BLK BlackRock Inc

By James Mackintosh 

Climate change poses two distinct risks for investors, and a special one for fund managers. The pledge last week by Larry Fink, CEO of fund giant BlackRock Inc., to push clients toward environmental, social and governance investing highlights another risk: that markets are shifting from harnessing the wisdom of crowds to the wisdom of a handful of powerful money-management executives.

Leave the pros and cons of ESG aside for a moment. Whatever you think of Mr. Fink's view, his letter highlights the power he wields over the direction of corporate America, thanks to the votes of BlackRock's extensive holdings. Shareholders used to have diverse views, with individual managers even within the same organization often disagreeing on what companies should do. Just as the market is meant to set prices by balancing many different opinions, there were many people deciding on any given shareholder vote.

That's changing fast. Index funds are now as big as actively run mutual funds, but are disproportionately run by just three companies: BlackRock, Vanguard Group and State Street Corp. We shouldn't exaggerate: BlackRock doesn't own enough stock to dictate to CEOs. But between them, the three indexing giants hold roughly a fifth of the S&P 500 through funds they run for investors, and are often -- as with JP Morgan Chase & Co. -- the three biggest shareholders.

Their decisions on any controversial vote are already highly influential on the outcome, and the trend toward indexing shows no sign of slowing.

Agree or disagree with Mr. Fink's demand for more action from companies on climate issues, the fact that just one man -- albeit a very smart man -- is in a position to do this in the first place is scary. This is probably one reason Mr. Fink promised more transparency over voting. But as the power of just three companies keeps growing, it is time governments started to think about spreading voting more widely. One way would be to give investors in index funds the decision on how to vote. After all, it is investors' money, not Mr. Fink's.

Still, Mr. Fink is surely right that investors should worry about climate risks leading to big shifts of capital, and therefore big price moves. The trouble is that we know very little about what those shifts of capital will be and where they will lead to profit or loss, both because we cannot be sure how weather patterns will be affected and because much else depends on politics.

Aside from some obvious examples -- beachfront real estate in Florida -- it is hard to have much confidence in assessments of the physical effect of climate change on economies or companies, let alone on share prices.

BlackRock thinks it is starting to get a handle on which municipalities, and so their bonds, will suffer most; on increased risk to commercial mortgages from hurricanes; and on which electric utilities have, like PG&E, invested too little to counter climate risk. But these are early days.

The political impact is even harder to quantify, because governments might do a lot, or nothing. Even when governments do act, shareholders of "dirty" companies might benefit; anticipation of multibillion-euro compensation payments in Germany's belated deal last week to end coal-fired power by 2038 led the shares of the country's coal-reliant utility RWE AG to jump.

The risk for fund managers is clearer: If they don't act, they face the prospect of protests and loss of assets from clients most worried about climate. BlackRock is the obvious target, as the world's biggest manager: Extinction Rebellion activists glued themselves to its London building last year. Worse for Mr. Fink, its approach to engaging with companies was a contributing factor to last year's loss of roughly half its $50 billion mandate from Japan's Government Pension Investment Fund, the world's biggest institutional investor. Going public with a strong commitment to tackling climate change is a sensible way to counter the risk to BlackRock itself.

That doesn't mean Mr. Fink is right that incorporating ESG into investment will lead to better performance, something he insists in a letter to clients is the reason to integrate "sustainability" into how the company manages money.

Performance of BlackRock's own iShares range of ESG funds shows that ESG is no guarantee of gold-plated returns.

Its two oldest in the U.S., set up in 2005 and 2006 and now tracking the MSCI USA ESG Select index and the MSCI KLD 400 Social index, have both lagged behind iShares' S&P 500 fund.

Two more recent funds set up in 2016 and last year are slightly ahead, as U.S. ESG approaches have mostly beaten the S&P in the past three years. It's possible that U.S. ESG is starting to outperform as it becomes fashionable. It's also possible that this is just a temporary advantage from holding less in oil stocks during a rough patch for crude producers.

Whatever your views on the merits of ESG investing, BlackRock will now be nudging clients toward ESG funds and pushing companies to act. The chances are that this will be marginal in the efforts to do more to tackle climate change, at best. But by sending a signal that serious money is not just prepared for government action on carbon but might even welcome it, it is just possible it will make that government action more likely.

Write to James Mackintosh at James.Mackintosh@wsj.com

(END) Dow Jones Newswires

January 19, 2020 05:44 ET (10:44 GMT)

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