Wei Li, Global Chief Investment Strategist together with Vivek Paul, Senior Portfolio Strategist, Debarshi Basu, Head of Quantitative Research and Sophie Thurner, Sustainable Product Specialist, all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
The powerful economic restart has led to a rally in the traditional energy sector. This has raised concerns that sustainable assets may face pressure after stellar performance in 2020. We view such a short-term focus as misguided. The power of the near-term restart should not be confused with the slow transition to sustainability that we see driving long-term returns.
The Covid pandemic has accelerated structural trends including an increased focus on sustainability, and heightened attention on underappreciated sustainability-related risks and supply chain resilience. Sustainable exchange-traded products (ETPs) globally attracted record cumulative inflows of $87 billion in 2020, and this year looks on track to significantly eclipse last year’s record flows. See the chart above. An increasing political, regulatory and societal focus on sustainability across developed markets in particular means that the shift toward sustainable assets looks set to power ahead, in our view. The acceleration in sustainable fund flows has taken place in a dynamic market environment – from last year’s Covid-induced economic shock and subsequent market recovery, through an economic restart that is now boosting cyclical assets such as value exposures. The persistence of the inflows speaks to our view that we are likely in the early stages of a shift in investor preferences toward sustainable assets – the full effects of which are likely not yet reflected in market prices.
The investment case for sustainable assets is about their resilience and long-term return prospects, in our view. In 2021, we see the restart as the dominant driver of returns – and supporting assets exposed to today’s dominant energy sources. Yet this does not change our confidence in sustainability as a key driver of long-term returns. Sustainability will drive returns over time and beyond the restart, as the energy transition progresses, the economy restructures and capital is reallocated. That is why we think judging the impact of sustainability on near-term returns is wrong. We also believe sustainable exposures add potential resilience to portfolios, partly driven by a quality tilt in sustainable index methodologies toward companies with strong profitability and low leverage. Sustainable characteristics ranging from carbon efficiency to job satisfaction of employees and the effectiveness of a company’s board also add to the resilience properties, in our view.
We see climate change in particular as a key driver of returns – one that will boost growth and risk asset returns against a “no action” baseline. After a long transition to a low-carbon economy, assets backed by high sustainability will likely be more expensive – while other assets will have become cheaper, in our view. Sustainable assets should earn a return benefit during this transition, in addition to providing greater resilience against risks such as the physical disruptions from climate change. We believe the long-term effect of sustainability on asset performance has yet to be efficiently priced in, and see an opportunity today to position long-term portfolios to capture the potential historic return opportunity.
Our updated, climate-aware return assumptions for strategic portfolios have included the effect of climate change – and of the “green” transition to a net-zero world. Using a sectoral lens, we see technology and healthcare benefiting the most, and carbon-intensive sectors with less transition opportunities such as energy and utilities lagging. This in turn increases our strategic preference for developed market (DM) equities, at the expense of high yield and some emerging market (EM) debt.
The bottom line: We see the tectonic shift toward sustainability as still in its early stages. Other drivers of asset performance, such as the powerful economic restart, could dominate in the near term. But we believe the shift in investor preferences toward sustainable assets will be persistent, accelerated by political and regulatory changes. This is why we have a strategic preference for companies and sectors positioned to potentially benefit from the transition to a more sustainable future.
U.S. 10-year Treasury yields held below the 14-month peak hit earlier last week. President Joe Biden’s $2.25 trillion jobs and infrastructure plan is likely more medium-term in nature. Yet over the short term the prospect of even more stimulus may reinforce the cyclical rotation that is underway. We expect equities and other risk assets to be supported by the new nominal – a more muted response of government yields to stronger growth and higher inflation than in the past as central banks lean against any sharp yield rises.
U.S. services PMI will be in focus this week. Investors are eager to gauge the status of the restart in the services sector – the most affected by the pandemic. U.S. consumer confidence has rebounded to the highest level since March 2020 and consumer spending on key services has been rising – against the backdrop of rising Covid infections. We still see the broad vaccine-led restart intact and expect the U.S. to beat on restart expectations as its vaccine rollout accelerates.
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