GLOBAL WEEKLY COMMENTARY

Sustainable investing: it’s a long game

Key points

Drivers of asset returns
We see sustainability as a key driver of long-term asset returns even as other drivers could be more powerful in the near term, such as the economic restart.
Market backdrop
The White House announced a $2.25 trillion jobs and infrastructure plan, adding to the unprecedented fiscal support since last year.
Data watch
U.S. services sector activity data will be in focus, as consumer confidence has returned to pre-Covid levels – against the backdrop of rising Covid infections.

The powerful economic restart has led to a rally in the traditional energy sector. This has raised concerns that sustainable assets may face pressure after stellar performance in 2020. We view such a short-term focus as misguided. The power of the near-term restart should not be confused with the slow transition to sustainability that we see driving long-term returns.

Chart of the week
Cumulative flows into global sustainable ETPs, 2019-2021 year to date

Chart of the week: The chart shows the growth of cumulative flows into global sustainable ETPs so far this year has been much stronger than 2020 or 2019.

 

Sources: BlackRock Investment Institute, with data from BlackRock ETF and Index Investment and Markit, as of March 5, 2021. Notes: The chart shows cumulative flows into sustainable exchange-trade products (ETPs) listed globally. Sustainable ETPs include a wide range of products that pursue a dedicated sustainable objective, whether using a broad ESG, exclusionary, impact, screened, sustainability-related, sustainable/environment, sustainable/ESG integration, or thematic strategy.

The Covid pandemic has accelerated structural trends including an increased focus on sustainability, and heightened attention on underappreciated sustainability-related risks and supply chain resilience. Sustainable exchange-traded products (ETPs) globally attracted record cumulative inflows of $87 billion in 2020, and this year looks on track to significantly eclipse last year’s record flows. See the chart above. An increasing political, regulatory and societal focus on sustainability across developed markets in particular means that the shift toward sustainable assets looks set to power ahead, in our view. The acceleration in sustainable fund flows has taken place in a dynamic market environment – from last year’s Covid-induced economic shock and subsequent market recovery, through an economic restart that is now boosting cyclical assets such as value exposures. The persistence of the inflows speaks to our view that we are likely in the early stages of a shift in investor preferences toward sustainable assets – the full effects of which are likely not yet reflected in market prices.

The investment case for sustainable assets is about their resilience and long-term return prospects, in our view. In 2021, we see the restart as the dominant driver of returns – and supporting assets exposed to today’s dominant energy sources. Yet this does not change our confidence in sustainability as a key driver of long-term returns. Sustainability will drive returns over time and beyond the restart, as the energy transition progresses, the economy restructures and capital is reallocated. That is why we think judging the impact of sustainability on near-term returns is wrong. We also believe sustainable exposures add potential resilience to portfolios, partly driven by a quality tilt in sustainable index methodologies toward companies with strong profitability and low leverage. Sustainable characteristics ranging from carbon efficiency to job satisfaction of employees and the effectiveness of a company’s board also add to the resilience properties, in our view.

We see climate change in particular as a key driver of returns – one that will boost growth and risk asset returns against a “no action” baseline. After a long transition to a low-carbon economy, assets backed by high sustainability will likely be more expensive – while other assets will have become cheaper, in our view. Sustainable assets should earn a return benefit during this transition, in addition to providing greater resilience against risks such as the  physical disruptions from climate change. We believe the long-term effect of sustainability on asset performance has yet to be efficiently priced in, and see an opportunity today to position long-term portfolios to capture the potential historic return opportunity.

Our updated, climate-aware return assumptions for strategic portfolios have included the effect of climate change – and of the “green” transition to a net-zero world. Using a sectoral lens, we see technology and healthcare benefiting the most, and carbon-intensive sectors with less transition opportunities such as energy and utilities lagging. This in turn increases our strategic preference for developed market (DM) equities, at the expense of high yield and some emerging market (EM) debt.

The bottom line: We see the tectonic shift toward sustainability as still in its early stages. Other drivers of asset performance, such as the powerful economic restart, could dominate in the near term. But we believe the shift in investor preferences toward sustainable assets will be persistent, accelerated by political and regulatory changes. This is why we have a strategic preference for companies and sectors positioned to potentially benefit from the transition to a more sustainable future.

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Delayed, but not derailed
We see the economic restart in many European countries being delayed - but not derailed. Read why in our macro insights.
BlackRock Investment Institute Macro insights

Assets in review
Selected asset performance, 2021 year-to-date and range

Chart: Selected asset performance, 2021 year-to-date and range

 

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream as of March 31, 2021. Notes: The two ends of the bars show the lowest and highest returns at any point this year to date, and the dots represent current 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, in descending order: spot Brent crude, MSCI Europe Index, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Emerging Markets Index, Bank of America Merrill Lynch Global High Yield Index, Refinitiv Datastream Italy 10-year benchmark government bond index,, Refinitiv Datastream Germany 10-year benchmark government bond index, Bank of America Merrill Lynch Global Broad Corporate Index, J.P. Morgan EMBI index, Refinitiv Datastream U.S. 10-year benchmark government bond index and spot gold.

