As the idea of incorporating environmental, social, and governance principles into the investment process is growing, it’s being documented that this trend is not simply a fad—while academics debate the full relationship between ESG factors and asset returns, there’s plenty of research that shows that ethical investing does indeed yield positive returns. Still, as more buy-side firms have looked to slice off their own piece of the ESG pie, they’ve hit barriers when it comes to finding tradable signals from these non-standardized datasets, and that there are vast data gaps that can hinder modeling efforts.

BlackRock is looking to help firms fill some of those modeling gaps, announcing the launch of Aladdin Climate at the beginning of December, which aims to provide modeling and risk management services through the Aladdin platform. But at the core of the asset manager’s climate efforts is the ability to provide forward-looking analytics, rather than providing a point-in-time snapshot of an asset or corporation’s ESG positioning.

At the beginning of 2020, Mary-Catherine Lader was appointed to the newly-created role of head of Aladdin Sustainability, a group that falls under the company’s technology division and aims to provide new ESG analytics and tools for users. She says that Aladdin Climate is another move by the firm to give context around an investment’s future state.

“We’re going to see sustainability data transition from being a point-in-time snapshot, to more predictive and forward-looking,” Lader tells WatersTechnology. “Today, we have a few facts about a company; in the future, we expect that you’ll have lots more unstructured data at your fingertips that an investor can use a software tool to predict—to model—how a company’s performance in a certain area might change over time.”

So, for example, corporations are increasingly reporting their carbon footprint, both from the impact their businesses have on the environment, as well as for Scope 3 (or indirect) emissions, but those calculations are typically provided once a year, she says. “What we increasingly want for climate risk is to understand how a company is positioned for the future—not necessarily for carbon footprint of today.”

These models change depending on the sector that the company targets. Looking at oil and gas companies, some are investing heavily in renewable energy, while others are preparing for the likelihood of a carbon tax or a policy regime that penalizes emitters of fossil fuels. Those that are better positioned for a future state are more likely to continue to grow (or, if a trader thinks there will be a significant rollback of sustainability mandates in the future, the antipodean argument takes precedent).

In this scenario, Aladdin Sustainability’s models aim to show the difference between one oil and gas company from another and how they are positioned for the future. To do that, the group looks at factors like how they’re investing in new facilities, looking at the growth of their renewable energy production, and incorporating the impact that the company has on the environment in which they operate, among other factors. Blending a diverse group of factors together allows BlackRock to move beyond a point-in-time carbon emission, for example, to a future-looking metric about where the company is heading.

“The whole point of estimating physical climate risk is to think about the impact of future changes in the climate—not today’s climate—on an asset or on a corporation. To do that, you have to have forward-looking models,” Lader says. “What a company is telling you about what they are doing today isn’t that helpful; it’s useful to know where their facilities are and their physical footprint, but you have to bring together lots of different data sources to have a full perspective on how, say, mortgage-backed securities in California are going to be differently affected by different climate scenarios.”

Sticking with that MBS example, these portfolios consist of hundreds of thousands of mortgages attached to properties that might be distributed all across the US. She says that understanding the impact of a high- or low-emission scenario—the various scenarios a community might take to reduce or ignore greenhouse gases in the future—on each of those individual properties requires knowing, on a very specific geographic level—25 meters (~82 feet) by 25 meters—what the impact will be if emissions don’t change and temperatures and/or the sea-level rises.

“It is hard to predict what will occur in society in the next five years, let alone to predict the next 100,” she says. “Society could continue to pollute heavily, or it could switch to minimal emissions in harnessing its energy, or anything in between.”

If, for example, emissions don’t improve significantly, portfolio managers need to model for what the change to home prices will be, what’s the impact on employment, and how employment and home prices affect the probability of default or affect other important risk metrics for managing a mortgage portfolio, Lader says.

Vendor Partnerships

ESG is an incredibly wide and varied category of alternative data—the E, the S, and the G are truly individual siloes, even as the industry has crammed these three categories together. And even sustainability means different things to different people.

For BlackRock, the key is blending a range of data providers and research companies together to feed into their forward-looking models. In mid-January (before this interview with Lader was conducted), BlackRock announced that it was taking a minority investment in Clarity AI, a sustainability analytics and data science platform. The vendor uses machine learning to provide actionable insights around companies, countries, and local governments.

Additionally, on the Aladdin Climate offering, the asset manager built new partnerships with Sustainalytics (which Morningstar acquired in April) and Refinitiv. Aladdin now offers over 1,200 key performance indicators to help portfolio and risk managers identify sustainability-related risks.

Lader adds that BlackRock has partnered with Rhodium Group, which provides a research and collaboration platform around climate science, to monitor companies’ physical location risk. She adds that the firm is partnering with several other firms specializing in modeling around sectors including oil and gas, utilities, the automotive sector, and modeling different policy scenarios.

“Rather than expect every investor in the world to educate themselves about climate change and do their own calculations, we’re doing that work, infusing it with the financial models that they use already [with Aladdin], and then right where you see a price, we’re showing an investor a climate-adjusted price and letting them choose different scenarios so that they can express their view of the future,” Lader says.