photo by Jim Henderson
The world’s largest asset manager recently stated a commitment to going green. But as BlackRock founder and CEO Larry Fink made clear, that decision was mainly about the shade of green found on currency.
In BlackRock’s annual letter to clients, the firm announced a new commitment to meet demand for investments created with environmental sustainability in mind. “Because sustainable investment options have the potential to offer clients better outcomes, we are making sustainability integral to the way BlackRock manages risk, constructs portfolios, designs products, and engages with companies,” the letter stated. BlackRock has said it believes that portfolios designed with sustainability, especially environmental sustainability, in mind will offer better risk-adjusted returns for its investors.
BlackRock made clear that changes to portfolios will happen in consultation with clients, meaning individual preferences may shape how much does (or does not) change in a particular investment strategy. But overall, the firm has said it will default to using sustainable versions of funds in its model portfolios and its basic approach to asset allocation. The company will hold individual portfolio managers responsible for managing exposure to sustainability risks in actively managed portfolios, just as it holds them accountable for managing credit or liquidity risk.
BlackRock’s announcement strikes me as admirable and smart. But will it work?
Criticism of the plan fall mainly into two camps: ideological and practical. The first sort of objection appeared in the comment section of The Wall Street Journal, where some readers accused BlackRock and Fink of political correctness and “virtue signaling.” (The latter term indicates conspicuously expressing moral values, often with the sense of feigning them for unearned credit with listeners or customers.) A lot of critics, in the Journal’s comment section and elsewhere, also focused on whether they thought Fink’s evaluation of future climate change was flawed, mischaracterized or flat-out wrong. There are several references to the climate predictions of Al Gore and Greta Thunberg, and the general tone suggested that they are the Chicken Littles of climate change, leading people like Fink astray.
You likely already have your own opinions about humans’ contributions to climate change, which will shape your evaluation of whether focusing on environmental concerns in investment decisions is inherently worthwhile. Yet I would argue that this is not the point. As Fink pointed out, the company’s decision was not political, but rather a reflection of client demand.
In a letter to CEOs, Fink wrote, “Over time, companies and countries that do not respond to stakeholders and address sustainability risks will encounter growing skepticism from the markets, and in turn, a higher cost of capital.” The argument he lays out is that companies that fail to respond to growing public interest in and calls for sustainability will face a competitive disadvantage compared to companies that do respond. Fink’s position is that sustainability is not tangential to investment valuations; it is an integral part of the evaluation process. In an interview, Fink was even more concise. “We are fiduciaries,” Fink said. “Politics isn’t part of this.”
Investors in their 20s and 30s are, as a group, especially sensitive to companies’ environmental impact, but they aren’t alone. According to a 2019 report from the Morgan Stanley Institute for Sustainable Investing, among 1,000 investors surveyed, 85% were interested in sustainable investment options. That figure jumped to 95% for millennials. Gen Xers are reportedly showing growing interest in socially conscious investments, too.
Many of BlackRock’s new policies center on investing models designed around environmental, social and governance, or ESG, concerns. These include environmental sustainability, though not exclusively; many ESGs exclude tobacco companies or casino operators, for example. ESG-focused mutual funds and exchange-traded funds aren’t new, though they have gained popularity in recent years. At the end of 2018, there were more than 350 ESG funds available to investors. According to Morningstar Inc., ESG funds took in a record $20 billion in new investments in 2019. It makes perfect sense that BlackRock sees anticipating and meeting customer demand in this area as a priority. Conversely, companies that do not offer investments designed with environmental concerns in mind may stand to lose significant future business. BlackRock is positioning itself to stay ahead of the curve.
Given its size – BlackRock currently manages $7.43 trillion in client assets – the firm will not draw a bright line when it comes to investing for environmental sustainability. The firm has pledged some divestment in coal, for example, but those promises represent less than 0.1% of BlackRock’s overall assets. But if sustainable companies reach more investors than their competitors over time, businesses will have an incentive to modify their approach wherever practical. Fink’s language in his letter to CEOs explicitly, and likely deliberately, echoes the statement from The Business Roundtable last year announcing that corporations shared a commitment to serve all stakeholders, not only those who hold shares. Fink, however, tied this commitment directly to profitability, arguing that the two are intrinsically linked.
Some criticisms of BlackRock’s plan are less focused on the ideological impact of the change, and instead raise practical concerns. Much of BlackRock’s business is founded on index funds. By their nature, these funds track an existing index, which means there is little room to choose which companies the funds include. BlackRock has said, however, it will work with major index providers to develop sustainable versions of major indexes. The asset manager’s size means this possibility is not as far-fetched as it otherwise might be. And, of course, actively managed funds already offer the freedom for managers to shape them according to a variety of criteria, including sustainability.
For now, I suspect the largest effect will come from proxy voting. As a massive investment manager, BlackRock engages with companies on shareholders’ behalf, and policy changes here could create significant pressures on company behavior. In its client letter, BlackRock pledged to include “Sustainable Development Goals,” including clean energy policies, in its annual update to its voting guidelines. BlackRock also says it plans to press companies to disclose details about their plans to address environmental sustainability. The firm will mirror this call for transparency in its own move from annual to quarterly voting disclosure, with more timely disclosure for “key high-profile votes.” Given its size, BlackRock could influence a lot of public companies this way.
Current ESG funds often come with slightly higher fees than other actively managed funds. This reflects the additional research managers undertake, as well as the reality that such funds often work with a smaller asset base than similar non-ESG options. BlackRock’s size is also an advantage here. At its scale, BlackRock can plausibly back up a pledge to make green funds competitive when it comes to expenses due to economies of scale. And its pledge to double its ESG offerings means sustainably minded investors will have more options to choose from.
Change comes to all industries, the energy sector among the rest. Commercial enterprises, including asset management firms, must remain sensitive to what their clients want if they hope to succeed in the long run. BlackRock seems to be making a sensible business decision as public attitudes toward fossil fuels continue to shift. Some may view investing with a focus on ESG factors as drawing an arbitrary line in the sand and forgoing investments in companies that fall below certain expectations. Yet BlackRock and other investors who focus on such criteria are merely calling for more accountability and asking all companies to raise the bar for how they operate.
Whether BlackRock’s push toward greener investments will mean more green in the company’s coffers will largely depend on its execution. But the fundamental idea is sound.