From Wall Street to Davos, sustainable investing is blazing a new path into the mainstream. After years of mostly just talking about socially responsible investing, the world is actually coming to realize that ESG, or environmental, social, and governance, factors aren’t just about improving the world. They also measure risk, and they’re starting to help investors make money.
I’m Alex Eule, and welcome to The Readback. This week, we’re joined by Barron’s senior writer Leslie Norton, who has spent several years covering sustainable investing.
Alex Eule: Hey, Leslie
Leslie Norton: Hey.
Alex Eule: We’ve been talking about sustainable investing for years now, but have we finally reached a tipping point?
Leslie Norton: I think so. Just last week, Larry Fink wrote his widely read letter to CEOs and to clients.
Archived Recording: Larry Fink, founder and CEO of BlackRock, announcing today that the firm will make investment decisions with environmental sustainability as its core.
Leslie Norton: And in the letter, he said that
BlackRock (ticker: BLK),
which is the world’s largest asset manager, with more than $7 trillion under management, would seek to double the number of sustainable ETFs that they offer.
Archived Recording: In the letter, Fink writes: “The evidence on climate risk is compelling investors to reassess core assumptions of modern finance. He continues to say, quote, in the near future, and sooner than most anticipate, there will be a significant reallocation of capital.”
Leslie Norton: And also, to boost, by tenfold, the number of sustainable assets that they manage. Right now they have $90 billion in sustainable assets. They want to get that up to $1 trillion.
And I would bet that they can do it. Many people are interested in sustainable investing. Assets into sustainable investing funds grew fourfold last year. And just after Larry’s letter dropped, there were inflows of $1 billion into one of BlackRock’s big sustainable ETFs.
Alex Eule: And this isn’t necessarily anymore just people wanting to do good, right? I mean, why is Larry Fink interested in sustainable investing or ESG investing?
Leslie Norton: Well, a critical part of Larry Fink’s letter was about climate risk. Now, climate change is obviously a political football in the U.S.d States. And what Larry is doing is placing it squarely in the heart of the investment process as a measure of climate risk.
Larry Fink (Archived Recording): We should not avoid the conversation about climate change, because climate change is now becoming an investment risk. And no differently as investors focus on, well, yield curve or whatever forms of risk we have, it was very clear to me we need to now bring forward.
Leslie Norton: And climate is a very, very long-term risk. That is why people haven’t done much about it.
But that future is approaching. A 30-year mortgage could literally be underwater, depending on where it is located. And he wants investors and clients to put this at the heart of their investment process and understand where they are putting their money.
Alex Eule: Yeah, and that is fascinating to me because, I mean, like you said, investors understand risk. That is the language they speak.
Leslie Norton: That is right, well, one of the things he said last week was that he got an email from a client in a red state who thanked him profusely for writing the letter, and said, we are going to put this at the heart of our investment process.
Alex Eule: Can you define ESG for us?
Leslie Norton: Right, ESG stands for environmental, social, and governance principles. They now are critical to what we think of as sustainable investing. It used to be socially responsible investing. That was the previous iteration, and that was just about screens, about divesting from Sudan or South Africa. Or various other countries that people didn’t find socially acceptable because of their social practices. So now we are in this ESG iteration, where everything is looked at through the lens of risk. And in the future, it is probably going to evolve to impact, where investors are going to try to measure the social impact of their corporations in a variety of sectors.
Alex Eule: And I just want to point out, then the E, the S, and the G, governance, and sort of the makeup of a company’s board really has as much of a factor in these ratings then as how you’re affecting the climate, as a company.
Leslie Norton: Right, because the governance and the board actually tells the company what to do in terms of their practices. And they follow up to make sure that a company has done what the board has asked.
Alex Eule: So climate change is also a major topic at the World Economic Forum in Davos this week. Tell us a little bit more about the evolution. I mean, how have we got into this point? How long have you been thinking and writing about sustainability?
Leslie Norton: I’ve been writing about sustainability for a few years here at Barron’s. We started covering it about four years ago, when we started publishing our annual ranking of sustainable funds. It is part of our mutual fund coverage, and it was about an area of the fund industry that was growing, and we thought we should shine a light on it. But what has happened is, partly because of Larry Fink, who, a couple of years ago, wrote a very, very widely read letter that said that corporations should have a social purpose. This has gathered steam within the corporate community.
