Par Andre Bertolotti — Head of Global Sustainable Research and Data, BlackRock Sustainable Investing; Tariq Fancy — Chief Investment Officer of Sustainable Investing;
et Isabelle Mateos y Lago — Chief Multi-Asset Strategist, BlackRock Investment Institute;
et Giulia Pellegrini — Head of EMD Sustainable Investing and portfolio manager;
et Ashley Schulten — Head of Responsible Investing for Global Fixed Income; Josephine Smith — Factor Based Strategies Group


For years, many investors saw sustainable investing as a trade-off.
They viewed it as a sacrifice of value for “values.” And to be fair, they
were often right. But that is no longer the case. What has changed?
More granular data, more sophisticated analysis, and deeper societal
appreciation for and understanding of what sustainability means
for people, companies and countries. There is increasing awareness
that material sustainability-related factors — often characterized
as environmental, social and governance, or ESG — can be tied to
a company’s long-term growth potential. This makes sustainable
investing something investors can no longer afford to ignore.

We are seeing greater interest from our clients in sustainable investing. Investors want
deeper knowledge about the field, more sustainable investing options, enhanced
data and reporting on impact, and increased commitment from asset managers to
integrate sustainability into investment processes. Millennials, in particular, look set
to propel the future of sustainable investing. This group of future financial decisionmakers
is asking more of companies. And regulators are expanding their focus
on incorporating sustainability into investment information and decision making.
BlackRock is increasing its focus on sustainability across the board — from our
investment processes to the investment solutions we offer. There is growing
recognition that the field presents a largely untapped source of information that
can potentially identify investment risks and generate excess returns. At the same
time, the data are imperfect, scoring methodologies differ, and investors need
to gain greater clarity on the pitfalls of this emerging field. This paper discusses
three key themes driving transformation in sustainable investing: the aim to create
sustainable portfolios and strategies that do not compromise financial returns;
the effort to use innovative research to go beyond headline ESG scores; and the
integration of sustainability-related issues into traditional investment strategies.
Our work fuels our conviction that the future of investing is sustainable.



•• Sustainable investing is no longer a niche area; it is going mainstream. Assets in dedicated
sustainable investing strategies have grown at a rapid pace in recent years. We are seeing a surge
in clients’ and portfolio managers’ interest in incorporating sustainability-related insights into
their investments. This demand looks poised to accelerate — driven by societal and demographic
changes, increased regulation and government focus, and greater investment conviction.
•• Enhanced data and insights make it possible to create sustainable portfolios without compromising
financial goals. Our research, which relies on backtested data, shows how ESG-focused indexes
have matched or exceeded returns of their standard counterparts, with comparable volatility.
We find ESG has much in common with existing quality metrics such as strong balance sheets,
suggesting ESG-friendly portfolios could be more resilient in downturns. These resilience properties
deserve attention as market uncertainty increases. In other words: We have arrived at a “why not?”
moment in sustainable investing.
•• Driving innovation in sustainable investing requires going beneath the headlines. ESG data have
evolved, but are still incomplete. We believe the most meaningful investment insights are found
beneath the headline ESG scores. Alpha-seeking strategies focus on understanding and exploiting
key performance indicators at the sector, industry and company level. New technologies and
methodologies have allowed us to make great strides in improving sustainability data. This includes
techniques to estimate missing data, and determine their materiality to investment performance.
•• Integration of sustainability considerations into investment processes is on the rise — and for
good reason. BlackRock’s approach, outlined in our 2018 ESG Investment Statement, starts with
making better research and data available to all our investment teams. The goal is to help them
identify and implement investment process enhancements. Incorporating relevant sustainability
insights can provide a more holistic view of investment risks and opportunities. There is no onesize-
fits-all approach, but the opportunity to improve investment processes by integrating material
sustainability considerations is real and growing. BlackRock also actively engages with companies
to encourage business practices consistent with delivering sustainable long-term financial returns.


A “why not?” moment
We detail our framework for thinking about sustainable investing, and show how building
sustainable portfolios need not mean giving up performance.


Growing up
The universe of dedicated sustainable investment
funds is growing: A current combined total of roughly
$760 billion in European and U.S. mutual funds and
exchange-traded funds (ETFs) is up from $453 billion
in 2013. See the Sustainable swell chart. Asset owners’
increasing interest in this area is driving strong growth
in new products and innovation. More than 100 new
sustainable mutual funds and ETFs were launched
in the U.S. alone from 2015 to 2017, according to
Morningstar Research.
We expect significant growth in mainstream sustainable
investing options, and see demand for related funds
growing at a double-digit pace through the next decade,
as the chart shows. This growth will likely be driven by
millennials (those born between the early-1980s and
late-1990s), a generation that tends to be keenly focused
on company values and is set to experience growth in
net wealth as its members advance in the labor force
and grow their incomes.
In addition, governments across most major geographies
are increasing their regulatory focus on incorporating
sustainability considerations into investments. The
European Union and individual European countries
are moving forward with specific directives. In Asia,
an increased regulatory focus has come in response
to environmental issues.
The U.S. stands apart — in particular, U.S. guidance
for private-sector retirement plans stresses fiduciaries
must not put ESG goals ahead of financial ones. Yet
the U.S. regulatory regime does allow consideration of
sustainability issues as a way to generate returns. The
thrust of these global regulatory actions could herald
greater capital allocation to sustainable companies
and assets over time.


Definitions and data
The concept of “sustainable investing” can mean many
different things. Asset owners and asset managers
often operate with multiple definitions, messages and
motivations. BlackRock operates from a simple definition
of sustainable investing: Combining traditional investing
with sustainability-related insights in an effort to reduce
risk and enhance long-term returns.
Our view: Companies with strong performance
on material sustainability issues have potential to
outperform those with poor performance. This is in line
with a growing body of academic evidence, including
the 2016 Harvard Business School study Corporate
Sustainability: First Evidence on Materiality.
ESG is often conflated or used interchangeably with the
term “sustainable investing.” We see sustainable investing
as the umbrella and ESG as a data toolkit for identifying
and informing our solutions. Importantly, ESG integration
(page 14) is just one aspect of ESG investing.


