On January 14, 2020, BlackRock (BLK) issued a letter called “Sustainability as BlackRock’s New Standard for Investing.” Given the numerous headlines surrounding this development, we are providing this guide to reinforce the views from PNC Investment Strategy on responsible investing (RI).
What major changes were announced by BLK?
By the end of 2020, all active portfolios and advisory strategies will be fully environmental, social, and governance (ESG) integrated — meaning that, at the portfolio level, BLK portfolio managers will be accountable for appropriately managing exposure to ESG risks and documenting how those considerations have affected investment decisions. For example, one particular change is an explicit removal of companies that generate more than 25% of revenues from thermal coal production from all actively managed debt and equity funds, and no additional investments in alternatives with the same parameters. Notably, this does not affect passive strategies such as iShares products that track traditional indexes. As it stands currently, the announcement is only affecting actively managed funds.
BLK creates investment products, PNC is an asset manager/allocator. What is the difference, and why does that matter?
PNC is an asset manager, which means we are acting in an advisory capacity for our clients. While we believe evaluation of ESG risks is a core component of our evaluation, we do not incorporate these views into the portfolios unless discussed and agreed upon with clients. In our view, BLK’s announcement was from the point of view of creating products comprising individual securities that reflect their company’s corporate sustainability values/views. As an asset manager, we need to have capabilities to achieve client goals and objectives via RI as well as traditional portfolio management means. We remain committed to RI solutions for clients; however, we believe it is the client’s choice to implement them from a holistic total portfolio perspective.
What is PNC’s view on responsible investing?
In summary, we do not view RI as an investment philosophy or as a separate and distinct asset class. Rather, we view RI as an implementation strategy in a goals-based framework.
It is a lens or filter we can use to implement a portfolio that aligns with an investor’s goals, intentions, values, or mission. RI requires a keen understanding of values coupled with portfolio knowledge and the ability to look beyond traditional portfolio construction and customize to the investor’s RI view.
Not every issue or concern is always best addressed within an investment portfolio, but we think some may be. Thus, RI can be implemented through various means at the asset class, investment manager, and security selection levels. It is simply an application of our core, underlying fundamental beliefs regarding investment strategy, portfolio construction, manager due diligence, and security selection. We also believe RI is a core part of our investment and portfolio strategy offering.
What is PNC’s view on sustainability-themed investing?
We actively seek to identify attractive thematic investment opportunities in the sustainability arena. These types of themes can include but are not exclusive to low-carbon and clean-technology-related, green bonds, water, and renewable energy. We integrate these various themes into portfolios as attractive opportunities present themselves and on a client-by-client basis where relevant. Additionally, we provide sustainability-themed analysis on the fund and company level, which allows for the assessment and sorting of investments in our offering from an RI perspective.
What is PNC’s view on RI active management versus passive implementation?
Our view is that RI is best pursued via more actively managed strategies as opposed to a purely passive implementation.
To focus on a client’s specific goals/ objectives, we believe RI requires a high degree of customization — it is not suitable for a one-size-fits-all approach. We can provide step-by-step guidance and a road map, but every investor’s destination will most likely be unique and different depending on his or her values, missions, or intentions in conjunction with the individual’s financial goals/objectives.
What is PNC’s view on risk management in an RI portfolio?
RI is not a portfolio management strategy that should be implemented and evaluated in isolation; it is highly interconnected with so many major global forces/ trends (for example, economic, social, political). The chart below examines the spider web effect that quickly develops when linking RI to many hot button issues facing investors today — and this is just covering the topic of sustainability! On the one hand, these RI trends are creating new opportunities for investors to exploit; on the other hand, these trends, coupled with better data thanks to advances in technology and increases in voluntary disclosure from companies, may actually be uncovering new risks for investors to consider and evaluate.
Global Trends in Sustainability
Source: PwC, Project Blue
We use third-party ESG data to help identify and understand the financial impacts of material ESG-related risks embedded in our clients’ portfolios and assess how those risks may or may not affect longer-term performance. Additionally, we recommend being mindful of portfolio diversification when implementing RI. As with any concentrated investment portfolio, volatility can be expected to increase in concert with narrowly defined objectives.
A simplistic example of this is being so narrowly focused on renewable energy that a portfolio’s energy exposure is restricted to investing only in wind and solar power operators. Because of this high degree of concentrated exposure, a portfolio might become particularly vulnerable to the business cycle fluctuations associated with renewable energy (in particular, commodity prices), potentially taking an investor’s portfolio on a volatile ride.
