Portfolio Adviser • Portfolio Adviser Magazine Responsible Investing • THE INCREASING DEMAND FOR CLIMATE-AWARE INVESTING

James Gloak, lead product strategist, iShares Sustainable Investing, BlackRock, looks at the increasing demand for climate-aware investing

Q: Sustainable investing has become more mainstream in recent years. What catalysts have been driving this trend?

A: It certainly has come a very long way in a short space of time. If we look at sustainable ETFs in Europe, at the end of 2019 they totalled $40bn in assets under management (AUM). By the end of August this year, this had jumped to $183bn. There are three main drivers behind this: client demand, regulatory pressure and growing corporate responsibility.

Investors are now understanding how environmental, social and governance (ESG) issues play an important role in the performance of a company and that they now have the tools and products to integrate ESG into their portfolios. There is the growing consensus that sustainability can be a persistent driver of returns and is fuelling a global reallocation of capital towards the more sustainable companies.

At the same time European regulations like the EU’s Sustainable Finance Disclosure Regulation (SFDR) are providing greater standardisation and transparency to give investors greater confidence to convert from standard portfolios to sustainable ones.

Risk: The ESG considerations discussed herein may affect an investment team’s decision to invest in certain companies or industries from time to time. Results may differ from portfolios that do not apply similar ESG considerations to their investment process.

Q: How has the role of climate change investing evolved over the past year or two?

A: To set the scene, we had the United Nations Climate Change talks in Paris in 2015 when an international agreement was reached to try to limit temperature increases to below two degrees over pre-industrial levels. However, the subsequent years following the agreement resulted in little real action with regards to climate index investing.

In 2018, we did start to get a swell of urgency around climate issues, whether this was a result of the rise of climate change activism or the release of a special report by the UN’s Intergovernmental Panel on Climate Change (IPCC) on the impacts of global warming of 1.50C above pre-industrial levels. We then had the wildfi res in Australia in 2019 and California in 2020, physical examples of the growing risks the planet faces from climate change.

This has led to today’s understanding and general acceptance that climate risk is investment risk and the growing body of research that shows the impact of climate change on investment prices and performance. Insurance premiums are a vivid example of this, where flood insurance premiums rise as we’ve seen greater impacts of natural catastrophes from flooding.

Climate risk and the ongoing transition to a low carbon economy will continue to bring investment opportunities as demand for solutions to mitigate physical climate risk fosters new business models.

The result is that in the past 12 months we have seen a significant movement in the ETF space in terms of the number of climate change strategies on offer. Today there are 42 climate-dedicated ETFs in Europe, accounting for just under $8bn in AUM, whereas a year ago, the number of strategies was nearly half and the AUM totalled $1.9bn.

A: We strongly support regulatory initiatives to set consistent standards and increase transparency for sustainable portfolios. We have been very transparent about what we have done and what is still to do. Product innovation is at the forefront of expanding the choice of products we offer, especially following the surge in climate metrics that have come to the market in the past 18 months as well as the release of sustainable-focused regulations.

We recently launched a range of new funds that are designed to help clients achieve their climate goals, in this case through incorporating the requirements laid down by the EU in its ‘Paris Aligned Benchmark’. We’re also introducing analytical tools to calculate the climate risk embedded in investment portfolios and partnering with institutional clients to invest in renewable infrastructure around the world.

By integrating climate considerations into investment processes, index products and index strategies, BlackRock can help investors build more resilient portfolios. There is a significant learning requirement with regards to climate change terminology and therefore it is incumbent on us to assist in the understanding of the differences between a climate transition product, a Paris-aligned offering, or having a net-zero objective or being 1.50C aligned’.

At Black Rock we have identified three distinct approaches to climate investing: Reduce, Prioritise, Target. Funds aimed at ‘reduction’ seek to limit a portfolio’s exposure to the highest carbon emitters and may do so through the application of stringent fossil fuel-related business screens. These funds can be used as broad building blocks of a diversified portfolio.

Funds aimed at ‘prioritising’ allocate capital based on a company or government’s commitments and actions to climate transition, through say the inclusion of science-based targets or integrating climate-specific metrics into the index strategy.

Finally, funds aimed at ‘targeting’ invest in a specific sustainable activity or projects that advance environmental purposes, such as green bonds.

With these three approaches, we hope to bring increased structure to the climate investing space. An investor is quickly able to understand the main approaches open to them and can opt to ‘reduce, prioritise or target’ their climate exposure dependent on their sustainability goals and investment needs.

A: In 2020, a BlackRock survey of global clients revealed that climate change is perceived as the most urgent issue that investors wish to address.

For most investors until recently, divestment of fossil fuels was the predominant and only way to express a climate-oriented objective. But this is changing. ETFs and index investing are bringing transparency and greater accessibility to this emerging segment.

Today there are 42 climate-dedicated ETFs in Europe, up from five at the start of 2020.1 The strategies have evolved from just fossil fuel divestment offerings to those adhering to climate alignment targets and incorporating the latest climate metrics and warming scenarios.

At BlackRock our main aim is to provide choice and transparency in combination with constant innovation as we build out investment opportunities across the climate spectrum. There is now a broad selection of climate strategies for clients to tap into when they are ready to make their allocations and understand where they want to position on their climate investment journey. And this product innovation is set to continue.

The latest climate solution clients are enquiring about is ‘net-zero’ carbon emission strategies. There remains challenges in bringing this strategy to market and while it continues to be a focus of research, the strategies we have today, such as those aligned to the Paris Agreement, we believe are the first step on the journey towards net-zero strategies of the future.

Q: So should investors have both ESG and climate change ETFs in their portfolios, or is it a case of one versus the other?

A: It is entirely down to the client’s sustainability goals and investment needs. Climate ETFs are more likely to have a greater focus on fossil fuel exposure and carbon intensity reduction than their ESG-focused counterparts.

What is evident is that there is a wide variety of choice now available with regards to ESG and climate ETFs, albeit they are still single-strategy offerings. There is a growing discussion about the makeup of strategies and whether the two main areas of sustainable investing, ESG and climate, could be equally serviced within a single methodology, thereby allowing an investor to get their ESG and climate exposure in the same product.

The United Nations COP26 climate talks in Glasgow this November are likely to increase momentum with regards to the number of climate strategies coming to market, as well as further product innovation as more climate-based data and metrics become available. The talks could also focus investors and corporate attention to impending climate risks and challenges faced, and in doing so initiate investment decision making with a climate or sustainable objective.

We are still very much at the beginning of the journey for climate-based strategies. The increasing number of sustainable ETFs, including climate-oriented ETFs, offer new and convenient ways for all investors to access innovative strategies. We believe this choice is going to play a key role in the transition to a low-carbon economy by providing investors with the options, backed up by the transparency they need, to pursue their specifi c fi nancial and sustainability goals. ■

'Source: BlackRock, Global Business Intelligence, as of 15 September 2021. For illustrative purposes only. All amounts given in USD.

JAMES GLOAK, lead product strategist, iShares Sustainable Investing, BlackRock

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. This material is for distribution to Professional Clients (as defined by the Financial Conduct Authority or MiFID Rules) only and should not be relied upon by any other persons. Issued by BlackRock Advisors (UK) Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL, Tel: +44(0)2077433000. Registered in England and Wales No. 00796793. For your protection, calls are usually recorded. Please refer to the Financial Conduct Authority website for a list of authorised activities conducted by BlackRock. © 2021 BlackRock, Inc. All Rights reserved. 1849894