Sustainable swell
Assets of sustainable mutual funds and ETFs, 2013–2028


There’s no guarantee that forward-looking estimates will come to pass.
Sources: BlackRock, with data from Broadridge/Simfund, June 2018. Notes: The
chart shows the total assets under management in ESG mutual funds (MFs) and ETFs
globally. The 2019 to 2028 figures are based on BlackRock estimates, assuming a 5%
annual growth rate in the underlying markets. Other assumptions: MF asset growth
starts at 5% in 2019 and declines by 0.5% annually through 2022, then at a zeroto-
0.5% rate annually thereafter. ETF asset growth starts at 45% and decreases by 5%
annually through 2022, with a zero-to-3% pace thereafter.


Forming a framework
Starting from our simple definition, we then distill client
motivations into a spectrum from Avoid to Advance.
“Avoid” eliminates exposures to certain companies or
sectors that pose reputational risks or violate the asset
owner’s values. “Advance” aligns capital with certain
behaviors, activities and outcomes. This might include
using ESG scores as an additional layer in the traditional
investment process. Other ways to advance include
thematic and impact investing, as detailed below. We
use this framework to think about sustainable investing
solutions (note that ESG integration is a separate
process — see page 14 for more).
ESG data is most often categorized as “non-accounting”
information because it captures components important
for valuations that are not traditionally reported. The
valuation of companies has become more complex,
with a growing portion tied up in intangible assets. ESG
metrics provide insights into these intangibles, such
as brand value and reputation, by measuring decisions
taken by company management that affect operational
efficiency and future strategic directions. At a high level:
• Environmental (E) covers themes such as climate
risks, natural resources scarcity and pollution.
• Social (S) includes labor issues and product
liability risks such as data security.
• Governance (G) encompasses items such
as corporate board quality and effectiveness.


From “why” to “why not”
ESG research has come a long way. Information was
once manually gathered from limited sources. Now, a
growing industry provides robust data culled from the
public sphere, gives ESG ratings and helps improve
ESG reporting and disclosures. Gaps remain, but better
quality and coverage in data and research give us more
confidence in using ESG insights for both index and
alpha-seeking investment strategies. See page 10.
The challenge with ESG data is not just an issue of quality
and consistency. Different definitions and approaches can
lead ESG providers to differing conclusions on the same
asset or security. It is important to understand which data
sources asset managers are relying on, and how that data
is being built into investment strategies. It’s a key reason
we advocate greater transparency in ESG data. See
BlackRock’s Exploring ESG: A practitioner’s perspective.
ESG-focused strategies carry risks like any other
investments. Yet we see encouraging evidence that
investors can make their portfolios more sustainable
without compromising on traditional financial goals. We
show how backtests of ESG indexes reveal risk/return
metrics in line with conventional benchmarks in stocks
and bonds (page 6), and how investors can combine
the value factor and ESG exposures. We analyze ESG
through a factor lens; show how ESG can add resilience
to portfolios (page 7); and explore how enhanced data
can help increase investment conviction in emerging
markets (page 13).


Avoid and advance
Sustainable investing styles



Sources: BlackRock Investment Institute and BlackRock Sustainable Investing, December 2018.


ESG in equities
Our research suggests investors do not need to choose
between the pursuit of returns and ESG excellence.
ESG-focused indexes are still relatively young and
performance histories include backtested data, but
we see the evidence as promising. When looking at
traditional indexes alongside MSCI’s ESG-focused
derivatives of them, annualized total returns since
2012 matched or exceeded the standard index in
both developed and emerging markets (EMs), with
comparable volatility. Valuation metrics were nearly
identical. See the An ESG lens for equities table below.
Traditional sustainable indexes were designed to select
top-rated ESG securities within a given sector or remove
certain business involvement areas. They were based on
an exclusions-focused approach, and performance and
portfolio characteristics notably deviated from marketcap-
weighted indexes. In contrast, optimized indexes
can help improve a portfolio-level ESG rating while still
tracking traditional benchmarks. They allow investors
to invest in higher-rated ESG companies without taking
on unintended risks such as sector concentration. The
optimized approach can be tailored to achieve carbonreduction
goals, whether through a low-carbon strategy
or a dual-objective (ESG + low carbon) strategy.


A proxy for quality in bonds
Results are similar in fixed income. Over the past
decade, global high yield bonds from issuers with
higher ESG ratings (A or AA on MSCI’s rating scale) have
generated stronger information ratios — a gauge of riskadjusted
returns — than bonds with lower ESG ratings,
despite their lower yields. See BlackRock’s Sustainable
investing: a ‘why not’ moment for details. Notably, the
global high yield issuers in our study without historical
ESG rating coverage (almost half) generated lower riskadjusted
returns than rated issuers. Growing coverage
should help provide more granular analysis over time.
In the investment grade market, we found an ESGfriendly
version of the U.S. corporate index generated
near-identical risk-adjusted performance to its parent
index over the past decade. See page 9 of the paper
cited above for details. This research underscores our
view that ESG-friendly bond portfolios should generate
total returns similar to traditional portfolios over a
full market cycle — even if they sacrifice a little yield.
The argument for ESG becomes even more compelling
over longer time horizons. This is because ESGrelated
risks tend to compound. Consider long-term
infrastructure bonds where projects are exposed to
flood risks that could intensify due to rising sea levels.


