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Ursula Marchioni, BlackRock

Sustainability in portfolios – an evolution or a revolution?


Ursula Marchioni, head of BlackRock Portfolio Analysis and Solutions in EMEA, writes that multi-asset investors are stepping up their move toward sustainability across portfolios through a variety of different routes.

For many investors, the Covid-19 pandemic reinforced the need to enhance portfolio resilience. While markets have, overall, performed strongly in the recovery following the initial shock of Spring 2020, a new investment world has emerged, one where uncertainty is much greater. Against this backdrop many investors are reassessing the features of their portfolios to ensure they are better prepared for the future. 

Enhancing sustainable investing has been at the forefront of this broader push for resilience – for two main reasons. Firstly, sustainable strategies have been known for some time to exhibit ‘quality’ features. Throughout the Covid shock, as evidenced in February and March 2020, strategies with such quality features have often delivered out-performance vs traditional ‘peers’. Secondly, a combination of heightened societal and investor focus on climate change, regulatory initiatives (SFDR) and end investor demand has solidified the significance of sustainable investing. As a result, and as we approach year-end rebalancing, ESG integration is today firmly at the top of investor priorities across Europe.

Across our wealth client base, the share of ESG products in portfolios has risen sharply over recent years, jumping from approximately 12.5 per cent in 2019 to 17.5 per cent on average across all the portfolios we have analysed in 2020 (as at 31 Dec 2020). Historically, efforts to integrate ESG have typically been associated with equity allocations and focused on the role of investors as owners of equity and stewards of capital shaping the trajectory for environmental, social and governance factors across investee companies. Yet the trends we have observed through the pandemic evidence a much more widespread push, with ESG integration now being approached in more holistic ways across asset classes. 

Fixed income is just one area in which we are seeing a major sustainable transformation. Across the client portfolios we have helped restructure throughout 2020, the adoption of fixed income ESG building blocks has risen to 17 per cent, from approximately 13 per cent in the previous year (as at 31 December 2019). 

Across investor types, increased ESG adoption has been supported by the greater breadth of, as well as improved access to, sustainable products. Historically, investors tended to implement sustainable investing at the ‘fringes’ of their portfolios, using these strategies as any other theme or alpha play in the ‘satellite’ component of their allocation. Now sustainable strategies have moved to the core of portfolios as we observe allocation to mainstream exposures, often held for buy-and-hold purposes, being replaced with sustainable strategies. This transition is one of the key drivers of the acceleration in sustainable flows, as core portfolio allocations tend to represent the larger component of overall portfolios and lead to the larger ‘money in motion’.

The increasing range of sustainable tools available has made this possible as core and satellite exposures can be reached whether through Paris-aligned building blocks, factor-focused ESG products, fixed income ESG products targeting a specific part of the yield curve (such as ESG ultra-short duration building blocks) and more. While we still see more limited adoption in the cash and alternative spaces, we expect product innovation to accelerate and extend into these areas over time.

We acknowledge that sustainable investing remains a journey for investors, taking different routes depending on the specific investor’s sustainable and overall investment objective. 
Based on our conversations with clients, we have observed three dominant approaches to incorporating sustainable investing in multi asset portfolios across EMEA:

1.    ESG is integrated at single strategy level, akin to selecting and investing in an alpha play;
2.    ESG integration executed across the entire portfolio – to implement a traditional asset allocation framework – i.e. allocating to asset classes and regions without taking sustainability into consideration;
3.    ESG integration at all levels – leading to a transformation not only of product choices across asset classes and sleeves, but also a re-think of the strategic asset allocation these express. 

For those integrating ESG at a single strategy level, and akin to any other alpha plays, allocations to sustainable building blocks tend to correspond with specific, focused opportunities. Assessing the historical and prospective returns of the sustainable building blocks is usually the focus of investors when performing such due diligence. For example, the investor’s goal might be the addition of sustainable building blocks towards increasing the portfolio’s tilt to quality, with the aim to reduce volatility and enhance profitability across the portfolio more broadly.

Investors looking at sustainability as a financial risk and opportunity, tend to recognise its value across not just a few strategies, but rather the entire portfolio. To meet this goal, investors aim to replace all existing building blocks held in portfolios with sustainable alternatives. Analysis of the various product substitutions can be used to demonstrate the relative benefits and potential impacts of different ESG products (e.g. screened, SRI etc) on a portfolio’s sustainability metrics. These must be coupled with an assessment of how the replacement of existing strategies with sustainable building blocks impact the financial features and risk factor exposures of the overall portfolio – to ensure no material deviation from the target (still traditional) asset allocation is unintendedly introduced as a ‘cost’ for the sustainable upgrade. 

For the investors most advanced in their sustainable journey, it is clear that the climate transition will benefit certain industries and economies over others. Therefore, the asset allocation must also evolve. For these clients, the implementation of sustainable investing goes beyond the selection of a few strategies, and also goes beyond the idea to buy sustainable products to fulfil an asset allocation which continues to be built ‘as it was in the past’. It is a call to restructure and redesign the entire investment process which is a change we are seeing resonate more and more with investors. 

Some investors are still at the early stages of their sustainable investing journey and may still be looking for the map, never mind assessing the routes across it. 

We advise investors to break down their thoughts using a three-step approach to get started. First, investors need to set an ESG objective; what do they ultimately want to achieve? Second, it is important to think about how they will get there – and whether sustainability targets will become part of their Strategic Asset Allocation (‘SAA’) – or be a component of the implementation phase only. Finally, investors should consider the types of products they might wish to make use of.

There is no doubt that, in today’s market, sustainability is a key consideration for the majority of investors. Yet, while the shift to sustainable has picked up pace, accelerating rapidly over the past 18 months, adoption and integration remains very much an evolution rather than revolution. As the space matures, an increasing number of investors will graduate from adopting sustainability at product level, to embedding ESG across the whole portfolio construction process. This transition is hard work, and not something that happens overnight, but must remain the ultimate goal for investors looking to play their part in advancing sustainable investing, towards ultimately delivering a better financial future to their end clients. 

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