Market backdrop

U.S. 10-year Treasury yields held below the 14-month peak hit earlier last week. President Joe Biden’s $2.25 trillion jobs and infrastructure plan is likely more medium-term in nature. Yet over the short term the prospect of even more stimulus may reinforce the cyclical rotation that is underway. We expect equities and other risk assets to be supported by the new nominal – a more muted response of government yields to stronger growth and higher inflation than in the past as central banks lean against any sharp yield rises.

Week ahead

April. 5 – U.S. ISM services purchasing managers’ index, factory orders
April. 6 – China Caixin services PMI

U.S. services PMI will be in focus this week. Investors are eager to gauge the status of the restart in the services sector – the most affected by the pandemic. U.S. consumer confidence has rebounded to the highest level since March 2020 and consumer spending on key services has been rising – against the backdrop of rising Covid infections. We still see the broad vaccine-led restart intact and expect the U.S. to beat on restart expectations as its vaccine rollout accelerates.

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Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, September 2020

Asset Strategic view Tactical view
Equities Strategic equities - neutral Tactical view - neutral
We have turned neutral on equities on a strategic horizon given increased valuations and a challenging backdrop for earnings and dividend payouts. We move to a modest underweight in DM equities and tilt toward EM equities. Tactically, we are also neutral on equities overall . We like the quality factor for its resilience and favor Europe among cyclical exposures.
Credit Strategic equities - neutral Tactical view - neutral
We have turned neutral on credit on a strategic basis because we see investment grade (IG) spreads offering less compensation for any increase in default risks. We still like high yield for income. On a tactical horizon, we strongly prefer high yield for its income and more room for spread tightening. We are neutral on IG and underweight emerging market debt.
Govt Bonds Strategic equities - neutral Tactical view - neutral
The strategic case for holding nominal government bonds has materially diminished with yields closer to perceived lower bounds. Such low rates reduce the asset class’s ability to act as ballast against equity market selloffs. We prefer inflation-linked bonds as we see risks of higher inflation in the medium term. On a tactical basis, we keep duration at neutral as unprecedented policy accommodation suppresses yields.
Cash Tactical view - neutral Tactical view - neutral
We are neutral on cash. Holding some cash makes sense as a buffer against supply shocks that could drive both stocks and bonds lower.
Private markets Strategic equities - neutral Tactical view - neutral
Non-traditional return streams, including private credit, have the potential to add value and diversification. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private assets reflect a diverse array of exposures but valuations and inherent uncertainties of some private assets keep us neutral overall.

Note: Views are from a U.S. dollar perspective, September 2020. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

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

Legend Granular
Equities

Asset Tactical view
United States United States
We are neutral on U.S. equities. Risks of fading fiscal stimulus and an extended epidemic are threatening to derail the market’s strong run. Renewed U.S.-China tensions and a divisive election also weigh.
Europe
Europe
We are overweight European equities. The region is exposed to a cyclical upside as the economy restarts, against a backdrop of solid public health measures and a galvanizing policy response.
Japan
Japan
We keep Japanese equities at neutral. We see strong fiscal policy and public health measures allowing for rapid normalization.
Emerging markets Emerging markets
We are underweight emerging market equities. We are concerned about the pandemic’s spread and see less room or willingness for policy measures to cushion the impact in many – but not all – countries.
Asia ex-Japan Asia ex-Japan
We hold Asia ex-Japan equities at neutral. Renewed U.S.-China tension is a risk. China’s goal to balance growth with financial stability has led to relatively muted policy measures to cushion the virus fallout.
Momentum Momentum
We keep momentum at neutral. The sectoral composition of the factor provides exposure to both growth (tech) and defensive stocks (pharma). Yet momentum’s high concentration poses risks as recovery takes hold.
Value
Value
We are neutral on value. We see the ongoing restart of economies likely benefiting cyclical assets and potentially helping value stage a rebound after a long stretch of underperformance.
Minimum volatility Minimum volatility
We hold min vol at neutral. The restart of economies is likely to benefit cyclical assets and reduce the need for defensive exposures.
Quality
Quality
We keep our strong overweight on quality. We see it as the most resilient exposure against a range of outcomes in terms of developments in the pandemic and economy.