An ESG lens for equities
Comparison of traditional equity benchmarks and backtested ESG-focused counterparts by region, 2012–2018


Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data
from MSCI, November 2018. Notes: The data cover May 31, 2012, to Nov. 30, 2018. Returns are annualized gross returns in U.S. dollar terms. Number of stocks, price-to-earnings ratio
and dividend yield are monthly averages. Indexes used are the MSCI USA Index, MSCI World ex-U.S. Index, MSCI EM Index (“Traditional” columns) and MSCI’s ESG-focused derivations
of each (MSCI USA ESG Focus Index, MSCI World ex-U.S. Focus Index and MSCI Emerging Markets ESG Focus Index). The data shown prior to inception for each MSCI ESG Focus index
(August 2016 for U.S.; March 2017 for World ex-U.S.; April 2016 for EM) are backtested. They are optimized to maximize ESG exposure within constraints (example: a tracking error of
50 basis points and maximum active weight of 2% for each index constituent for USA ESG Focus). Backtested performance is hypothetical, simulated and is not indicative of actual or
future returns. Backtested performance is developed with the benefit of hindsight, has inherent limitations and invariably shows positive rates of return. ESG scores shown are average
scores for each index based on MSCI data. See important notes on the back page.



ESG, factors and resilience
Factor-based investing offers a different lens for viewing
equity performance by isolating traits that are broad,
persistent drivers of return. We analyzed the relationship
between four style factors — quality, low-volatility, value
and momentum — and ESG scores using Thomson
Reuters ASSET4 data on 2,800 global stocks. We then
built hypothetical factor exposures that stripped out
the impact of broad market moves. Our findings: Lowvolatility
and quality embed a stronger tilt to high ESG
scorers; the momentum factor showed modestly greater
ties to lower ESG companies. See page 7 of Sustainable
investing: a ‘why not’ moment for details.
We have not yet found reliable evidence to suggest
ESG has been a factor itself. But the idea that companies
with higher ESG scores exhibit quality and low-volatility
characteristics is an important insight. It suggests an
ESG tilt may add resilience to portfolios.
Resilience is a key consideration for long-term investors.
Given enough time, periods of negative returns can
rattle even the most experienced investors. And resilience
is a particularly welcome characteristic at a time when
the economic cycle is entering its latter stages. Quality
companies with strong balance sheets and cash flows
can provide a measure of resilience, we believe. They
can extend a larger buffer against equity market
downturns than weaker peers. See BlackRock’s 2019
Investment Outlook and page 8 for details.
We believe the same principle applies to companies
that exhibit strong ESG characteristics. Strong
ESG performers may be better at managing legal,
reputational and financial risks. These findings are
consistent with external research. Example: AQR finds
that stocks with the worst ESG scores are 10% to 15%
more volatile than those with the best scores — and
that poor ESG performance points to future risks not
captured in standard risk models. See AQR’s 2017
paper Assessing Risk Through Environmental, Social
and Governance Exposures. Other research shows
companies that provide greater transparency into their
operations have outperformed others during equity
market down drifts. See the 2017 academic study
ESG Shareholder Engagement and Downside Risk.


ESG with a value bent
Can investors incorporate ESG considerations into
their portfolios while maintaining their desired factor
exposures? We partnered with index provider FTSE
Russell to find out. The goal: to develop a customized
value index with an ESG tilt, based on the FTSE
Developed Index of global developed market equities.
A key consideration was whether incorporating an
ESG adjustment to the index design would result in
unintended impacts to its value exposure — and vice
versa. Security weights were tilted based on how well
(or poorly) companies manage ESG risks according
to FTSE Russell’s ESG ratings data.
We started with the ESG-tilted FTSE Developed Index,
with the trade-off of a greater tracking error from
the market-cap-weighted parent index. Our finding:
Increasing the value exposure did not result in a
material decline in its average ESG score. See the
blue and green lines in the Best of both worlds chart.
In short, we found investors could increase their
exposure to the value factor while also maintaining a
higher overall ESG score than the parent benchmark.
ESG, factors and resilience
Factor-based investing offers a different lens for viewing
equity performance by isolating traits that are broad,
persistent drivers of return. We analyzed the relationship
between four style factors — quality, low-volatility, value
and momentum — and ESG scores using Thomson
Reuters ASSET4 data on 2,800 global stocks. We then
built hypothetical factor exposures that stripped out
the impact of broad market moves. Our findings: Lowvolatility
and quality embed a stronger tilt to high ESG
scorers; the momentum factor showed modestly greater
ties to lower ESG companies. See page 7 of Sustainable
investing: a ‘why not’ moment for details.
We have not yet found reliable evidence to suggest
ESG has been a factor itself. But the idea that companies
with higher ESG scores exhibit quality and low-volatility
characteristics is an important insight. It suggests an
ESG tilt may add resilience to portfolios.
Resilience is a key consideration for long-term investors.
Given enough time, periods of negative returns can
rattle even the most experienced investors. And resilience
is a particularly welcome characteristic at a time when
the economic cycle is entering its latter stages. Quality
companies with strong balance sheets and cash flows
can provide a measure of resilience, we believe. They
can extend a larger buffer against equity market
downturns than weaker peers. See BlackRock’s 2019
Investment Outlook and page 8 for details.
We believe the same principle applies to companies
that exhibit strong ESG characteristics. Strong
ESG performers may be better at managing legal,
reputational and financial risks. These findings are
consistent with external research. Example: AQR finds
that stocks with the worst ESG scores are 10% to 15%
more volatile than those with the best scores — and
that poor ESG performance points to future risks not
captured in standard risk models. See AQR’s 2017
paper Assessing Risk Through Environmental, Social
and Governance Exposures. Other research shows
companies that provide greater transparency into their
operations have outperformed others during equity
market down drifts. See the 2017 academic study
ESG Shareholder Engagement and Downside Risk.


