Unpacking responsible, sustainable investing

In episode 17 of the Financial Checkup, BlackRock - the world’s largest asset manager and investment partner for the Advantages Retirement Plan™ - discusses upcoming changes to its target date funds to include a stronger emphasis on ESG (Environmental, Social and Governance) factors.

Transcript

Farzan Qureshi:

Our fiduciary lens is that we want to deliver the best returns to participants in their best interests and we believe that leaning into this dimension of sustainability is in the best interest of participants and will deliver that best return for them going forward.

Speaker 2:

Welcome to The Financial Checkup, a podcast series devoted to improving the financial health and retirement readiness of physicians and their spouses or common law partners. This series is brought to you by the Award-Winning Advantages Retirement Plan from OMA Insurance.

Alex Mazer:

My name is Alex Maser. I'm the co-founder and co CEO of Commonwealth.

Farzan Qureshi:

Hi, my name is Farzan Qureshi. I'm a director retirement strategist at BlackRock in Toronto.

Speaker 2:

This series is for educational purposes and should not be considered investment, tax, financial, or other professional advice. The views or opinions expressed by the presenters are solely their own and do not necessarily represent the views or opinions of BlackRock, the OMA, OMA Insurance, or the Advantages Retirement Plan.

Alex Mazer:

Farzan, one of the big issues that has come up in the last couple of years and plan members are thinking about this is how environmental, social, and governance factors are incorporated into their investments, so things like climate change. Could you speak to how BlackRock thinks about those things as the world's largest asset manager and specifically how you're thinking about those things with respect to the LifePath portfolios?

Farzan Qureshi:

Absolutely, and this is something that BlackRock has been fairly front footed on over the last number of years, talking about climate risk, talking about sustainability risk. We think of these risks as material investment risks that we need to consider given that you're beginning to see a lot of regulatory action around this, around the world as well so there's a regulatory risk aspect. In addition to that, overall sustainability, climate risk, which is a real financial risk in many, many senses. We're seeing the same type of consideration being given by major regulators be that OSFI in Canada, the organization that looks after financial institutions, as well as the Bank of Canada and other regulators beginning to look at sustainability risk quite carefully.

BlackRock, in our view, is that these are material risks that are going to manifest themselves in the coming months, weeks, decades as we move into a transition towards a lower carbon economy. Now that transition is already begun. It's not something that's going to happen many years in the future. It's something that's here now today. We're beginning to see it as countries and governments have made their own commitments to net zero. We see that in the marketplace, and we see this as being a big headwind or tailwind, lots of opportunities, lots of risks also in the marketplace over the next decades.Given that retirement investing is a multi-decade endeavor, we want to take this into account in our own portfolios. So how do we take it into account?

We as an index fund manager, managing target date funds with index funds want to incorporate it by using index funds that are incorporating and taking into account ESG and sustainability risks into their construction. So within LifePath portfolios, we are moving away from the market cap weighted indices and equities, so the S&P TSX composite, S&P 500, these are broad markets that ultimately just pick the largest stock in the index and weight them accordingly. The indexes that we are moving to also do that, they take into account those largest stocks in each and every industry, but they also then put a layer of scrutiny around their ESG and ranking in terms of their sustainability ranking as ranked by an outside independent MSCI index provider.

MSCI is creating these indices that mimic the long broad nature of the broad markets, but with a sustainability uplift, so they're higher weighting to those companies with better sustainability scores and under weighting companies with lower sustainability scores within the same sector. At the index the level, each and every one of those indices has a higher sustainability profile while still delivering that broad market exposure that we want to Canadian equities, to US equities, to international and emerging market equities.

BlackRock and LifePath is looking to incorporate sustainability into our portfolios. We're making this shift from market cap indices to ESG-optimized indices in the coming quarters, starting in Q4 of this year. At the overall portfolio level, we do not change our overall risk and return objective, and our overall objective to deliver consistent spending power to participants remains the same, but we are incorporating this ESG and sustainability lens directly into our asset mix.

Alex Mazer:

So in other words, plan members can expect to see a shift for the companies that they own within their LifePath portfolios towards companies that have a higher sustainability rating according to these indices that are crafted around sustainability.

Farzan Qureshi:

That's exactly it. In the underlying portfolios, there will be exposure to higher sustainability companies while still getting that overall broad market exposure that we want, tilting into sustainability as a factor that we think is going to impact the portfolios in the coming 10, 20, 30 years. We're not blind to it, we're not looking to reduce returns, we're actually believe that we will deliver better long term risk adjusted returns by tilting into this view with companies that have a better sustainability metrics going forward.

Alex Mazer:

And what effect, for somebody who's worried about their own carbon footprint or the carbon intensity of their investments, do you have any sense of how that shift might affect, say, the carbon footprint of the LifePath portfolios?

Farzan Qureshi:

Yeah, certainly. The LifePath portfolios, the actual carbon emissions footprint in those portfolios is coming down. There is a measurable decrease in that carbon emissions footprint when going from kind of market cap indices where we are today to the ESG-optimized indices where we're going to. You're almost seeing, without getting into exact numbers, somewhere in the order of 20 to 30% carbon emissions reduction in the equity component of LifePath portfolios as we move in this direction.