Pursuing RI is, in effect, another lens through which we can examine potential risks. Proactively avoiding companies exposed to these sustainability risks can be beneficial for portfolios, just as investing in companies that are actively improving their risk profiles on more traditional dimensions can be a driver of better risk-adjusted returns in the long run.
Bottom line: Be conscious of the risks taken in portfolios and confirm the portfolio is adequately positioned to be compensated for those risks. We view RI as a goals-based investing approach; thus, there is no one-size-fits-all approach, and it certainly is not the goal of all investors.
We are here to help clients achieve their financial goals and objectives, and if that includes RI we have the solutions and goals-based strategies to help guide them along the way.
Appendix: PNC’s Responsible Investment Strategy
As technology and science create new business and investment opportunities, they also create new responsibilities. While society may enjoy the immediate benefits of technological and scientific advances, it must also consider their impact on future generations. By changing the dynamic among investors, businesses, and the public, responsible investing (RI) can help keep today’s innovation sustainable, and current decisions and actions well-positioned for the success of future generations.
In the face of constant change, we believe markets can be inefficient and investment opportunities are ever-evolving. A thorough understanding of the past, however, combined with a rigorous analysis of the present can give us insight into what we view as the most probable outcomes. Investors who do not respond to these changing market dynamics may miss significant opportunities. The rise of RI is a perfect example of the rapidly evolving investment landscape, one that has created both challenges and opportunities for investors.
Responsible Investing Is a Goals-Based Strategy
We define RI as a goals-based investment strategy that:
- proactively supports certain values or causes;
- excludes or restricts certain portfolio exposures that may conflict with those values; and/or
- defines a specific, targeted impact and allocates capital toward that objective.
In many cases, the above factors are not mutually exclusive. That is, investors may want to incorporate some combination, or all, of the above into their portfolios.
Additionally, we do not view RI as an investment philosophy or as a separate and distinct asset class, but rather as an implementation strategy. It is a lens or filter we can use to implement a portfolio that aligns with an individual investor’s goals, intentions, values, or mission. RI requires a keen understanding of values coupled with portfolio knowledge and the ability to look beyond traditional portfolio construction and customize to the investor’s RI view. Not every issue or concern is always best addressed within an investment portfolio, but we think some may be. Thus, RI can be implemented through various means at the asset class, investment manager, and security selection levels.
In the continuum in the chart below, the arrows under each investment category highlight the typical investor objective or goal associated with each approach to RI. The solutions overlap at multiple points in the continuum because we believe it is possible to achieve multiple goals and objectives depending on the RI path chosen. Understanding where an investor’s goals fall on this continuum has important implications for setting expectations and also in defining and measuring success over time.
Spectrum of Responsible Investing
Our Core RI Beliefs
We believe RI is an implementation strategy and, as such, does not require the development of a separate and distinct investment philosophy or process.
It is simply an application of our core, underlying fundamental beliefs regarding investment strategy, portfolio construction, manager due diligence, and security selection. We also believe RI is a core part of our investment and portfolio strategy offering.
How We Invest…Through an RI Lens
- Focused on goals: Our process begins by understanding each client’s unique values and intentions. A values-based investment approach is most effective when it distinguishes among the “must-haves,” “important-to-haves,” and “nice-to-haves.”
- Flexible: We build portfolios tailored to each client’s particular investment needs, restrictions, and values. We do not believe a one-size-fits-all approach is always necessary or appropriate when implementing an RI portfolio.
- Deep analysis: Robust quantitative analyses combined with strong qualitative research can help generate meaningful insight not attainable by either method on its own, so we use both to help derive optimal RI portfolio solutions for our clients.
Our Approach…to Evaluating RI Opportunities
- Dynamic: Markets evolve, and portfolios need to adjust accordingly to generate attractive returns. The rapid evolution of the RI landscape has begun to shine a light on potential new investment opportunities and risks.
- Long-term view: Markets may be ever-changing, but we believe patient investors can capitalize on proven long-term trends. The RI landscape has expanded significantly, thus we expect the future to look much different from the past. Many thematic strategies we use within portfolios may require taking a more secular view of the world because demographic shifts, environmental trends, and so on can take considerable time to unfold.
- Value oriented: We seek to identify investment opportunities that are undervalued and/or mispriced by the market. Not all RI-oriented investments are attractive from a valuation standpoint at any given time, but some may be. We use our rigorous, disciplined, and repeatable investment process as a guide to help determine what relative value ultimately looks like.
