BlackRock ESG MSCI Mexico ETF’s big hit & the OECD on ESG

This week, we are taking a break from our ESG Development Heatmaps (other sectors coming up next week) to share a couple of interesting things from the ESG world.

BlackRock ESG MSCI Mexico ETF big hit

The big Mexican ESG news of the week was the following Bloomberg article, showing that Blackrock’s new ESG ETF has attracted US$460m in new money, 10% funded from withdraws from its mainstream Mexico ETF (Naftrac) and the rest with new money. (Read article here)

The only problem is that the BlackRock ESG MSCI Mexico ETF looks quite similar to the existing Naftrac index, with most of its 24 constituents in the 35-strong Naftrac and at similar weights. Some companies are perhaps included at a higher weight in ESG versus Naftrac index because they have decent ESG disclosure, not because they necessarily do society a lot of good. Of course, this similarity in indices mainly reflects the lack of depth in the Mexican market, which makes constructing a liquid ESG portfolio very difficult. Still, progress is progress.

The following tables show the difference in portfolio weights for each company between the BlackRock ESG MSCI Mexico ETF and the Naftrac, split by those who have been benefitted and those who have been hurt by this recent shift:

As a reminder, MSCI ESG Indices take a regular MSCI Index as the starting point (in this case, MSCI Mexico) and then optimize the exposure to ESG factors, while maintaining sector diversification and using MSCI ESG ratings. This basically translates into a relative performance index within each sector which has the same liquidity constraints than the regular MSCI Mexico index (leaving out companies with great ESG policies but not enough stock liquidity). Again, in a market with less ESG development such as Mexico, this methodology won’t guarantee all constituents are great at ESG topics. For a more detailed description of the underlying index behind Blackrock’s ESG ETF, you can go here.

OECD Business and Finance Outlook 2020

We also want to briefly comment on the OECD Business and Finance Outlook 2020 report (found here). This is an almost 200 pages long report, and the focus this year is on ESG investing. If there is one in depth report on ESG you should read in 2020, it’s this one. It provides an admirably honest look at the state of ESG investing and integration; how far ESG has come, the challenges ahead, and what should be done to address them.

The report evaluates current ESG practices and identifies priorities and actions to better align investments with sustainable long-term value. In particular, the report highlights the urgent need for more consistent, comparable, and verifiable data on ESG performance. Even the OECD is confused by all the different metrics and standards out there.

Some highlights:

+ There is not much evidence ESG funds outperform standard funds, risk-adjusted – but ESG funds did seem to outperform during the COVID-19 pandemic.

+ The sustainable market size has grown by approximately 30% since 2016, reaching up to US$30 trillion in total assets across the five most relevant markets. The European Union continues to lead in total invested assets committed to sustainable investments, reaching US$14 trillion, followed by the U.S. at US$12 trillion.

+ “Greening” the financial system. Studies show that more than one ESG score provider has inconsistencies when it comes to the “E”: many times, companies with high overall scores also correlate with high non-renewable energy use, water use, pollution and waste generation, and/or high emissions. Despite having similar scoring categories, inconsistencies in measurement criteria remain across score providers.

+ A working paper from the ECB demonstrates that for given levels of economic development, financial development, and environmental regulation, CO2 emissions per capita are lower in economies that rely more on stock market equity. This is because stock markets reallocate investment towards less polluting sectors more effectively than other types of financial markets, and because equity markets also push remaining carbon intensive sectors to develop and implement greener technologies.

+ The main strategies to integrate ESG criteria into investments are:

1) Exclusion or avoidance: divest or “cut off” from controversial sectors such as weapons, coal, gambling and tobacco.

2) Norm-based or inclusionary screening: frequently happens after former step; investors develop a rating system or scale of expected ESG level, and pick outperformers that surpass that average.

3) Best-in-class approach: The “best” companies within the reach and limitations of their sector. For example, the oil producers with the best practices and lowest emissions.

+ ESG is driving corporate decisions in terms of how much and to whom banks will lend their money. Financing operations with debt will be increasingly difficult for companies without ESG policies. Banks need to improve their ESG risk management.

+ Governments can improve ESG outcomes as owners of large companies and as investors. About one quarter of the world’s largest companies are state owned and they should lead by example.

+ Institutional investors are increasingly integrating ESG factors in their decisions. That said, many are confused by the plethora of ESG rankings, which often lead to different conclusions, and self-reporting bias. There is a need for standardized data and checks which would help build trust. External data sets may just lead to box ticking exercises.

+ Challenges in ESG investments could undermine confidence in ESG metrics. Regulators and authorities need to improve transparency, consistency and alignment with materiality and clarity of labels. There is a long way to go on deciding how best to audit ESG information. As this happens, ESG investing and integration can make the world a better and safer place.

I hope you found this interesting. As usual, if there is anything we can help you with, please reach out.

Best,

Marimar

Partner, Miranda ESG