ESG Investments

ESG (“Environmental, Social and Governance”) investing means to integrate environmental, social impacts and governance factors in the investment and decision-making process. Practically, these factors can be clustered into the three ESG pillars. Some example are: renewable energy, climate risks and waste (Environmental) or the importance of diversity in corporate boards and employees (Social). 

According to MSCI, the increasing adoption of ESG investments practices is mainly caused by a changing world and changing investors. In addition to environmental changes, there is a rising regulatory pressure – for example, a recent French law requires large investors to disclose the carbon footprint of their assets. In addition, the so-called demographic transition is taking place: an aging population combined with lower fertility rates created new categories of investors, such as women and Millennials. According to Cerulli Associates, “More than two-thirds of investors under 30 would prefer that their investments have a positive social or environmental impact”. More than 94% of Millenial investors surveyed by Morgan Stanley said they are interested in sustainable investing, which is relevant also because $30 trillion of wealth transfer from Baby Boomers to 90 million of Millenials is expected to take place over the next decades (Accenture, 2012).

ESG investing is not a “all in or nothing” decision. It has a broad range of applications and can be tailored to investors’ goals and desires. There is a broad range of ESG investments strategies that BlackRock clustered into 2 macro-categories: Avoid and Advance
Avoid – or Exclude – means to eliminate exposures to companies or sectors that create certain risks or violate investor’s values – especially on a long term perspective – such as tobacco and weapon producers. 

On the other hand, to Advance means to proactively align capital with certain desired ESG outcomes while pursuing financial returns. There are many ways to advance, for example through Integration or Impact investing
The Integration strategy is based on the systematic inclusion of ESG risks and opportunities in the traditional investment process to enhance long-term risk-adjusted returns, for example with an environmental focus on renewable energy. 
Through Impact investing, investors seek tangible non-financial outcomes, such as promoting energy or water savings, in addition to returns. The most common example is green bonds, which might be issued to finance renewable energy projects or clean public transportation.

There is a huge debate around the myth that incorporating ESG factors into the investment process hurts performance. However, some empirical studies (MSCI, 2017 and Harvard Business School, 2015) suggest that companies with strong ESG practices display a lower cost of capital, a lower volatility and fewer instances of bribery, corruption and fraud over certain time periods. Therefore, they historically exhibit lower risk and even outperformance over the medium term for portfolios that integrate key ESG factors in the investment process.

However, it is true that ESG data have several drawbacks. A 2015 Harvard Business School study in fact concluded that “only 20% of the items in its sustainability dataset could be deemed ‘financial material’”. The main “weakness” related to ESG score is the deficiencies of the data on which they are based, which are in fact still suffering from high subjectivity because they are mainly self-reported. In addition, there are coverage issues since ESG data are relatively recent and only reported once a year. For this reason, ESG ratings are also hardly comparable between different companies, as opposed to standard ratings.

Anyway, as evidence points out, ESG-friendly portfolios could underperform in ‘risk-on’ periods – but be more resilient in downturns, since they help mitigate the impact of ESG risks. 

As shown in the graph (Morningstar, FT), an increasing demand has caused a surge of ESG funds: the number of sustainable mutual funds has grown by 80% since 2012, while assets under management in ESG mutual funds have almost doubled to $1.8 trillion.

Since the beginning of 2020, BlackRock has also made it its top priority to put ESG investments at the center of its corporate strategy, leading the way toward the transition. As Larry Fink, BlackRock CEO, stated in an HSBC Interview at the beginning of the year: “We live under the rule of maximizing return. We believe a portfolio that focuses on sustainability and climate change will outperform, so it is going to be a good investment and it will also help the planet”. 

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