Fixed income

Asset Tactical view
U.S. Treasuries  
   U.S. Treasuries
We still like U.S. Treasuries. Long-term yields are likely to fall further than other developed market peers, even as low rates reduce their ability to cushion against risk asset selloffs.
Treasury Inflation-Protected Securities Treasury Inflation-Protected Securities
We are neutral on TIPS. A huge decline in rates makes the entry point less attractive. We still see potential for higher inflation over time and like TIPS in strategic allocations.
German bunds 
    Europe
We remain underweight bunds as current yield levels provide little cushion against major risk events. Also, potential issuance related to the proposed EU recovery fund could compete with bunds for investment.
Euro area peripherals Japan
We are overweight euro area peripheral government bonds despite recent outperformance. We see further rate compression due to stepped-up quantitative easing by the European Central Bank and other policy actions.
Global investment grade Global investment grade
We downgrade investment grade credit to neutral. We see little room for further yield spread compression, as we see deeper rate cuts and more asset purchases as unlikely as policy response. Central bank asset purchases and a broadly stable rates backdrop still are supportive.
Global high yield 
Global high yield
We increase our overweight on high yield. We see the very high implied default rates as overly pessimistic, and high yield remains an attractive source of income in a yield-starved world.
Emerging market - hard currency Emerging market - hard currency
We are underweight hard-currency EM debt due to the pandemic’s spread, heavy exposure to energy exporters and limited policy space in some emerging economies. Default risks may be underpriced.
Emerging market - local currency Value
We have downgraded local-currency EM debt to underweight. We see many EM countries as having insufficient capacity to rein in the virus spread and limited policy space to cushion the shock from the pandemic.
Asia fixed income  
Asia fixed income
We are neutral on Asia fixed income. The pandemic’s containment in many countries and low energy exposure are positives. Renewed U.S.-China tensions and China’s relatively muted policy fallout are risks.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. 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.

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Read details about our investment themes and more in our 2021 Global outlook.

The new normal

 

Our new nominal theme – that nominal yields will be less sensitive to expectations for higher inflation – has been confirmed by the Fed’s March policy meeting. The Fed made it clear that the bar for reassessing its policy rate path was not met and that it was too soon to talk about tapering bond purchases, while embracing a material improvement in its outlook. We believe this clear reaffirmation of its commitment to be well “behind the curve” on inflation and to wait to see it move above target has helped the Fed regain control of the narrative – for now.

    • We believe the recent rise in nominal government bond yields, led by real yields, is justified and reflects markets awakening to positive developments on the faster-than-expected activity restart combined with historically large fiscal stimulus – all helped by a ramp-up in vaccinations in the U.S.
    • We expect short-term rates will stay anchored near zero, supporting equity valuations. The Fed could be more willing to lean against rising long-term yields than the past, yet the direction of travel over the next few years is clearly towards higher long-term yields. We see important limits on the level of yields the global economy can withstand.
    • Market implication: We favor inflation-linked bonds amid inflationary pressures in the medium term. Tactically we prefer to take risk in equities over credit amid low rates and tight spreads.
Globalization

 

Covid-19 has accelerated geopolitical transformations such as a bipolar U.S.-China world order and a rewiring of global supply chains, placing greater weight on resilience.

    • The Biden administration is engaging in strategic competition with China, particularly on technology, and has criticized Beijing on human rights issues. The tensions were on display in a bilateral diplomatic meeting in Alaska.
    • We see assets exposed to Chinese growth as core strategic holdings that are distinct from EM exposures. There is a case for greater exposure to China-exposed assets for potential returns and diversification, in our view.
    • We expect persistent inflows to Asian assets as we believe many global investors remain underinvested and China’s weight in global indexes grows. Risks to China-exposed assets include China’s high debt levels and U.S.-China conflicts, but we believe investors are compensated for these risks.
    • Market implication: Strategically we favor deliberate country diversification and above-benchmark China exposures. Tactically we like Asia ex-Japan equities, and see UK equities as an inexpensive, cyclical exposure.
Turbocharged transformations

 

The pandemic has added fuel to pre-existing structural trends such as an increased focus on sustainability, rising inequality within and across nations, and the dominance of e-commerce at the expense of traditional retail.

    • The pandemic has focused attention on underappreciated sustainability-related factors and supply chain resilience.
    • It has also accelerated “winner takes all” dynamics that have led to the strong performance of a handful of tech giants in recent years. We see tech as having long-term structural tailwinds despite its increased valuations, yet it could face challenges from higher corporate taxes and tighter regulation under a united Democratic government.
    • The pandemic has heightened the focus on inequalities within and across countries due to the varying quality of public health infrastructure – particularly across EMs – and access to healthcare.
    • Market implication: Strategically we see returns being driven by climate change impacts, and view developed market equities as an asset class positioned to capture the opportunities from the climate transition. Tactically we favor tech and healthcare as well as selected cyclical exposures.

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Wei Li
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Wei Li, Managing Director, is Global Chief Investment Strategist at the BlackRock Investment Institute (BII), where she leads its team of investment strategists
Vivek Paul
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 ...
Debarshi Basu
Head of Quantitative Research – BlackRock Sustainable Investing
Debarshi Basu, Director, is Head of Quantitative Research at BlackRock Sustainable Investing.
Sophie Thurner
Sustainable Product Specialist - BlackRock ETF and Index Investment
Sophie Thurner, Associate, is a sustainable product specialist at BlackRock's ETF and Index Investment group.