology change from time to time based on its own policies and procedures. Index methodology is available upon request. Back tested data is calculated by individual index providers and used in analysis until live index data is available. This analysis uses back tested data from MSCI and Thomson Reuters.

MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. There are no assurances that the hypothetical portfolio’s objectives will be met. Additionally, there are frequently sharp differences between a hypothetical performance record and the actual record subsequently achieved. Another inherent limitation of these results is that the allocation decisions reflected in the performance record were not made under actual market conditions and, therefore, cannot completely account for the impact of financial risk in actual portfolio management. The performance shown does not represent any existing portfolio, and as such, is not an investible product.

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