Best of both worlds
Value and ESG exposures of hypothetical global equity index


Past performance is not a reliable indicator of current or future results. It is not
possible to invest directly in an index. Sources: BlackRock Sustainable Investing
and BlackRock Investment Institute, with data from FTSE Russell as of January 2018.
The chart shows the ESG and value exposures of a hypothetical optimized global
equity index, based on the FTSE Developed Index. FTSE Russell applies an ESG tilt to
the parent index; the chart shows its active value exposure for given levels of tracking
error (active risk relative to the parent index). ESG ratings refer to FTSE Russell’s ESG
ratings, ranging from 0 (no disclosure) to 5 (best practice).


Beyond headline ESG scores
We explain how it is necessary to go deeper than headline ESG metrics to drive
innovative research in sustainable investing and generate alpha insights.


Consensus is limited when it comes to which ESG issues
and information are material. Universally accepted
reporting standards are still lacking, despite the efforts
of standard-setting organizations. Part of the problem:
too many standard setters. Company-level ESG ratings
from different rating agencies can vary greatly due to
differences in methodologies. As a result, investors need
to undertake their own due diligence to understand
the ESG rating agency’s process and methodology.
To be sure, ESG scores offer valuable insight about an
issuer. Yet the top-line ESG score is an amalgamation
of measures — think gender pay gap, pollution, board
structure — that came together over time under the
“ESG” label. A lot of granularity, and critical insight,
can be hidden below.
The opportunity in sustainable investing is to recognize
and exploit the utility of headline ESG scores for efforts
like portfolio building blocks, while also going below
the headline to explore the insights that more granular
component data can provide. Progress on the “E” front
illustrates this point:
Environmental risks are increasing in prominence and
impact. Three of the top-five risks deemed most likely
to occur over the next 10 years are environmental in
nature, according to the World Economic Forum’s
Global Risks Report 2018. Extreme weather events
ranked first, natural disasters second, and failure of
climate change mitigation and adaption came in fifth.
Environmental risks also account for four of the five
risks expected to have the biggest impact over the
next 10 years, the World Economic Forum found.
Last year alone brought massive hurricane damage
on the East Coast of the U.S. and wildfires on the
West Coast; flooding and mudslides in Japan; and
a 7.5 magnitude earthquake and coincident tsunami
in Indonesia — to name just a few.


What does it mean for investors? Climate change has
been shown to pose significant financial challenges,
as well as potential opportunities. A study from The
Economist Intelligence Unit (EIU) in 2015 pegged the
average expected loss from climate change to the total
global stock of manageable financial assets at $4.2
trillion through the end of the century — roughly equal to
Japan’s GDP. And a faster pace of global warming could
significantly inflate the damage, especially when lower
rates are used to discount future losses into present
value. See the EIU’s 2015 paper, The cost of inaction:
recognizing the value at risk from climate change.
We believe company disclosure on climate change
strategy and performance can meaningfully impact the
companies in which we invest, particularly those that
face a material climate risk. See BlackRock’s Adapting
portfolios to climate change of 2016 for details.
The level of disclosure has been improving over the past
few years, but there is still little scrutiny on the quality of
the disclosure. Existing data providers do not yet offer
a holistic assessment of this quality. BSI developed a
proprietary climate risk disclosure indicator to fill the
gap. The indicator provides a standardized disclosure
score for North American and European energy and
utility companies that BlackRock has engaged with since
2017. The score is based on a company’s governance,
strategy and targets in regard to climate risk disclosure.
We incorporated the indicator into a new low-carbon
transition framework in an effort to:
1 gain forward-looking insights into a company’s
long-term performance;
2 leverage insights based on our engagements with
the largest carbon emitters in our holdings; and
3 enhance our ongoing engagement with companies
most exposed to climate-related risk.
We provide details of this framework on page 11.


the data
With the growing interest in sustainable investing, data
providers have increased their efforts in gathering and
reporting varied ESG indicators. For example, MSCI,
an ESG data provider, has boosted the number of
companies under its coverage more than fourfold
over the past decade — and today reports on more
than twice as many key performance indicators (KPIs).
See the Broader coverage chart.
However, the lack of accepted data-reporting standards
means investors cannot readily compare or combine
insights across providers. This limits the ability to fully
harness the potential of ESG information. We view the
remaining data deficiencies as an opportunity. We
have created a customized database that combines
data across many ESG sources, affording us expanded
coverage across companies, a richer description of each
company across KPIs, and a deeper history of ESG data.
This allows us to develop and test investment ideas
based on our own sustainable insights by building
on the diverse KPI measures we believe are material.
The early history of ESG data providers has roots
in small companies serving a limited investor base.
Over time, these small firms have been acquired and
resourced to grow beyond their modest origins to cover
more companies and markets. The result is a historical
database with good coverage of the present but
patchy coverage in older periods, making historical
analysis challenging.
This lack of historical data is an impediment, particularly
the gaps in granular level data points such as renewable
energy use, corruption management and labor
management scores that aggregate to overall ESG
scores. In looking through the historical data, we
noticed the missing ESG data was not absent because
companies did not report, but because the companies
simply were not covered by the data providers. We
approached this missing data challenge with the
hypothesis that gaps in historical ESG data could
be estimated given enough other data from similar
companies. We apply a statistical method that estimates
data missing from older ESG datasets in an effort to
address the gaps.


The challenge of estimating missing data cuts across
industries. Consider the example of Netflix. The mediaservices
provider started a competition in 2006 for any
researcher that could develop an efficient approach to
estimating missing data in the company’s broad movierating
dataset. Solutions to these types of challenges
have become more popular (and robust) in recent
years thanks to improvements in machine learning and
big-data techniques. We draw on one such method,
called generalized low rank modeling (GLRM), to help
us estimate the missing data in big sets of ESG data.
This approach helped us discover patterns in ESG data
that persisted through time. Why is this important?
It gives us confidence in estimating missing data.
We believe the ability to compare companies across a
particular ESG metric is important in explaining relative
performance. The estimation of missing ESG values with
GLRM provides a richer set of historical ESG data that
can be used to compare companies across the market —
or to analyze the trends of a specific company over the
course of time.
Other early research by BlackRock includes applying
cutting-edge physical climate models to assess risks to
assets in specific locations — from flooding, wildfires and
other weather events. We plan to detail this work in an
upcoming publication.


