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iShares ESG Aware MSCI USA Small-Cap ETF ESML Sustainability

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Sustainability Analysis

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Sustainability Summary

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iShares ESG Aware MSCI USA Small-Cap ETF has several promising attributes that may appeal to sustainability-focused investors.

This strategy has an above-average Morningstar Sustainability Rating of 4 globes, indicating that the ESG risk of holdings in its portfolio is relatively low compared with those of its peers in the US Equity Small Cap category. ESG risk measures the degree to which material environmental, social, and governance issues, such as climate change, biodiversity, human capital, as well as bribery and corruption, could affect valuations. ESG risk differs from impact, which is about driving positive environmental and social outcomes for society’s benefit.

iShares ESG Aware MSCI USA Small-Cap ETF has a sustainability or ESG-focused mandate. Funds with an ESG-focused mandate are more likely to align with the expectations of an investor who cares about sustainability issues. The fund exhibits negligible exposure (0.33%) to companies with high or severe controversies. Controversies are incidents that have a negative impact on stakeholders or the environment, which create some degree of financial risk for the company. Examples of types of controversies include bribery and corruption scandals, workplace discrimination and environmental incidents. Severe and high controversies can have significant financial repercussions, ranging from legal penalties to consumer boycotts. Such controversies can also damage the reputation of both companies themselves and their shareholders.

By prospectus, the fund aims to avoid, or limit its exposure to, companies associated with controversial weapons, tobacco, thermal coal, and and small arms. Yet this goal is far from achieved, as the fund exhibits 0.66%, 0.37%, 0.19%, and 0.37% exposure to controversial weapons, tobacco, thermal coal, and small arms, respectively. This compares with 0.71%, 0.35%, 1.06%, and 0.64% for its average peer in the US Equity Small Cap category.

iShares ESG Aware MSCI USA Small-Cap ETF has a 12-month asset-weighted Carbon Risk Score of 11.1. This is situated at the lower end of the medium carbon risk band, suggesting that its portfolio holdings are not among the worst-positioned to transition to a low-carbon economy, but they are not among the best-positioned either. Investors concerned about the transition risks may prefer to consider funds with negligible or low carbon risk. Such funds invest in companies that tend to operate in sectors less exposed to the transition (such as healthcare and IT) and/or companies in more carbon-intensive sectors (such as industrials and utilities) but that consider climate change in their business strategy and products, and therefore are positively aligned with the transition. Currently, the fund has 7.5% involvement in fossil fuels, which is roughly in line with 7.7% for its average category peer. Companies are considered involved in fossil fuels if they derive some revenue from thermal coal, oil, and gas. The fund's 6.4% involvement in carbon solutions is roughly in line with the 5.8% average involvement of its peers in the Small Blend category. Carbon solutions include products and services related to renewable energy, energy efficiency, green buildings, green transportation, and so on.

ESG Commitment Level Asset Manager

 | Basic  

BlackRock’s efforts to build out topnotch resources and integrate ESG considerations in most parts of its business is impressive, but its sheer size and asset mix hamper its ability to fully embrace a culture of sustainable investing. The firm earns a Morningstar ESG Commitment Level of Basic. In January 2020, CEO Larry Fink made a high-profile declaration that sustainability would become BlackRock’s standard for investing, and this kick-started the firm’s ESG efforts. Since then, the firm has ramped up its integration of ESG criteria to include nearly all actively managed strategies (roughly one third of the firm’s assets) and rolled out fund-level ESG disclosures for all funds. BlackRock has also rolled out dozens of ESG-focused product offerings in recent years. However, both in terms of assets and volume, strategies that cater to sustainability-focused investors continue to be dwarfed by those that don’t (accounting for 4% versus 60% of assets, respectively). Despite being the world’s largest asset manager, BlackRock’s ability to push for improvement on ESG issues at investee companies seems limited. Fear of accusations of anticompetitive behavior means the firm is reluctant to file or co-file shareholder resolutions or join onto collaborative engagements. More recently, BlackRock has found itself at the center of anti-ESG sentiment in the United States, making the manager hesitant to promote a strong sustainability agenda, as evidenced by its latest voting record. BlackRock backed only half of key ESG resolutions in 2022, down from 72% in 2021, although still up from 16% in 2020. On climate-specific proposals, BlackRock’s support also waned in 2022, judging them too prescriptive. But changes are afoot to give shareholders a bigger voice in the conversation. In 2021, BlackRock rolled out a pass-through proxy-voting program it calls “Voting Choice,” which allows clients to choose a proxy-voting policy that reflects their individual priorities, effectively empowering investors to vote their own proxies. This option is not yet available to all shareholders, but it is a suitable workaround for those clients who can leverage it. BlackRock’s size gives it an edge over peers, particularly in its ability to process massive volumes of ESG data and translate it into meaningful investment insights. Still, the firm restructured its central sustainable-investing team in October 2022. Some functions, including sustainability research and ESG monitoring, moved into the broader BlackRock Investment Institute, and other functions such as client engagement remain in the renamed Sustainable Transition Solutions unit. The reorganization makes sense in principle, but it will take time for the team to harness new synergies and settle into new roles. The group hasn’t been immune to turnover either. Roughly 30 sustainability-focused professionals (of a team of 70) left the firm since the beginning of 2019, although their roles were quickly backfilled. When it comes to driving outcomes for sustainability-focused investors, BlackRock’s size is in many ways its biggest strength and its biggest weakness, but bright spots remain.