How a BlackRock ETF Fell Out of Favor and Sunk Sustainable Fund Flows

Changes to popular model portfolios can “make or break” the story of sustainable investing in the U.S.


Illustration by RIA Intel

A change to BlackRock’s model portfolios is largely to blame for more money flowing out of U.S. sustainable investment funds than into them during the first quarter. It’s the latest sign that large asset managers dominate sustainable investing in the U.S.

In March, investors withdrew $6.5 billion from the iShares ESG Aware MSCI USA ETF (ticker: ESGU) — 15 times more than the second-biggest loser for the quarter — leaving the once popular fund with an estimated $14.2 billion in assets, according to Morningstar.

The fund’s activity was a major contributor to the sustainable fund universe in the U.S. falling into negative territory with $5.2 billion in net outflows during the first quarter. After a long period of growth for sustainable investment funds in the U.S., it was the third quarter in the past year that there were net outflows. Sustainable funds in the U.S., which now number 638, manage a total of $299 billion in assets, according to Morningstar.

In Europe, whose industry is far more mature than in the U.S., more than 5,400 sustainable investment funds tracked by Morningstar had inflows of $32 billion in the first quarter. Europe’s sustainable funds have $2.2 trillion, or 84 percent of all assets globally. In other global regions, sustainable investment funds had inflows or outflows of about $1 billion.

BlackRock is bearing the brunt of a politicized debate over ESG investing principles but the outflows from iShares ESG Aware MSCI USA ETF are unrelated to that, according to insiders. In his annual letter to investors in March, Larry Fink, chairman and CEO of BlackRock, emphasized the asset manager’s commitment to sustainability.

In March, BlackRock’s ETF lost more than one-fifth of its assets around the time that the manager made changes to its actively managed, ETF model portfolios used by financial advisors to manage about $40 billion in assets. The model portfolio team pared back the allocation to the iShares ESG Aware MSCI USA ETF in its portfolios and largely replaced it with the iShares MSCI USA Quality Factor ETF (ticker: QUAL), according to Morningstar. The iShares MSCI USA Quality Factor ETF had nearly $5 billion of inflows the week of March 20.

The change was one of several changes to the model portfolios done to reduce risk and improve their performance. Both ETFs have exposure to large and mid-cap stocks, but QUAL, unlike ESGU, has a more defensive positioning and has almost no banking sector exposure — attributes potentially valuable after recent bank failures, according to Morningstar.

ESGU has last 9.07 percent and QUAL has lost 6.16 over the past year.

Although BlackRock does not typically comment on individual fund flows, a spokesperson said in a statement, “As a fiduciary, BlackRock designs models to seek to deliver on an objective defined by an advisor’s client while controlling for risk, in an efficient, cost-effective manner. As we rebalance our models to capture opportunities in the market, some ETFs included in BlackRock model portfolios experience inflows or outflows, driven by advisors who trade their clients’ portfolios in line with BlackRock’s models.”

BlackRock is unique because its sustainable assets simultaneously make up a small percentage of its $9.1 trillion total but a significant portion of all sustainable investments in the U.S., said Alyssa Stankiewicz, an associate director for Morningstar Research. She added that the manager also attracts a disproportionate amount of attention as a company for its sustainable investing.

“The U.S. sustainable funds landscape is dominated by just a few asset managers with a lot of household recognition to their names. I think that’s really incredible. The other thing that really struck me about this quarter: the fact that this one fund can really make or break the story about positive or negative is so different from what we see in Europe,” Stankiewicz said, commenting on ESGU.

Model portfolios have long steered flows to and away from individual funds but the influence was especially stark in the first quarter of the year because sustainable investing in the U.S. is still relatively nascent, according to Stankiewicz. Someday, inflows and outflows of sustainable investments might look more like conventional open-end funds and ETFs and be less affected by changes to model portfolios or even simple rebalances, she added.

Meanwhile, BlackRock, Vanguard and other big managers continue to attract more money. Among the top 10 sustainable funds in the first quarter, in terms of net flows, six were either from BlackRock or Vanguard, according to Morningstar.

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