GLOBAL WEEKLY COMMENTARY

Tectonic shift to sustainable investing

Key points

Long-term trend
Investors should keep a long-term perspective amid market volatility, including a focus on portfolio resilience through sustainable investing.
Policy action
Historic U.S. policy actions, including over $2 trillion in fiscal support and a raft of Federal Reserve measures, helped calm markets.
Data watch
This week’s data are likely to show further signs of economic damage caused by the coronavirus outbreak and containment measures.

It’s important to keep a long-term perspective amid market volatility – such as the extraordinary moves of recent weeks. One enduring trend we see is a move to sustainable investing: a structural shift in investor preferences leading to large and persistent flows into assets perceived as more resilient to sustainability-related risks such as climate change. Investors rebalancing portfolios after the risk asset selloff may consider leaning into sustainable assets.

The rising tide of sustainable investing

A long-term perspective is key to navigating market volatility. One enduring trend: sustainability. Our latest episode of the BlackRock Bottom Line talks about how money has continued to move into sustainable assets this year through the market selloff.

  • Transcript

    It’s important that investors keep a long-term perspective during market volatility. One long-term theme: sustainable investing. 

    The BlackRock Bottom Line: The rising tide of sustainable investing

    Changing investor preferences are leading to increased investment into sustainable assets. Fund flows in 2020 offer a miniature version of this shift. Money has consistently flowed into sustainable exchange-traded-funds (ETFs) this year. But traditional ETFs have seen heavy outflows in the market selloff. Flows to sustainable funds are still very small compared with flows to traditional funds, but we are seeing evidence of a structural shift toward sustainable investing. We see portfolio rebalancing after recent selloffs in risk assets as an opportunity to substitute some traditional assets with sustainable ones. The Bottom Line: Flows into sustainable assets are still at the beginning, and we believe markets aren’t pricing in a shift to sustainable investing yet. Investors holding sustainable assets may gain a return advantage over the long transition.

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Chart of the week
Net inflows to global sustainable and traditional ETFs, 2020

Net inflows to global sustainable and traditional ETFs, 2020

 

Source: BlackRock Investment Institute, as of March 25, 2020. Notes: Global sustainable ETFs as any exchange-traded funds that pursue a dedicated sustainable objective, whether using a broad ESG, thematic, impact, or exclusionary strategy. Traditional ETFs are any other ETFs that are not directly focused on sustainability.

We see a sustainable investing wave playing out in financial markets over the coming decades, remaking economies and industries as capital is reallocated to sustainable assets. This year’s fund flows may offer a miniature version of this shift. Sustainable exchange-traded funds (ETFs) have kept attracting assets this year, while traditional ETFs have seen heavy outflows in the market selloff. See the chart above. Net inflows into sustainable ETFs totaled $14 billion as of March 24, already more than half of 2019’s full-year figure, our data showed. To be sure: The total assets under management of sustainable ETFs are just 1% of that of total ETFs, and flows to sustainable funds are still very small compared with those to traditional funds. Yet the growing interest offers a glimpse of what may lie ahead: a significant structural shift toward sustainable investing, driven by broad societal preferences. As a result, we see portfolio rebalancing in the current environment as an opportunity to substitute some traditional assets with sustainable ones, with an eye on potential long-term benefits.

How should we expect sustainable investing strategies to perform over the long term? Skeptics have long argued the following: 1) Financial markets are efficient, so if sustainability matters it should already be reflected in market prices; 2) if investors care about sustainability, they should be willing to accept lower returns by paying a premium for “green assets”; 3) conversely, investors will earn a greater return as compensation for owning higher-risk “brown assets.” This logic leads to the conclusion that we can simply ignore sustainability: Tilting toward green assets will be costly and owning brown assets will offer relatively higher expected returns. We disagree.

Why? Financial markets are imperfect at pricing information about the far-off future, even when the structural shifts are well understood. Think of slow-moving demographic trends such as population ageing and its implications for asset prices. When we complete the transition to a low-carbon economy in which sustainability will be fully embedded in marketing pricing, assets backed by high sustainability will be more expensive – while other assets will have become cheaper or disappeared altogether, in our view. Sustainable assets should earn a return benefit during the long transition to this state, in addition to greater resilience against risks such as physical disruptions from climate change. This implies the conclusion that sustainable investing requires sacrificing returns is a myth, in our view. Sustainable investing will likely carry a return advantage over years and decades, as we detail in our recent paper Sustainability: the tectonic shift transforming investing.

This phenomenon could already be playing out to some extent this year. We studied the performance of the MSCI World SRI Select Reduced Fossil Fuels Index as a proxy for sustainable global equities since late January, when China first acknowledged the coronavirus outbreak. This index outperformed its parent (MSCI World) over the period, likely due to its reduced exposure to the hard-hit energy sector. Our analysis of MSCI’s back-tested data suggests the index outperformed during the market selloffs of mid-2015 and the fourth quarter of 2018. Moreover, other broad ESG equity indexes slightly outperformed their traditional counterparts in developed equity markets over the recent market plunge, we find.