Now, in many other countries of the world, the UK, Europe, et cetera, they are portfolios being designed with very specific carbon emissions reductions targets in mind and so this is an evolution, as we think about how to incorporate sustainability into our broader portfolios, you're going to see more and more metrics around carbon emissions reductions and other things being able to being discussed and being able to share with participants and plan sponsors. More to come around this type of approach, but absolutely, certainly as we move to a more sustainability orientation, there is going to be a measured and meaningful reduction in carbon emissions in the portfolios that participants are holding.

Alex Mazer:

BlackRock has made the decision to integrate ESG factors into their core target date fund portfolios rather than creating a separate set of ESG funds. Why did BlackRock make that decision?

Farzan Qureshi:

This is one of our best ideas and we want to incorporate it into all of our portfolios. We are seeing a regulatory dimension to this as well. We're seeing an unambiguous push in Canada and other major countries, except maybe the US, where sustainability and ESG is becoming part of the pension legislation framework as well. We're a little bit ahead of it with this LifePath change, but certainly in Europe, even in South America and in Asia, that is a regulatory push that's happening where DC plans are being forced to incorporate these types of sustainability strategies into their default strategies.

For us, given that it's our best idea, we think it's one of our best ideas, we want to incorporate it directly into our flagship product. Again, we ultimately believe and have conviction that this will lead to better risk adjusted returns over the long term, given that markets and market cap weighted indices are maybe not paying attention enough to sustainability issues as they're constructed today. But we believe that this is going to be a meaningful macro driver of returns going forward, and we want to have exposure to it, both from an opportunities perspective, but also from that risk mitigation perspective. It is incorporated in all our flagship portfolios around the world, except the US where we've launched a separate strategy just given the regulatory ambiguity in the US that is still going on around ESG and sustainability.

Alex Mazer:

We're very pleased that BlackRock is moving in this direction because part of our philosophy is to give people a very streamlined set of portfolios that are going to get the best results for them. We know that more and more plan members are interested in ESG, but they're also interested in getting the best risk adjusted returns with a simple approach. The ability to continue to offer a simple lineup of target date funds that also are incorporating this significant risk with an expectation of continued strong risk adjusted returns in the future is a positive for us.

Farzan Qureshi:

Yeah, absolutely. We're doing this ESG evolution and incorporation using our fiduciary lens. Our fiduciary lens is that we want to deliver the best returns to participants in their best interests and we believe that leaning into this kind of tilt and this dimension of sustainability is in the best interest of participants and will deliver that best return for them going forward. We're not doing this to push our values on ESG on anybody, but we are doing this not to sacrifice returns and add some societal value, but really in the vein of delivering the best financial outcome to LifePath participants over the long term.

Alex Mazer:

Could you, just for people that are not familiar with the LifePath funds, could you in just a simple way, describe what is inside a typical LifePath portfolio that one of our plant members might have?

Farzan Qureshi:

Sure. LifePath holds allocations to three different asset buckets. We have allocations to growth buckets, which is equities, so stocks, meaning broadly diversified, Canadian, US, international, and emerging market stocks. We also have exposure to inflation hedging asset classes like real estate, REITs, infrastructure, public equities, commodities, and real return bonds. Then we have exposure to ballast securities, so things that are high quality, fixed income bonds, meaning the universe bond index. A very broadly diversified portfolio. I've mentioned equities, alternatives like real estate as well as bonds. In that total LifePath portfolio. Each LifePath vintage, whether it's 2060 LifePath or retirement LifePath, will have close to 10,000 securities across all these different dimensions, growth, inflation hedging, and stability and protection.

Alex Mazer:

How is that diversified around the world? If a typical investor hold a LifePath fund, what kind of geographies do they hold assets in?

Farzan Qureshi:

Majority of their assets will likely be in Canadian, depending on where they are on the Glide Path, I would say. For younger investors, they will have a much more global oriented portfolio, so lots of US, international, emerging market stocks, but also some Canadian equities, more Canadian equities than maybe the overall market. The market in Canada is about 3% of the total world market, we hold slightly more. We have a home country bias given that Canadians spend in Canadian dollars, et cetera, and our retirement basket is more Canadian oriented, lots of Canadian assets, but lots of global assets. As we move to retirement, that retirement vintage, we have 60% fixed income, which is Canadian fixed income of Canadian bonds, and then about 40% of international stocks, which includes US, international, developed markets, as well as emerging markets, as well as some of those additional alternative asset classes. A mixture of Canadian, a lot more Canadian exposure as you get closer to retirement, but a lot more global exposure as you are further away from retirement.

Alex Mazer:

It sounds like every plan member, no matter what their age, it's going to change a bit, but they're always going to have a pretty broad exposure to geographies around the world. They're not going to have all their eggs, in other words, in one country, and be exposed to the potential risks of that.

Farzan Qureshi:

Absolutely. That's one of the benefits of LifePath is this broad kind of exposure that BlackRock can deliver, given that we're one of the world's largest asset managers, we have assets in every single country around the world, and we want to deliver that kind of global exposure to, again, mitigate some of those individual risks from individual countries as described.

Alex Mazer:

Well, thank you very much, Farzan. We really appreciate you taking the time to share your insights.

Farzan Qureshi:

Thank you for having me. Thank you to Commonwealth for being such a great partner to BlackRock. We continue to look forward to working closely with you and our mutual clients and plan sponsor partners together. Thank you.

Speaker 2:

The Financial Checkup series is producing collaboration with OMA Insurance and Commonwealth, the administration and technology partner for the Advantages Retirement Plan.