BlackRock Aims to Beat Benchmarks

The launch of two new funds by US asset management giant BlackRock is a clear sign of sustainable investing gaining momentum. Not only are markets getting more comfortable with sustainable investing, they are also anticipating it will outperform conventional investing. Like many existing products, the new BlackRock exchange traded funds (ETFs) were constructed by "tilting" benchmark indexes to overweight or underweight companies based on a climate rating. However, unlike other products that aim at reducing the carbon footprint of the parent index while achieving the same financial outcome, these two "carbon transition readiness" ETFs seek to beat their benchmarks. The BlackRock funds are "trying to beat the benchmark by making bets on how companies might be better positioned for a low-carbon future," says Nicholas Abel, sustainable investment officer at Calstrs, the Californian public pension fund. And they are off to a flying start. The two funds, called the US Carbon Transition Readiness ETF and World ex-US Carbon Transition Readiness ETF, raised almost $2 billion in just a couple of weeks. Calstrs, which partnered with BlackRock to develop the funds, contributed $1 billion (NE May7'20). While existing strategies based on low-carbon indexes are risk neutral and try to match the benchmark, they mostly rely on past emissions data and are "inherently backward looking," says Abel (NE Sep.26'19). The strategy of these funds is based on a transition score built around five underlying "pillars," which include exposure to fossil fuels as well as to clean technologies such as renewable energy, energy efficiency and low-carbon transport -- plus the way energy, water and waste are managed. Less Carbon Intensive The resulting portfolios are substantially less carbon intensive than their benchmarks. The US ETF, for example, involves 47% less carbon emissions per million dollars in sales and 55% less fossil fuel reserves than the underlying Russell 1000. Likewise, the international fund is 18% less carbon intensive and involves 45% less fossil fuel reserves than the parent MSCI ACWI ex-US. However, as most companies are only starting to transition, green revenues remain marginal, at 5.56% and 6.45% of total sales in the US and international ETFs, respectively, versus 4.85% and 3.41% in the respective parent indexes. The new BlackRock ETFs and existing low-carbon indexes aim to achieve their objectives without overly distorting sector distribution, leading to the reweighting of individual stocks within sectors. Differences with the benchmarks can be spectacular, particularly in the oil and gas sector. Exxon Mobil, for example, is slashed from 0.62% of the Russell 1000 to just 0.18% of BlackRock's US ETF. Roughly half of US oil and gas producers including Hess and Occidental, and services provider Halliburton, are excluded altogether, while the main winners of the reweighting process include pipeline operators EQT, Kinder Morgan and Williams, service companies Baker Hughes and Schlumberger, and LNG company Cheniere Energy. Surprise Exclusions The composition of the World ETF has a few surprises. While excluding 75% of oil and gas companies it overweights infrastructure and LNG companies such as TC Energy, Keyera and Woodside, plus Total and, to a lesser extent, Royal Dutch Shell and BP. But Eni, OMV and Repsol are excluded, despite their ambitious climate commitments. "This is largely a byproduct of the quantitative modeling," Abel tells Energy Intelligence. "It's not just about statements that companies are making: there are multiple qualitative and quantitative data points that are driving the allocation decision" (NE Jan.21'21). Other low-carbon products involve similar levels of stock selectivity but sometimes significant differences in how individual companies are reweighted. MSCI's ACWI Low-Carbon Target US index, for example, eliminates Exxon and ConocoPhillips whereas BlackRock's US Carbon Transition Readiness ETF merely underweights them. Yet they concur on excluding half of the sector, including Hess, Oxy and Pioneer Natural Resources, and on massively overweighting Kinder Morgan. AP4, the Swedish pension fund, was the first institutional investor to use low-carbon indexes, deciding in 2012 to hedge the carbon exposure of its US equity holdings in the S&P 500 by switching to the S&P 500 Carbon Efficient Select index, which essentially excludes the 20% worst performers in terms of carbon intensity. More recently AP4, along with French pension fund FRR, asset manager Amundi and MSCI, launched the Low-Carbon Leaders index family based on existing MSCI indexes and aimed at excluding the worst performers in terms of carbon intensity and fossil fuel reserves. S&P has similar low-carbon versions of its main indexes which allow investors to minimize implied carbon emissions, or address the estimated impact on companies of Paris-compliant carbon pricing. Notable users of such low-carbon and other sustainable indexes include Japan's Government Pension Investment Fund (GPIF), the world's largest asset owner, with about $30 billion invested in indexes from S&P, FTSE and MSCI. Calstrs also invested $2.5 billion in 2016 in a portfolio replicating MSCI's ACWI Low-Carbon Target index. Philippe Roos, Strasbourg BlackRock's Transition Readiness Funds Company (US) Transition