This year’s Davos is specifically about sustainability, and I’ll give you a little bit of background to that. Last year, the Business Roundtable, which is, along with the Chamber of Commerce, one of the biggest sort of corporate trade groups, I would say, issued a letter that said that corporations should have a purpose. And that corporations should not only focus on shareholder return. But that they should also focus on the needs of a variety of stakeholders, including customers, employees, and including suppliers.
Alex Eule: And that is a big change from the days of just driving shareholder return.
Leslie Norton: That is right. In the 1970s, Milton Friedman, the eminent economist, said the sole purpose of a corporation should be to produce shareholder return. And now it is moved away from that. Now the people at the Business Roundtable and also sustainable investing would argue that this is about producing long-term shareholder return. This is about making sure companies are durable, that they survive for the long-term because they have a clientele that is happy with them.
Alex Eule: This all sounds fascinating, but also kind of complicated. So, do investors now have the tools they need to make decisions around ESG factors?
Leslie Norton: Well, they have some of the tools they need. One of the things that Larry Fink asked companies to do in his letter to companies is to report along sustainability metrics, things that are material to whether they will face risk in the future or not. And one of the things that we looked at here at Barron’s, and we’ve been doing this for the fourth year now, are the funds that had above average or high sustainability ratings. And then we ranked them in terms of their returns for 2019. What we discovered was, for the fourth year running, the number of funds that outperformed the S & P 500 was much higher in sustainable mutual funds than they were for the active management universe in general.
Alex Eule: Fascinating, so doing good here means doing well?
Leslie Norton: Yes, doing good means doing well. Now, there is a caveat there. A lot of the stocks that these funds own are actually stocks that performed well in 2019.
Alex Eule: Right.
Leslie Norton: These were stocks that, in a low-growth universe with zero earnings growth, actually had earnings growth, actually had good balance sheets. These were quality growth companies. And these kinds of sustainable investments, where the companies are going to be durable because of their characteristics, tend to coincide with the investments that sustainable funds own. So we ran into a bunch of funds, including the top one, that don’t regard themselves as sustainable. The manager of the top mutual fund last year, which is a tiny fund called Matthew 25 (MXXVX), he invests in quality growth companies. And in fact, when I called him, he said, what’s a sustainable fund?
Alex Eule: Do you think that there is just a clear connection then between a quality growth company and a sustainable company?
Leslie Norton: I think, in the past, there has been a connection. One of the things that will happen as we go forward is that more and more companies will be reporting sustainability metrics, obviously. More and more companies will do what the Business Roundtable asks, and take into account the needs of a variety of stakeholders. So it may well be that these companies are moving in that direction anyway.
Alex Eule: So Leslie, what do you think, is all this just a passing fad, or is sustainable investing really here to stay?
Leslie Norton: I think sustainable investing is really here to stay. We have gotten more and more interest from all kinds of investors. We’ve gotten interest, in particular, from millennials and younger investors, who want to vote their values and want to invest with their values. As we know, they already consume with their values. So as this group ages, as they inherit money, we are going to see them investing in sustainable funds.
Alex Eule: And do you think this is more than just a generational change?
Leslie Norton: I think it is more than just a generational change. We are also seeing sort of older investors taking this into account. And one of the things that is persuading them is looking at the returns of these funds and seeing that they don’t actually give up anything for performance. However, there is a real big issue for older investors, which is that if they are in retirement, fossil fuel companies, oil companies have some of the largest dividends out there. And if they need income, where else are they gonna get it?
Alex Eule: So what’s someone searching for yield and in need of yield supposed to do in this situation?
Leslie Norton: Well, it is a choice that they are going have to make. Larry Fink, when I asked him this question last week, actually said, look, there are plenty of other yield-paying investments out there. You can look, and Fink didn’t say this, but I would imagine you can look in MLPs, or real estate, or a bunch of other investments. But it is something that people are going to have to do for themselves as they go down this journey.
Alex Eule: All right, Leslie, thanks so much for joining us.
Leslie Norton: You’re welcome, thank you for having me.
Alex Eule: You can see the full ranking on the most sustainable mutual funds in the latest issue of Barron’s and, as always, on barrons.com. I’m Alex Eule. The show is produced by Mette Lutzhoft. The Readback will return next Wednesday.
The Readback is a business and finance podcast published every Wednesday. We’d love to know what you think of the show, so please take a moment to rate and review us in iTunes—or write to Alex Eule at [email protected] and producer Mette Lützhøft at [email protected].