Broader coverage
ESG reporting by MSCI ACWI companies, 2009 and 2017


Sources: BlackRock Sustainable Investing and BlackRock Investment Institute, with
data from MSCI, December 2018. Notes: We consider all 150 key metrics used by
MSCI in its ESG corporate ratings system. A company reporting a given key metric at
least once in a given year is considered one data point. The total number of potential
data points are calculated by multiplying the number of companies in the MSCI ACWI
Index (2,607 in 2009 and 2,622 in 2017) by 150. The green portion of each ring
shows the share of those data points that were actually reported by companies.


Putting data to work
An example of some of the deep work being done
to go beyond headline ESG scores is seen in our
analysis of companies’ readiness to function in a
low-carbon society.
The transition to a low-carbon economy refers to
the global shift to a society that is more efficient in
producing goods and services, and less reliant on
carbon dioxide (CO2) emissions. We see this transition
creating risks and opportunities for companies, and
creating winners and losers in the process.
The BlackRock Sustainable Investing (BSI) team has
performed a transition readiness analysis to help assess
the potential financial impact. The approach looks at
how well positioned companies are to both maximize
the potential opportunities and minimize the risks
associated with the transition to a low-carbon economy.
We plan to provide further details on this approach
in an upcoming academic paper.
The transition readiness of a company is based on its
exposure and management to five financially material
transition characteristics, or “investment pillars.” The
pillars are categorized by a company’s core business
involvement and natural resource management. See
the Transition ready graphic below for descriptions
of each pillar.



Differentiating insights
We assess companies across each of the five pillars by
distilling over 200 individual key performance indicators
— from both external and proprietary BlackRock data
sources — into a single value. This process is based on
a qualitative assessment of the data and quantitative
testing to evaluate the robustness of our calculations.
Once pillar assessments are made for each company,
they are combined into a single score based on the
industry in which that company functions. The relative
weighting of a company’s performance across the
five pillars will depend on what we believe to be most
financially relevant for its industry. The framework
draws from the Sustainability Accounting Standards
Board (SASB) sector-specific standards and BlackRock’s
own analysis to determine which issues are most
financially material for each industry. For example,
health care companies are primarily evaluated relative
to their energy, water and waste management,
whereas transportation companies are evaluated on
their greenhouse gas emissions and carbon-efficient
technology exposure.
We looked at our transition readiness assessment versus
environmental and headline ESG scores published by
popular data providers and found a positive but low
correlation to both. This implies it may be capturing
new — and potentially differentiating — financial insights
relative to existing data sources.


Transition ready
Five pillars of BlackRock’s transition readiness assessment process

Sources: BlackRock Sustainable Investing and BlackRock Investment Institute, December 2018.
Note: The table is for illustrative purposes only.


Putting transition readiness to the test
The goal of a transition-ready investment approach:
directing capital to companies best positioned to
navigate the global transition to a low-carbon economy.
Can this help deliver competitive long-term financial
returns relative to traditional benchmarks? We put
our idea to the test within a hypothetical equity
portfolio. The analysis used a portfolio invested in
non-U.S. developed market stocks from 2010 to 2018.
Going industry by industry, we increased exposure to
companies with high transition readiness assessments
versus their low-performing peers. This hypothetical
portfolio had an annual tracking error of 100 basis points
relative to the broad benchmark, the MSCI World ex-U.S.
Index. The aim was to determine if a focus on transition
readiness might have improved an investor’s historical
risk-adjusted return over that time period.
What we found: Overweighting companies with better
transition readiness characteristics, and underweighting
their less-prepared peers, resulted in outperformance
of our hypothetical portfolio versus the benchmark
index. An analysis using the MSCI USA Index yielded a
similar result. Given our view that the trends driving the
transition are only set to accelerate, we see reason to
envision further upside potential in the future.


A win-win
Regulatory action and technological innovation are the
two primary drivers of the transition to a low-carbon
economy. This is fueled in part by growing recognition
of the risks posed by climate change.
On the regulatory front, the number of climate laws
passed globally has doubled every five years since 1997,
according to a 2015 study from leading climate and
governmental organizations that looked at legislation
in 99 countries. The world has adopted clean energy far
faster than experts expected, and countries have moved
aggressively in the past few years to reach their targets.
Within technological innovation, price reductions
and efficiency improvements have accelerated the
deployment of carbon-efficient technologies to replace
existing carbon-emitting activities. We see these forces
advancing the transition to a low-carbon economy.
The upshot: Beyond the potential financial uplift, a
transition-ready approach is also designed to provide
better environmental outcomes relative to standard
benchmarks. Returning to our hypothetical equity
portfolio, we find a focus on transition readiness showed
a 50% reduction in emissions intensity and 30% increase
in exposure to clean technology relative to the standard
benchmark. See the Environmental validation chart.


Environmental validation
Environmental metrics of a hypothetical “transition ready” equity index, 2015–2018


Past performance is no guarantee of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Sustainable Investing and BlackRock
Investment Institute, with data from MSCI and Sustainalytics, December 2018. Notes: The chart shows the emissions intensity and exposure to clean technology of a hypothetical
“transition ready” equity portfolio that is based on the MSCI World ex-U.S. Index. The hypothetical portfolio is designed to maximize BlackRock’s “transition ready” signal while
keeping within an annual tracking error of 100 basis points. Emissions intensity refers to MSCI-defined direct (Scope 1) and indirect (Scope 2) greenhouse gas emissions
normalized by annual sales. Clean tech exposure is represented by exposure to clean tech revenue as assessed by Sustainalytics, on a 0-100 scale (from the worst to the best).


