Do Physical and Transition Climate Risks Translate Into Investment Risks?

Contributors

Jaspreet Duhra, Managing Director, Global Head of ESG Indices, S&P Dow Jones Indices
Muhammad Masood, Director, iShares Sustainable Investing, BlackRock

As climate risk becomes better understood, interest in ESG investing grows. Jaspreet Duhra, Global Head of ESG Indices, and Muhammad Masood, Director of iShares Sustainable Investing, explore what’s driving heightened adoption of ESG strategies, ways to assess companies’ physical and transition climate risks, and the wide range of targeted ESG strategies now accessible to market participants looking to mitigate risks like these.

S&P DJI: ESG investing has become a more mainstream notion in recent years. What catalysts do you see driving that shift?

Muhammad:We are seeing a shift toward sustainable investing. To put this into context, EMEA investors are anticipating nearly 50% of their AUM to be in sustainable investing by 2025—this is up from just 21% in 2020.1 We have already started to see this fundamental reallocation of capital; in 2020, there were net inflows of USD 425 billion into sustainable assets globally. In H1 2021, we have already seen USD 353 billion.

This shift into sustainable investing has resulted from a range of factors, driven by changing consumer and investor preferences, improved sustainability data, and more sustainable investment options designed to meet various ESG and investment goals and the requirements of increasing regulation. This is fueling a global reallocation of capital toward more sustainable companies, which we expect to continue over many years.

S&P DJI: What role do you see for index-based strategies and ETFs in ESG investing?

Muhammad:Index investing has become a more common option for many investors looking to integrate sustainable considerations into their portfolio, and we see this through asset growth. AUM in index mutual funds and ETFs stands at over USD 630 billion as of June 2021, compared to just USD 469 billion at the end of 2020 and USD 220 billion at the end of 2019.

Much of this demand comes down to the choice that exists in the indexing space. Sustainable index funds and ETFs are covering exposures across almost every corner of the equity and fixed income investment universe and investors can also choose the sustainable approach that works for them. They can pick a business-involvement screened product, an ESG-tilted fund that maintains minimal tracking error with its underlying index, or a product that selects only the top ESG performers. Thematic and impact investing are also possible through ETFs, for example through clean energy and green bond ETFs. The rules-based approach adopted by index funds and ETFs can bring greater control and transparency to sustainable investing. Investors can learn the datasets being used, the criteria for security selection and weighting, and ultimately have full transparency into the ETF holdings, potentially giving them insight into why certain companies or issuers are being chosen and why others are excluded. As the regulatory landscape around sustainability evolves and investors look to adapt to this, index-based investing can play an instrumental role.

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