How We Build…RI Portfolios
- Integrated: Our investment strategy, manager research, and portfolio management teams work closely together to confirm that our best thinking is reflected in each RI decision.
- Open architecture: We believe skilled active RI managers exist and can be identified, but there are sectors and times when passive implementations are optimal. Our best thinking comes from employing a number of strategies, which we outline in the next section.
How We Express Our Clients’ Values and Intentions in Portfolios
The following illustrates how a client’s goals and values could be incorporated when implementing a responsible investing strategy.
Responsible Investing Goals
- Environmental, Social and Governance (ESG) integration
- Positive screening
- Negative/Exclusionary screening
- Impact investing
- Active ownership
- Community investing
- Sustainability-themed investing
Environmental, Social, and Governance (ESG) Integration
ESG criteria comprise a set of standards investors can use to evaluate investments and ultimately determine whether a company’s operations are “responsible.”
Environmental criteria look at how a company performs as a steward of the natural environment. Social criteria examine how a company manages relationships with its employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audit and internal controls, and shareholder rights. At one time, ESG analysis was considered a standalone, separate investment process. Today, we see widespread adoption and greater systematic integration of ESG issues and factors. The growing trend, in our view, should result in a more complete investment analysis and due diligence process, keener insight into potential risks, and ultimately better-informed investment decisions. We have developed a number of proprietary investment strategies that explicitly take ESG factors into consideration or require a certain level of ESG integration/scoring.
Screening Applications/Overlays Screening
Screening applications or overlays are commonly implemented in RI. Negative screens apply a set of predefined criteria to shrink an investment universe down to a smaller opportunity set with characteristics that are acceptable to the individual investor. Common examples of RI criteria used in negative screening applications might include ethically questionable industry classifications, such as alcohol, tobacco, casinos and gaming, and other “worst” corporate practices, as opposed to “best” practices, such as pollution, human rights, labor standards, animal welfare, and corporate governance. On the other hand, positive screens seek to proactively identify companies with more desirable RI characteristics. The criteria used in the RI screening process should be determined by and ultimately reflect the unique concerns and specific values of the investor. Thus, we may use both types of screening techniques, where applicable.
We actively seek to identify attractive thematic investment opportunities in the sustainability arena. These types of themes can include carbon footprint-related, clean technologies, green bonds, water, and renewable energies. We integrate these various themes into portfolios as attractive opportunities present themselves and on a client-by-client basis where relevant. Additionally, we provide sustainability-themed analysis on the fund and company level, which allows for the scoring and sorting of investments in our offering.
We define impact investing as investment in projects, companies, funds, or organizations with the goal of generating and measuring mission-driven social, environmental, or economic change in concert with an appropriate level of investment return. We help clients determine the type of impact they would like to achieve and then use products and solutions in the public and private markets to further that intention.
There are many ways to express ESG factors through passive implementation, but there is also a strong case for active management and alpha generation inactively engaging with a company’s board of directors, management teams, and so forth. We believe proxy voting is one of the most direct ways investors can influence company directives, making it an integral aspect of shareholder advocacy. As a result, we work closely with our clients who have a broad interest in supporting the ESG proxy voting mandate, encouraging them to vote consistent with best-in-class ESG standards. This perspective on proxy voting addresses investors’ desires for companies to disclose and mitigate risk on critical ESG issues. Some other examples of proxy voting standards that can be adopted are Public Pension or Taft-Hartley best practices, which were developed to focus on the diverse interests of public employees and union members, respectively.
TEXT VERSION OF GRAPHICS
Global Trends in Sustainability
This chart looks at the spider web effect that quickly develops when linking the RI theme of sustainability to many hot button issues facing investors today.
Sustainability global trends connect to:
- Demand for energy
- Growing Importance of emerging markets
- Population Growth
- Biodiversity loss
- Corporate leadership & competition
- Connectivity & information flows
- Regulation & government action
- Water scarcity
- Ethical consumerism
- Climate change
- Raw materials scarcity
Spectrum of Responsible Investing
The solutions overlap at multiple points in the continuum because it is possible to achieve multiple goals and objectives depending on the RI path chosen:
|Traditional investing||Competitive returns|
|Responsible investing||Competitive returns, ESG risk management|
|Sustainable investing||Competitive returns, ESG risk management, ESG opportunities|
|Thematic investing||Competitive returns, ESG risk management, ESG opportunities, maximum-impact solutions|
|Impact-first investing||ESG risk management, ESG opportunities, maximum-impact solutions|