Reading the fine print in ESG investing

More industry organizations and service providers are asking how they should analyze ESG investments — and are growing increasingly concerned that the ESG label may be just that and nothing more.

Earlier this month, the Institute for Pension Fund Integrity (IPFI) took a closer look at mega firm BlackRock’s increased interest in ESG investing. Did founder Larry Fink have a change of heart or was this just another marketing strategy?

Officials at the pension fund group say that over the last two years, the ETF and index shop has taken steps to reorient and redefine its identity, shifting from a brand focused on index investing to an ESG-driven investment shop.

“This course, while possibly more profitable for BlackRock, puts client portfolios in jeopardy,” said IPFI President Christopher Burnham. “If individual investors want to choose social investments, they are certainly welcome, but pension plans shouldn’t be making social and political decisions for their millions of members.”

Burnham, the former state treasurer for the State of Connecticut, added that instead pension executives would be wise to pursue the low-fee, index strategy that was the solid foundation on which BlackRock was built.

The IPFI’s concerns are multi-faceted and center on the issues of pricing and performance. They say that over time, BlackRock will look less like a low-fee, efficient index provider and more of a higher-fee forecaster of economic and social trends with a bias toward stocks and bonds that meet its new ESG bias.

The IPFI views BlackRock’s new focus as a strategy to draw in new customers by differentiating the firm from other index-specialists.

As for BlackRock, they see the pricing of stocks not properly reflecting the risks of climate change. But in speaking out for investors, Burnham’s group says this view could undermine the fiduciary duty of public pension fund managers, who will have to explain to retirees that their money is no longer being invested according to an established and proven methodology, but rather is open to influence from outside political interests.

According to IPFI, though, research has consistently indicated that conventional index portfolios outperform ESG portfolios.

“By increasing the importance of social and environmental investing in its clients’ portfolios, BlackRock has created a major distraction from the focus of achieving the highest risk-adjusted returns for its client,” officials wrote.

They point to the higher price of ESG with BlackRock’s iShares Global Clean Energy ETF, which is one of the largest ESG funds in the world, carries an expense ration 11.5 times as great as the expense ratio for the firm’s S&P 500 ETF.

While the IPFI sees the firm’s move as a marketing ploy with higher fees, officials at the firm remain steadfast in their sustainability course.

BlackRock CEO Larry Fink wrote in his 2020 letter to CEOs, the investment risks presented by climate change are set to accelerate a significant reallocation of capital, which will in turn have a profound impact on the pricing of risk and assets around the world.

Pension plans have already acted on their own in some instances. Most notably the $254 billion California State Teachers’ Retirement System in Sacramento has approved new policy language within the board’s corporate governance principles to support the transition to low-carbon investment principles.

The system is not alone as it stood alongside 477 other global investors in calling for private sector investment into low-carbon transition initiatives to achieve the goals of the Paris Agreement from 2015. The pension system has also established enhanced risk reporting related to climate risk management.

The sustainable investing methodology is shifting, however, as Tamara Close points out. Her firm provides advice on ESG integration.

In recently developing a Sustainable Risk Assessment Framework, Close has outlined the reality that most investors are moving quickly forward in creating methodologies that take a multi-layered approach to investing sustainably.

One of the key points she makes is that most investors understand that there is a dynamic materiality at play within ESG. Material ESG issues do evolve rapidly with industry changes and economic cycles.

As she has pointed out previously in an Alternatives Watch interview, COVID-19 pandemic is a perfect example of the shifts that can take place dramatically.

She says her firm is seeing a global shift to issues such as employee health and safety and labor practices that may not have been considered material just two months ago in industries such as financial services.

This reality shows that for investors, a closer look at what is at stake is needed to not only make sure that a portfolio’s ESG objectives are being met, but also investment performance aims.

Meanwhile other industry groups are providing guidance to fund managers looking to implement ESG and transparency is key.

The PRI approach to ESG is four-faceted – policy, governance, investment process and monitoring/reporting. Each was detailed in the group’s latest guidance.

The recently issued technical guidance on the United Nations Principles for Responsible Investment for hedge funds was built on the group’s roots of partnering with the world’s largest pension funds as signatories. The number of signatories reporting on the hedge fund module of the UNPRI has grown significantly over the last 2 years, officials add.

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