Governance insights in Japan
We believe there are important links between “G”
issues and company performance. And yet governance
issues are notoriously hard to measure in a tangible way
— both because disclosure is imperfect and because
governance issues are often regionally dependent.
This underscores the importance of having boots on
the ground with local expertise.
We highlight Japan as an example. Many existing
strategies that aim to use “G” to mitigate risks and/or
improve performance invest primarily in smaller firms.
They tend to take a “hands-on” approach by having
portfolio managers play an active engagement role
with a company’s management committee or through
consultation. Headline ESG ratings do not provide
a holistic view of these companies given a lack of
standardization and the idiosyncracies of local
business environments.
We see an opportunity to focus on large Japanese
firms with strong governance and long-term corporate
strategies. We believe such companies have the
potential to prevail over business cycles, a trend that
could positively accrue to long-run performance.
BlackRock’s Investment Stewardship team in Japan
started internally scoring companies based on
their engagement outcomes. The goal is to make
more informed voting decisions and enhance the
effectiveness of ongoing engagement work. These
scores provide a gauge of each company’s commitment
to its long-term corporate strategy, its quality of
management, capital allocation efficiency, sound KPI
procedures, and stakeholder relationships. We draw
on these insights in the portfolio construction process.
Read more on stewardship on page 15.


“The external data was patchy, often
outdated and based on global versus
local dynamics material to Japan.
We wanted a means to measure a
company’s leadership at the board and
management levels — and to capture
our own unique perspective.”
Akitsugu Era — Head of BlackRock’s
Investment Stewardship team in Japan


Deep roots in ESG
Role of E, S and G in the mining industry


Source: BlackRock Investment Institute, December 2018. Notes: The table shows the
three ESG pillars and relevance and application in the mining industry.


ESG in the mining industry
Mining is a business known to create noise pollution and
physical disruption, making responsible practices all the
more critical. The mining industry touches every aspect
of ESG, as shown in the Deep roots in ESG chart, and
is important to us as investors in the sector. Yet ESGrelated
metrics on miners can be highly subjective and
hard to quantify.
An ESG working group within our natural resources
investment team looks into data alternatives, including
an in-house effort to develop more reliable information.
We are also tracking initiatives to better align mining
companies with sustainable outcomes and integrate
financial and non-financial reporting in areas like ESG.
In the meantime, company managements are acutely
aware that little is made of a job well done in mining,
but any missteps receive intense scrutiny and can have
catastrophic results. This brings heightened attention
to best practices and makes a focus on all aspects of
ESG critical.
Social license and government partnerships are crucial
to avoiding blow-ups, and it’s imperative that investors
have robust means to assess and monitor companies on
these and all dimensions of ESG.


ESG is becoming a critical input in the EM investment
process, helping to identify risks that tend to be more
prevalent than in developed economies. BlackRock’s May
2018 paper Sustainable investing: a ‘why not’ moment
offers details. For example, shareholder protections
tend to be weaker, issuers have a poorer track record
of paying down debt, environmental standards tend
to be more lax, and corruption more prevalent.
These markets were once plagued by inconsistent
standards and disclosure of data, but the quality and
coverage of reported EM data have vastly improved
over the years. In particular, new sources of highfrequency
data — such as ESG data provider RepRisk’s
data on controversies — can fill gaps and help enhance
traditional ESG metrics. This helps address the issue
of timing lag — one of the perennial challenges in ESG
investing. And new computational techniques can
help make up for data deficiencies. We have been
exploring the use of algorithms that analyze and
score the content of sustainability-related media in
real time — and multiple languages.
We have partnered with J.P. Morgan to support the
launch of a suite of new ESG EM debt indexes to help
fill a void of ESG EM debt benchmarks in the market.
Key characteristics of the new indexes include:
•• Country exposures are reweighted based on
ESG scores.
•• The bottom ESG quintile of issuers is excluded.
•• Green bonds receive an outsized index weight.
•• Issuers deriving any revenues from weapons,
thermal coal or tobacco are excluded.
These new indexes combine information from multiple
sources, including Sustainalytics, RepRisk and the
Climate Bond Initiative. The Sustainable sovereigns chart
shows country weights in the new JESG EMBI Global
Index versus its standard counterpart.


“ESG information has been our primary tool for evaluating qualitative risk when appraising the
standard credit rating of a company. Our inclusion of material ESG metrics in the investment
process has evolved throughout the years as more data metrics and indicators of their materiality
have surfaced.”
Jack Deino — Head of BlackRock’s Emerging Markets Corporate Debt Team


Sustainable sovereigns
Country weights: ESG vs. standard EMD benchmark, 2018

Sources: BlackRock Investment Institute, with data from J.P. Morgan, December 2018.
Notes: The chart shows country weights in the JESG EMBI Global Index versus its
standard counterpart: the JPMorgan EMBI Global Diversified Index, as of December 20,
2018. The countries with the six largest weights in the JESG EMBI Global are shown,
plus China, the country with the largest weighting difference between the two indexes.


The ESG tilt results in some meaningful changes
in country weights relative to standard EM debt
benchmarks. The most notable poor ESG performer
— China — sees its index weight reduced by roughly
two-thirds. Leading issuers such as Hungary and Poland
see big uplifts in their index weight thanks to relatively
strong ESG performance. The new index (JESG EMBI
Global) carries a slightly lower yield than its parent
but is designed to deliver similar risk-adjusted returns.
See page 11 of the May 2018 paper for details.
The new ESG indexes also show higher credit quality than
their baseline indexes. J.P. Morgan estimates a singlenotch
rating upgrade to just 20% of the JESG EMBI would
take it into investment grade (IG) territory. By contrast,
80% of the parent index constituents would need to be
upgraded for it to become IG. Caveats apply: Future
performance may differ. The quality bias of ESG indexes
means they may underperform in risk-on periods. Yet
this quality can help provide insulation in downturns.


