Bad Day At BlackRock? ESG investing is already taking a toll on state pension funds—now it might transform the world’s largest private asset manager, too. Rupert Darwall
https://www.city-journal.org/blackrock-esg-strategy
“I don’t give a damn what these powerful corporations tell us and I don’t care about their profit margin. We need to get out of these fossil fuels before it’s too late for everybody.” These are not the words of a Sunrise Movement activist, though they could easily be mistaken for one, but New York City comptroller Scott Stringer, speaking at an online People’s Assembly on BlackRock last week. The gathering of activists and advocates was intended to discuss strategies for pushing BlackRock, the world’s largest asset manager, to make good on its promises to “place sustainability at the center” of its investment strategy. As environmental activists see it, the firm has a long way to go.
Stringer, an anti-fracking campaigner and protégé of Congressman Jerry Nadler, became comptroller in January 2014, when Bill de Blasio took over as mayor. He wanted to remake his office into “a think-tank for innovation and ideas,” Stringer declared on his first day. That’s a risky outlook for one assuming a position defined by law as the custodian of the city’s five pension funds, which totaled, in February 2020, $221.2 billion in assets. Early on, Stringer proclaimed a devotion to environmental, social, and corporate governance (ESG) factors in investing, and to finding investment managers dedicated to these principles. He launched a campaign on proxy access to enable shareholders to nominate directors—ticking the “G” for governance. He then moved on to the “S” with his Boardroom Accountability Project, writing to 151 companies asking that they disclose, among other things, the sexual orientation of their directors.
“E” for environment is the big one. When de Blasio announced in January 2018 that city pension funds would divest $5 billion worth of equity in fossil-fuel companies, Stringer justified the move by claiming retirees’ financial future was “linked to the sustainability of the planet.” The comptroller allocated 12 percent of the fund assets of the New York City Employees’ Retirement System—the largest of the city’s five pension funds—into the Developed Environmental Activist asset class, according to an American Council for Capital Formation report by Timothy Doyle. The move dragged down the fund’s already-poor investment returns.
According to Doyle, in 2017, Stringer submitted 92 shareholder proposals, putting NYCERS in the top 10 filers. Sadly for its beneficiaries and New York City taxpayers, Stringer’s performance as a top filer appears inversely correlated with his investment performance. The funds have consistently lagged the market and the NYCERS own benchmarks. A 2017 Manhattan Institute report estimated the fund’s pension liabilities at $142 billion, with an average funded ratio of 47 percent, meaning that the funds had less than half the money needed to pay promised benefits.
Doyle uncovered a similar story at CalPERS, the California public-employees retirement system and the largest state pension plan in the U.S. “Sustainability continues to be at the heart of what we do,” a 2014 report declared. “The first task in implementing this approach was to develop principles for sustainable investment across the CalPERS portfolio.” CalPERS honors the third of these principles—that investment decisions “may reflect wider stakeholder views, provided they are consistent with its fiduciary duty to members and beneficiaries”—more in the breach than in the observance. Doyle reviewed CalPERS’s private-equity investments and found that of its nine worst-performing funds, four were focused primarily on renewable/clean energy, while none of the top 25 performers were ESG-focused. During its period of intensified ESG activism, CalPERS managers converted a $3 billion surplus into a near $140 billion deficit.
Though senior CalPERS managers deploy pension-fund assets to champion political causes, Doyle notes that when it came to their own money, none of the board members or the senior investment officer allocated any personal capital to environment-focused funds or equities. Beneficiaries’ investment preferences are no different. A 2018 survey of pension-fund members by the Spectrem Group found that nearly 80 percent of pension-fund members nationwide believe that fund managers’ primary goal should be investment returns. Among those age 51 and older, the number increased to 91 percent, even if the pension member supported the particular cause. Only 11 percent of those surveyed wanted their pension to prioritize “worthy political and/or social causes,” even if those generate lower returns.
Two kinds of people will be involved in the pretense that ESG constraints don’t affect investment returns: those who realize it but obfuscate for “the greater good”; and true believers, for whom reasoned argument on the matter is akin to betrayal. When investing their beneficiaries’ money, CalPERS board members acted out the pretense; when their own, they ditched the pretense and avoided ESG-oriented investments.
Founded in 1988, BlackRock did not become the world’s largest fund manager by willingly sacrificing its own returns, as those mismanaging the pension funds of deep-blue states have done. BlackRock had powered itself to global leadership by providing low-cost, passive investment vehicles, an approach based on the Efficient Market Hypothesis stipulating that prices of securities fully reflect all available information. Because future price changes, on this view, represent a “random walk” and cannot be predicted, active investment strategies won’t generate abnormal profits. Thus, the rationale for BlackRock’s low-cost, low-fee, index-provider business model.
Competition has commoditized this model, leading to fee compression and putting BlackRock’s earnings under pressure. ESG offers BlackRock a path away from paper-thin margins and earnings stagnation—and a chance to improve its public image, to boot. The firm has well-developed political antennae. Bloomberg Businessweek recently dubbed BlackRock the fourth branch of government and called BlackRock founder, chairman, and CEO Larry Fink one of Wall Street’s “most important government whisperers.” Fink, Bloomberg Businessweek says, was on the shortlist to be Barack Obama’s second-term Treasury secretary and is in line for that post in a prospective Biden administration.
BlackRock’s ESG strategy can be described as a “marketing ploy with higher fees,” according to a report by the Institute for Pension Fund Integrity. The report points out that the fee-expense ratio of BlackRock’s Global Clean Energy ETF is 11.5 times that of its S&P 500 ETF. Small wonder that BlackRock has informed its clients that “sustainability should be our new standard for investing” and that it intends to make sustainable funds “the standard building blocks” of client portfolios. As the IPFI report puts it, over time BlackRock will look less like an efficient-index provider and more like a higher-fee forecaster of economic and social trends.
This shift in approach could have significant unintended consequences. Prioritizing ESG probably won’t be good for BlackRock’s clients. And if the firm’s stature encourages more public-sector investments in ESGs, the damage could be to more than just BlackRock’s bottom line.
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