A pivotal moment for sustainable investing

Brian Deese| Mike Pyle| Teresa O’Flynn| Thomas F. Callahan |May 18, 2020

Like all investment strategies, those focused on delivering exposure to positive environmental, social and governance (ESG) characteristics, in addition to financial returns, have been tested by the coronavirus crisis.

To gauge how these strategies have held up, and what may be in store for ESG investors when we exit the crisis, Mike Pyle, Global Chief Investment Strategist for the BlackRock Investment Institute, hosted a Market Pulse Call with Brian Deese, Global Head of Sustainable Investing; Teresa O'Flynn, Global Head of Sustainable Investing for BlackRock Alternative Investors; and Thomas Callahan, Head of BlackRock's Global Cash Management Business.

Following are highlights of their conversation.

Investors have been under incredible strain this year—has the pandemic shaken their beliefs about the importance of sustainability?

Quite the contrary. In the first quarter of 2020, we saw $44 billion in net inflows globally into sustainable strategies, which is the largest-ever quarterly inflow. And of course, this happened in a period when many traditional strategies were experiencing massive outflows. So, we think it’s safe to say that the response from investors has amplified how important they believe sustainability is in generating long-term value, regardless of how markets are behaving in the short term.

We echo that belief and have strong convictions around both the value of sustainability and its importance in increasing portfolio resilience over the long term.  We made a commitment in January to significantly expand our set of sustainable strategies to support our broader goal of democratizing access to sustainable investing. This is really all about making sure that wherever and whenever asset owners want to go sustainable, we can make it as easy as possible for them to do so.

Before the crisis, a large percentage of the ESG conversation was centered around the E—environmental factors, including climate change. Has that changed?

We’ve certainly seen social and governance concerns come to the fore. On the social side, the data coming from the customer base globally really underscores that people are looking for companies that are demonstrating, with actions not just words, that the health and safety of their employees and communities is paramount.  Companies that were stronger in those areas have been rewarded, and we anticipate that to continue going forward.

Regarding governance, there is a set of issues that is becoming more prominent and that we believe will become increasingly important as the response to the crisis evolves. In particular, the issues of dividends, stock buybacks and compensation. Governments globally are putting restrictions on companies that are seeking crisis assistance. We believe that in addition to these restrictions, there will also be increased stakeholder pressure on companies to prioritize managing these issues in a way that is reflective of the pain being felt across the economy.  And that as we come through this crisis, there will be a lasting focus and pressure on these governance issues as well. 

All of that is not to say that the environmental-related issues and the climate issues are less relevant. In fact, this crisis really underscores how devastating a global physical threat like a health pandemic is, and there are clear parallels between the effects of the pandemic and the potential impact of large-scale climate changes.

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There are clear parallels between the effects of the pandemic and the potential impact of large-scale climate changes.

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For ESG-minded alternative investors, renewable power has been an important asset class. How is the collapse in global energy demand affecting renewables?

We've certainly seen a dampening in electricity demand, as a result of travel restrictions, reduced activity in commercial and leisure sectors, and a slowdown in manufacturing.  But we believe these are short-term disruptions that won’t have any lasting impact on the long-term drivers of supply and demand in the renewable power market.

The world is increasingly relying on electricity as a source of energy, and its share of total energy demand is expected to grow from about 20 to 45 percent by 2040, according to the International Energy Agency. Meanwhile, the cost of wind and solar equipment has declined dramatically over the last five to 10 years—solar photovoltaic capital costs have fallen by 85% and onshore wind costs by 49% since 2010, according to Bloomberg New Energy Finance. Wind and solar are very cost-effective sources of power and are very well-positioned to help meet global carbon-reduction goals.

And the resilience of sustainability factors is evident in private renewable power infrastructure strategies. While many infrastructure sectors are GDP driven, renewables are a less economically sensitive asset class. The main return driver, wind and solar resources (i.e., “the weather”), is completely uncorrelated to general market factors including Covid-19, which highlights the diversification benefits of the asset class.

What about renewables projects that are currently under construction? Are Covid-19 and related supply chain disruptions affecting them?

In terms of supply chain disruption, it's important to highlight that China plays a key role in the supply chain for wind and solar power generation equipment as well as for lithium ion batteries, which are used in battery storage systems. China also plays a leading role in providing some of the materials required for construction, such as cranes and steel structures. So, disruptions of global supply chains certainly are having an impact on milestone delivery and completion dates for greenfield renewable projects.

But overall we're seeing strong evidence of the resilience of renewable power as an asset class during these times.  It's also important to point out that banks have generally remained willing to lend to new projects.  Deals that had been under negotiation pre-crisis are generally closing on the original terms.  We've seen a slight widening of spreads for new transactions, but this has been offset to some degree, or entirely, by a tightening of the underlying base rates. 

With construction projects, lenders are understandably spending more time looking at underlying schedules and trying to assess any Covid-related construction and equipment supply risks, but they are applying appropriate protective terms rather than abandoning transactions.

Maintaining ample cash has been top of mind for many investors throughout this crisis—how have sustainable cash strategies weathered the storm?

Some investors may be surprised to hear that there are ESG cash strategies, because it's really a new segment that just launched in early 2019.  But it was one of the big growth stories in the cash markets in the last year: as an industry, we essentially went from zero ESG money funds to nearly $30 billion. We think one of the reasons that ESG cash strategies were so well received is that they don’t force investors to make a “value-versus-values” tradeoff. They offer similar or equal yields as non-ESG strategies, but they have a credible and authentic sustainability framework and risk methodology.

Of course, when this crisis kicked in and the Fed announced an emergency 100 basis point rate cut in March, we saw wholesale outflows from institutional prime money funds, including ESG funds. This was not the reaction the Fed was hoping for, but it responded with a series of programs including the Money Market Mutual Fund Liquidity Facility to re-liquify and stabilize money markets.

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ESG cash strategies don’t force investors to make a value-versus-values tradeoff.

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When the dust settled, we looked at AUM across the money market landscape to see how ESG strategies fared relative to traditional strategies during what was essentially a market seizure. And frankly, we were a little bit shocked when we first looked at the data.  Not only did clients not run from green funds, they continued to allocate money. While institutional prime funds in the U.S. are still down approximately $100 billion in AUM, ESG funds have gained AUM.

We think the reason for this increase is that investors recognize the additional resilience ESG can provide. Many ESG issues tend to play out over the long term, but this crisis has pulled some of these risks forward, and companies with better credentials are proving more resilient. By adding ESG as a consideration in credit analysis and portfolio construction, short-term investors were largely able to avoid forced selling and extreme volatility.

Looking ahead, there is approximately $4 trillion sitting in government funds, and a month from now it looks as if those funds could be yielding zero, as we saw in the aftermath of the global financial crisis. As investor sentiment moves away from fear and back toward looking to improve returns on cash, we expect to see further adoption of strategies like ESG that can offer enhanced risk management, potential for improved return and a view toward values.

Any other surprises that have come out of the crisis and any parting thoughts about the future of sustainable investing?

Another thing that may surprise a lot of people is that if you look at the resilience of ESG strategies in the current downturn, it's not principally an energy story. While there are strategies that specifically screen for fossil fuel related companies, there are many ESG strategies that take a sector-neutral approach.  When you isolate the attribution of the outperformance for those sector-neutral ESG strategies, you see that there is something beyond the energy piece that is driving resilience.

Looking ahead, as institutions are reallocating back into risk assets, we think this will be a pivotal time for sustainable investing. The breadth and the quality of sustainable strategies, including building blocks like ESG cash offerings, are much greater than they were even one or two years ago. It’s now possible to embed sustainability throughout the portfolio construction process, and we think that the performance of sustainable strategies throughout this crisis is going to give them a tailwind moving forward. And the fact that almost all (94%) of the attendees to this call that answered our polling question believe that sustainability will become more important coming out of the pandemic lends credence to that view.

Mike Pyle
Global Chief Investment Strategist for the BlackRock Investment Institute
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Brian Deese
Global Head of Sustainable Investing
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Teresa O’Flynn
Global Head of Sustainable Investing for BlackRock Alternatives Investors
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Thomas Callahan
Head of BlackRock's Global Cash Management Business
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