ESG integration
There is no one-size-fits-all approach to ESG integration. We see it as using research, data
and insights to drive potential process enhancements across all investment activities.


More and more investors are looking to integrate
sustainability-related insights and data into their
traditional investment processes. A 2018 BlackRock
study of global insurance companies with almost
$8 trillion in assets under management pointed to
the increasing relevance of ESG in how they invest. A
hefty majority (83%) of insurers indicated that an ESG
investment policy was important to their firm, with 80%
already having one in place or planning to adopt one
within the next year.
A separate annual survey by BlackRock, conducted
in late 2018, found that increasing emphasis on ESG
or impact investing was the most significant focus for
institutional asset owners in the EMEA region (Europe,
Middle East and Africa) as they looked to rebalance
their equity portfolios heading into the new year.
Similarly, a 2018 State Street Global Advisors survey of
475 global institutional investors in the U.S., Europe and
Asia Pacific found that 44% were moving toward deeper
integration of ESG into research and security selection.
Of those investors, 14% said they had fully integrated
ESG into their investment processes.
The challenge: The industry faces a lot of questions
about what ESG integration means in practice for
asset owners, insurers and asset managers. There is
no one standard definition or approach. Some define
ESG integration as adding ESG metrics to investment
analysis; others claim ESG integration occurs at
the strategy level and boils down to the number
of sustainable strategies they offer. The breadth
of industry definitions is stoking confusion.


We draw a clear distinction between dedicated
sustainable investing products and the process of
integrating sustainability-related data or insights into
existing investment processes. ESG integration is about
making research, data and insights available to all of our
portfolio managers, and working with them to identify
potential process enhancements across all investment
activities. Our view is that material ESG insights have
the potential to augment traditional investment
processes, regardless of whether or not a strategy
has a sustainable mandate.
What this means: ESG integration centers on material
sustainability-related information as part of the total mix
of economic and financial indicators associated with
an investment — whether used in the research and due
diligence phase, or in actively monitoring portfolios
later in their lifecycle. ESG integration is not only about
increasing the quantity of information sources available
to portfolio managers, but also identifying information
that is additive to the investment process, whether those
insights are intended to mitigate risks or contribute to
long-term outperformance. The ESG considerations that
are material will vary by investment style, sector/industry,
market trends, and client objectives. (Read more on ESG
data progress and improvements on page 10.)
The quality of data is critical in this process. This is why
we see today’s data deficiencies as an opportunity, rather
than a limitation. Our efforts to go beyond headline
scores and dig deeper into ESG data (pages 9–13) help
propel our integration efforts. We believe more granular
insights can help identify market mispricings and
potentially enhance risk-adjusted returns over time.


“Integrating ESG metrics into a cash portfolio can be additive over the long run, despite our highly
restrictive investment universe and the relatively short maturities of cash investments. Companies that
incorporate sustainable practices into their business tend to have lower capital costs, and can be less
susceptible to operational risks. This can ultimately help improve the return profile of an investment.”
Rich Mejzak — Head of Global Portfolio Management for BlackRock’s Cash Management Group


A purposeful approach
The core elements of BlackRock’s approach to ESG
integration are:
1 driving research and insights to understand how
fast-improving ESG data influence investment
performance; and
2 integrating this effectively across our firm-wide
investment processes to help achieve better
financial outcomes.
ESG integration is not about imposing values on
investment teams, nor does it mean simply applying an
ESG label to existing products. We see it as a holistic
process that can help all of our teams become better
investors. See the Demystifying ESG integration graphic
for our view of what ESG integration is — and is not.
Our approach is governed by senior leadership
and executed by the professionals responsible for
investment decision-making. BlackRock published an
ESG Investment Statement in July 2018. The goal: to
be transparent about how we define responsibilities
and establish governance for this process. We believe
ESG integration applies to all styles of portfolio
management. In alpha-seeking disciplines, it is about
facilitating investment process enhancements owned by
portfolio management teams. In the case of indexing,
ESG-related matters are typically considered during
engagements with portfolio companies.


Stewards of capital
Those engagements are managed by our global
Investment Stewardship team and seen as a key
component of our mission to create better financial
futures for our clients. BlackRock believes in using
its voice as an investor, through direct engagement
and proxy voting. Companies should be encouraged
to adopt sound business practices consistent with
delivering sustainable long-term financial returns.
BlackRock’s Investment Stewardship team engages with
some 1,500 companies a year on material ESG issues
we believe affect our clients’ long-term economic
interests. When companies demonstrate poor
management of material ESG issues, we engage
constructively and privately to provide feedback and
discuss how the company’s approach may affect its
long-term performance.
Triggers for such discussions may include company
events that could affect shareholder value (e.g., a data
breach) or a concern around company performance
or governance (e.g., lack of board accountability).
Engagement aims to establish an open dialogue to
develop mutual understanding of governance matters.
It helps Investment Stewardship assess the merits of
a company’s approach to its governance and provide
feedback on any company’s practices that, in our
assessment, fall short of operational excellence. See
BlackRock’s The Investment Stewardship Ecosystem.


Demystifying ESG integration
BlackRock’s approach to ESG integration


Sources: BlackRock Sustainable Investing and BlackRock Investment Institute, December 2018.
Note: The table is for illustrative purposes only.


Team by team
Each of BlackRock’s active investment teams is
responsible for implementing ESG approaches in line
with its investment mandate. BSI acts as a partner to
help ensure consistency across the firm, providing
resources, guidance and best practices. This often takes
what is implicit and makes it explicit, formalizing what
many teams have been doing for years. Each investment
team is required to have a formal ESG integration
statement to underpin its respective approach.
Complementing this team-by-team approach is an internal
benchmarking process designed to measure and monitor
progress firm-wide. Each of BlackRock’s 73 investment
teams had been “baselined” as of late 2018. This includes
the status on ESG integration as well as for the resources,
opportunities and challenges associated with their ESG
integration work. This process will be updated regularly
to provide a diagnostic tool for measuring, managing and
reporting the state of ESG integration across teams to
the firm’s senior investment leadership.
BSI arranges “deep dives” with specific investment
teams to explore more ambitious investment process
improvements based on ESG insights or data. Each
series of deep dives culminates with an internal
symposium, where colleagues present on their key
accomplishments in ESG integration, how new tools
have improved their traditional investment processes,
and highlight and share best practices.
In most cases, these deep dives result in investment
teams creating and integrating proprietary mechanisms
to score securities or assets — measures that extend
well beyond headline ESG scores.


“In 2018 BlackRock Real Assets
developed and implemented
a proprietary ESG Investment
Questionnaire, required for all new
acquisitions across our platforms.
This provides a framework to help
identify and collate information on
material ESG risks and opportunities.”
Teresa O’Flynn — Global Head of BlackRock
Real Assets Sustainable Investing


One size does not fit all
We recognize there is no one-size-fits-all approach to
ESG integration. The availability and quality of ESG data
used by investment teams depends on factors such
as geography (greater coverage in developed versus
emerging markets), holding period and investing time
horizon. Physical climate risks such as coastal flooding,
for example, tend to compound over time and are more
material for longer-dated real assets than for short-term
assets such as cash.
Processes also vary greatly depending on the type of
investment solution. Case in point: A private equity team
may need to build a template to gather ESG information
on its investments, given the lack of third-party ESG
data on private companies and external fund managers.
Third-party ESG data is more readily available in EM
debt, for example, and could be incorporated into
a team’s credit scorecards and used to complement
internal fundamental analysis.
Ultimately, this diversity of investment approaches
presents an opportunity: We can use it to surface
the best ESG integration practices across a variety of
dimensions and share them across the firm to further
our collective efforts.
We have developed a matrix to help us identify common
characteristics across teams and pinpoint best practices
used to overcome challenges associated with each.
This allows for a deeper understanding of where BSI can
focus its efforts to advance practices that can be shared
We recognize that, just as with credit ratings, the highest
levels of integration may involve creating proprietary
measures that extend beyond headline ESG scores. The
most effective way to accomplish this is in the context of
the specific investment process and approach.
Ultimately, we see ESG integration as a way of
enhancing the investment process, not a box-ticking
exercise. There is no one-size-fits-all approach. We
believe it needs to be a rigorous, yet flexible process
to reflect the diversity of different investment styles
and teams.


Lessons and reflections
BlackRock has dedicated significant resources in a firmwide
effort to deepen the integration of sustainabilityrelated
insights and data into investment processes
globally. Several initial lessons have emerged. We share
them in an effort to advance the conversation industrywide
as we improve, test and calibrate our approach:
Setting internal goals and reporting on milestones is
key in helping push forward what is an evolving process.
Producing a clear and transparent diagnostic for senior
investment leaders helps to manage progress. It is also
valuable in identifying areas of strength within certain
teams, so more advanced teams can help others and
collaboratively address common challenges. Finally, it
helps guard against a siloed approach and outcome
whereby all teams work on challenges of ESG integration
independently and at different speeds. Following the
initial baselining, we found many teams faced similar
challenges and opportunities in augmenting their
investment processes with material ESG insights.
ESG integration must be viewed as a journey, not a
box-ticking exercise. Training our portfolio managers
in how to make sense of fast-improving ESG data
and insights is an important goal. The alternative of
parachuting ESG “specialists” into investment teams
generates less durable progress. Our teams’ approaches
are dynamic, defined by adaptation and innovation
as new sustainable investing insights and tools arise.
Data and technology tools are crucial. Portfolio
managers need the right data and technology tools to
measure and manage sustainability-related exposures
effectively. BlackRock has been building issuer-level
ESG information into Aladdin, the firm’s investment and
risk-management system, since 2015. Our own portfolio
managers and some clients can use Aladdin to monitor
portfolio risks and help inform investment decisions
based on ESG metrics.
We leverage our technology platform to drive four
objectives of ESG integration: increasing transparency,
mapping exposures, uncovering value and
implementation. We are investing in improving these
data and analytic tools.




Sustainability at BlackRock focuses not only on our
investment processes, sustainable investment solutions
and our stewardship of our clients’ assets. It also
involves the operations of BlackRock itself. As an asset
management firm, our objective is to secure better
financial futures for our clients and those they serve.
To achieve this goal, we must ensure the long-term
sustainability of our own firm. We published our mission
statement on sustainability in 2018, outlining our
approach to be an industry leader in how we incorporate
sustainability across the firm.
Governance and board
Our corporate governance framework is governed by
BlackRock’s board of directors and an accountable lead
independent director. Our board regularly reviews our
strategic framework for long-term value creation and
challenges management in executing on it. We believe
our board’s diversity of background and perspective
plays a significant role in its ability to evaluate BlackRock’s
management and operations.
Human impact
As an asset manager, the long-term sustainability of our
firm is heavily dependent on our people. We focus on
fostering a unifying culture; encouraging innovation;
ensuring that we are developing, retaining and recruiting
the best talent; aligning employee incentives and risktaking
with those of the firm; and incorporating inclusion
and diversity into all levels of our business.
Environmental sustainability
BlackRock’s business model is not carbon intensive,
yet we are committed to managing our impact on the
environment. We approach sustainability in a way that
decouples our growth from our environmental impact.
Our path to sustainability includes measurement and
management of carbon emissions and energy-efficiency
goals; consideration of renewable and alternative energy
sources; and disclosure of risks and opportunities around
climate change.
Read more about BlackRock’s approach to sustainability.




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