Insights

Here to stay

Feb 22, 2021
  • Dennis Lee, Market Insights Lead

In a week when typical market dynamics were upended, you could be forgiven if you missed BlackRock CEO Larry Fink’s annual letter to CEOs. But while the latest market game has us daydreaming about the next lottery ticker, the leader of the world’s largest asset manager flagged the importance of something more … sustainable.

Learning your letters

A quick recap: Fink’s annual letter tradition started in the wake of the financial crisis and has become an influential piece in the corporate world. The letter from 2019 reminded CEOs that profit and purpose are inextricably linked, and declared that companies should serve not just shareholders but all stakeholders. By August of that year, the Business Roundtable consisting of 181 CEOs of leading U.S companies signed a declaration outlining a shared commitment to customers, employees, suppliers, communities, in addition to shareholders. If you want to sound fancy at your next cocktail party,* make sure you ask someone what they think of this groundbreaking shift toward “stakeholder capitalism.”

*For those that may have forgotten, a cocktail party is a large social gathering in which friends and acquaintances gather in person to enjoy mixed drinks and converse in close proximity to each other.

A year later, Fink’s 2020 letter warned that climate change will be a defining factor in companies’ long-term prospects. Delta, BP, and Microsoft were just a few of the companies that announced sweeping climate-related efforts in the months following.

A sustainability premium

The 2021 letter doubles down on the messages from the previous years. It highlights the heightening urgency of investment risks related to climate change, while also highlighting that the climate transition presents a historic investment opportunity. And it re-emphasizes the theme of purpose – how companies should benefit all stakeholders.

Things get very interesting when Fink goes on to write:

“During 2020, 81% of a globally-representative selection of sustainable indexes outperformed their parent benchmarks1… (And) within industries – from automobiles to banks to oil and gas companies – we are seeing another divergence: companies with better ESG profiles are performing better than their peers, enjoying a “sustainability premium.” 2

A good ESG rating has pointed to better performance

A good ESG rating has pointed to better performance

BlackRock, from 1/1/2018 – 12/31/2020. Cumulative Total Return of MSCI USA Index and MSCI ESG-rated AAA and CCC companies within the MSCI USA Index (99.80% MSCI ESG coverage). Underlying stock ESG Rating data from MSCI ESG research and performance data from MSCI. As of 12/31/2020, there were 18 securities in the MSCI USA Index rated AAA and 8 securities rated CCC, out of 621 total in the MSCI USA Index. The MSCI ESG Rating is calculated as a direct mapping of ESG Quality Scores to letter rating categories (e.g. AAA = 8.6-10). The ESG Ratings range from leader (AAA, AA), average (A, BBB, BB) to laggard (B, CCC). For further details regarding MSCI's methodology, see the end of this document. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Learning your ESGs

OK, let’s back it up. What is sustainable investing exactly? What does purpose have to do with it? Are we not just talking about investing with a carbon-free lens?

In short, sustainable investing is defined by incorporating environmental, social, and governance insights (or ESG, for short). Companies are scored by ESG research and rating agencies like MSCI across a broad set of attributes, such as pollution and waste (Environmental), data privacy and health and safety of employees (Social), and board independence and accounting practices (Governance).

But sustainable investments consider both traditional analysis (e.g. corporate earnings, balance sheets) and ESG analysis. Consider a hypothetical situation in which two companies that have the same exact characteristics according to traditional measures, but differ on E, S, and G factors (see below). Which one would you expect to perform better?

An additional lens

An additional lens

For illustrative purposes only.

Sustainability is here to stay

The connection between purpose and sustainability is the larger point here – that what is good for the environment and for all stakeholders, can be good for profit.

And sustainability is moving from a niche category to one that will define the years to come. From January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets, a 96% increase over the whole of 2019.3 The advent of sustainable investing is akin to the introduction of organic apples. It’s a robust market that’s here to stay.

Bottom line

Whatever your views on the future, one theme that unifies all investors is the desire for long-term success. Sustainability goes beyond incorporating climate risks. It’s based on the belief that Fink outlines in his letter – that “the companies that seek to build long-term value for their stakeholders – will help deliver long-term returns to shareholders and build a brighter and more prosperous future for the world.” And it’s a theme that is likely to endure after the latest market games stop.