Sustainability in Defined Contribution: What are BlackRock doing?

16-Jul-2020

Capital at risk. This information should not be relied upon as investment advice, or a recommendation regarding any products, strategies. The environmental, social and governance (“ESG”) considerations discussed herein may affect an investment team’s decision to invest in certain companies or industries from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

Last month I wrote on “how to implement Environmental, Social and Governance (ESG) in Defined Contribution (DC)” when thinking about the long term. We received some great feedback from clients on the two main points: that if you believe in the value of sustainable investing, then a long term approach to implementation can be efficient and reduce costs; secondly it is about understanding the materiality of ESG risks that is most important when considering sustainable fund options.

We did however repeatedly receive one question “What are BlackRock doing about it?”

As DC glidepaths have changed through time, and increasingly focused on cost, we have seen that most assets are concentrated in passive equity allocations in the growth phase. What that means is ESG vehicles for these assets tend to be either “Screened” or “ESG” indices driven by ESG data. Both options are credible depending on the outcome investors want, but focus on risk mitigation more than anything else and we continue to build out our range of index investment options to meet these specific investment needs. But if we want to really build a sustainable portfolio for DC investors we need to have conviction that companies better managing their ESG risks and opportunities will outperform their peers over the long term. The challenge is that most ESG data by essence is static or backward-looking.

Over the past two years BlackRock’s Sustainable Investing Team have been developing an ESG scoring framework. Our objective was to deliver ESG investment insights direct to our investment teams. In doing that we focussed on two key things - financial materiality and forward-looking insights.

By financial materiality we mean identifying the E, S or G factors which actually matter and, in an investment sense ensuring you are rewarded when holding those risks. So we focus on those factors that are grounded in academic research and where we have the ability to validate them financially. Some of this research methodology is available on our views on investing for the low carbon transition in the ‘Investing in the Transition to a Low Carbon Economy’ research paper

To understand how companies will fare on ESG in the future requires an understanding of how companies are positioned now but also how they are adapting to the regulatory and technological trends we are seeing. So we add forward looking insights into our framework by also considering the trends companies are demonstrating, and, also through considering our view of future materiality of E, S and G factors to sectors.

As an example, during COVID-19, how companies treat their workforce has become a key topic of debate. We believe culture, and more broadly internal stakeholder management is a very material factor for most sectors. One of the data points we can look at is company diversity but rather than focussing on number of women on a board, we look at the trend a company is on for number of women in management roles. It is that kind of insight that gives us conviction to where a company is going to be in the future.

This scoring framework allows us to then build portfolios based on our ESG insights, but with companies’ long term performance in mind - an investment case that targets both the risk and opportunity. Through our systematic use of data and an optimisation process we can keep costs and tracking error low so as to really build core passive replacement suitable to the DC market, and which feed into the importance of long-term investment horizons of growth phases.

Conclusion

BlackRock has always been first and foremost an investment manager, we are proud of our history in managing risks over the long term and of technological innovation through Aladdin. By combining those two aspects of our DNA we have developed a framework to aid our own managers and one that is agile enough to incorporate new trends and research– ensuring its natural evolution and continued innovation. With that we believe we can deliver something both credible and accessible for DC investors seeking ESG options.

Risk: While proprietary technology platforms may help manage risk, risk cannot be eliminated.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy.