Climate Change and ESG Investing Lands Perhaps the Biggest Financial Backer to Date

Banking, finance, and taxes

Published: January 14, 2020 1:28 pm

Last Updated: January 30, 2020 11:14 am

Two investing themes have become much more dominant of late. One concerns climate change, and the other has a partial overlap as it covers the ESG theme of environmental, social and governance strategies. While “no oil company allowed” is not universal in the holdings within these themes, a growing segment of the investing public is trying to avoid investing in companies that are largely into fossil fuels and that are deemed to be environmentally insensitive. Some investors have referred to this rising theme as a “do-gooder” theme.

Larry Fink, board chair and chief executive of BlackRock Inc. (NYSE: BLK), has just joined in by issuing a letter to CEOs called “A Fundamental Reshaping of Finance.” While BlackRock is a household name in the investing community, the firm’s total assets under management were $6.96 trillion as of September 30, 2019, and that was likely more than $7 trillion under management at the end of 2019. An issue has been blooming in ESG and environmental issues within Goldman Sachs Group Inc. (NYSE: GS) as well.

Fink’s letter tells management of public companies that climate change has become a defining factor in their long-term prospects, that it will have an effect on economic growth and prosperity, and that the markets are not adequately factoring in this risk. Issues include whether cities can afford their infrastructure needs, whether 30-year mortgages can be properly issued/insured with climate risks, as well as concerns about inflation and emerging markets seeing productivity loss. It even assesses what risks municipal bonds face.

The heart of Fink’s letter:

Climate change has become a defining factor in companies’ long-term prospects. Last September, when millions of people took to the streets to demand action on climate change, many of them emphasized the significant and lasting impact that it will have on economic growth and prosperity – a risk that markets to date have been slower to reflect. But awareness is rapidly changing, and I believe we are on the edge of a fundamental reshaping of finance.

The evidence on climate risk is compelling investors to reassess core assumptions about modern finance. Research from a wide range of organizations – including the UN’s Intergovernmental Panel on Climate Change, the BlackRock Investment Institute, and many others, including new studies from McKinsey on the socioeconomic implications of physical climate risk – is deepening our understanding of how climate risk will impact both our physical world and the global system that finances economic growth.

This letter also pointed out the specific importance of climate change and how capital will be allocated ahead. Fink also discussed a more sustainable and inclusive capitalism. The letter went on to say:

Investors are increasingly reckoning with these questions and recognizing that climate risk is investment risk. Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock. From Europe to Australia, South America to China, Florida to Oregon, investors are asking how they should modify their portfolios. They are seeking to understand both the physical risks associated with climate change as well as the ways that climate policy will impact prices, costs, and demand across the entire economy.

These questions are driving a profound reassessment of risk and asset values. And because capital markets pull future risk forward, we will see changes in capital allocation more quickly than we see changes to the climate itself. In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.

In a separate letter to its own clients, BlackRock said that newer sustainable versions of model portfolios will use ESG — optimized index exposures rather than traditional market cap-weighted index exposures. The firm also will exit and avoid thermal coal producers, and BlackRock intends to double its offerings of ESG ETF products over the next few years. The firm will expand its ETFs with a fossil fuel screen, and it plans to engage with the major index providers to provide sustainable versions of their flagship indexes. While it already manages some $50 billion in solutions that support the transition to a low-carbon economy, along with renewable power infrastructure, it is offering investors exposure to the companies that are most effectively managing transition risk.