Bottom line: 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. This implies a return advantage may be gained over the long transition.

Stimulus surge
The focus is on how fiscal and monetary policy can support the eventual restart of the economic activity.
Learn more Learn more

Assets in review
Selected asset performance, 2020 year-to-date and range

Selected asset performance, 2020 year-to-date and range

 

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 Refinitiv Datastream, March 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.

Market backdrop
Fiscal and monetary policy action to bridge the economic impact of the coronavirus is starting to take shape as the outbreak and related containment measures propagate across the globe. The past week’s historic U.S. policy actions initially helped stabilize markets. We believe they are paving the road for an eventual – and strong – economic and market rebound, once we better understand the scale and impact of the outbreak.

Week ahead
Mar. 31 – Flash purchasing managers’ index (PMI) for the euro area, U.S., UK and Japan
Apr. 1 – Manufacturing PMI for the euro area, U.S., Japan, South Korea
Apr. 2 – European Central Bank General Council meeting; U.S. factory orders
Apr. 3 – U.S. nonfarm payrolls, ISM non-manufacturing PMI

Markets will keep an eye out for more signs of the impact of the pandemic disruption on growth, from manufacturing activity to consumer confidence. Last week’s flash PMI data for a number of economies including the U.S. and euro area hit record lows, showing the sharp contraction in activity that we had expected. We see activity ultimately returning with limited permanent damage – with the help of an overwhelming fiscal and monetary policy response.

Directional views
Six to 12-month tactical views on major global assets from a U.S. dollar perspective, March 2020

Directional View

Note: This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, March 2020

Granular View

Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

 

Read details about our investment themes and more in our 2020 Global outlook.

Activity standstill

 

Public health measures to combat the coronavirus outbreak are bringing economic activity to a near standstill and look set to cause a sharp contraction in economic growth in the second quarter.

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    • We expect economic activity to ultimately return with limited permanent damage as long as authorities deliver an overwhelming fiscal and monetary policy response to bridge businesses and households through the shock.
    • The U.S. will likely prove more resilient than many other developed economies because of a smaller share of manufacturing in its GDP, a relatively high share of healthcare spending and an aggressive policy response.
    • We expect a recovery in activity once disruptions dissipate, but their depth and duration are highly uncertain. This could weigh on consumption and investment.
    • The main risk to our view: a broadening of the outbreak is not met with a decisive policy response, causing lasting damage to the economy.
    • Market implication: We are sticking to benchmark holdings on an asset class level and favor rebalancing into the risk asset decline.
Bold policy action

 

U.S. policymakers have announced a fiscal package of more than $2 trillion and the Federal Reserve has launched extraordinary measures to cushion the economic and market impact. The fiscal package – larger than that delivered in the global financial crisis – includes measures we had advocated: “going direct”, or relieving the cash flow pressures facing households and businesses – especially smaller firms – with direct cash payments Read our bulletin on the historic policy response.

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    • Fiscal policy is the frontline of policy action and should focus on boosting public health measures and alleviating potential cash flow crunches through liquidity bridges. The U.S response follows coordinated fiscal and monetary action in Australia, Canada and the UK, and a patchwork of fiscal relief supported by monetary policy in the euro area.
    • The critical focus of central banks is alleviating the dysfunction of market pricing and tightening of financial conditions. Besides the Fed, The European Central Bank put together a bold response after its communication mishap earlier, launching a €750 billion bond buying program. European officials may also activate the European Stability Mechanism on relaxed terms to free up even more bond-buying capacity.
    • Market implication: Coupon income is crucial in an even more yield-starved world. Selected equity sectors offer attractive dividend income versus comparable investment grade credits.
Resilience rules

 

The valuations of developed government bonds look stretched in light of our economic outlook, but we still see them providing diversification – albeit less so with some yields near levels we consider to be their lower bounds. The recent bounce in Treasury yields off record lows illustrates the risk of snapbacks.

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    • A focus on sustainability can help make portfolios more resilient. We believe the adoption of sustainable investing is a new phenomenon that will carry a return advantage over years and decades.
    • Market implication: We prefer U.S. Treasuries to lower-yielding peers as portfolio ballast and see a strong case for integrating sustainability into investment processes.
Jean Boivin
Head – BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is the Head of the BlackRock Investment Institute (BII). The institute leverages BlackRock’s expertise and produces proprietary ...
Brian Deese
Global Head of Sustainable Investing – BlackRock
Brian Deese, Managing Director, is Global Head of Sustainable Investing at BlackRock.
Mike Pyle
Global Chief Investment Strategist – BlackRock Investment Institute
Mike Pyle, CFA, Managing Director, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment Institute ...
Vivek Paul
Senior Portfolio Strategist – BlackRock Investment Institute
Vivek Paul, FIA, Director, is Senior Portfolio Strategist for the Portfolio Research Group within the Blackrock Investment Institute (BII). The BII leverages BlackRock’s ...