BlackRock: Good governance and double materiality

October 22, 2025

_{This article was originally written in Dutch. This is an English translation.}

Recently, there has been debate within the pension sector about how the integration of sustainability factors into the investment process fits within fiduciary duty. Pension funds want to provide a good pension for their members in a responsible manner, but how do you weigh all the sustainability factors, and are they at odds with each other? And what value do good governance indicators add

By Katharina Schwaiger, PhD, Managing Director and Deputy CIO, Cherry Muijsson, PhD, Chief Investment Officer, Fiduciary team for pension funds in the UK, the Netherlands and the Nordics, and Ita Demyttenaere, Director of Sustainable and Transition Solutions, all working at BlackRock.

The challenge lies in achieving ESG integration with minimal impact on financial results. This often involves strategies such as exclusion, active shareholding or impact investing, but these are not without their drawbacks. Restricting the investment universe can create undesirable tracking error, and successful shareholding is difficult to quantify.

More recently, inclusion strategies have been emerging, whereby stock selection is carried out with the integration of sustainability and governance considerations. In this article, we discuss the advantages of such a strategy and the natural fit it can have within the fiduciary duty. We also examine a number of relevant indicators for their added value, both financially and socially (‘double materiality’). In doing so, it is crucial to be able to recognise good qualities in companies within the investment portfolio. Good governance is a foundation for any successful corporate strategy^[1] and also one of the crucial building blocks for defining a sustainable investment within the Sustainable Finance Disclosure Regulation (SFDR). Our research shows that good governance indicators can add value within an inclusion policy in the investment strategy.

Drivers for inclusion and exclusion

The trade-off between inclusion and exclusion within pension fund policy revolves around finding a balance between social values and financial returns. Inclusion means actively choosing companies that perform well on sustainability or social criteria, with the aim of combining positive impact and solid financial performance. The selection of the right sustainability and social factors is crucial here. There are material factors that have also had a positive effect on financial results historically. For example, the study by Khan, Serafeim and Yoon (2016) shows that companies that score well on materially relevant ESG themes achieve higher long-term returns on average.^[2]

Exclusion means that specific companies, sectors or countries are excluded from the portfolio, for example because of their involvement in fossil fuels, arms production or human rights violations. This strategy often reflects moral or legal boundaries.^[3] However, this can lead to a higher tracking error and missing out on fast-growing sectors: the so-called FOMO risk.^[4] At the same time, reputational risk is reduced, especially when positions and/or companies that play a role in environmental pollution, human rights violations or fraud are excluded. Growing legislation and regulations, such as SFDR, are also forcing pension funds to be more transparent and accountable about ESG integration.

Both cases require strategic choices, supported by data and dialogue. Pension funds are asked to make these considerations clear to participants, regulators and other stakeholders, with an eye to both the long-term financial and social impact.

How good governance can add value

Good governance refers to the quality of management and supervision, and to internal control within an organisation. Because it is not directly visible on the balance sheet, it is a crucial non-financial value component. Good governance influences a company's decision-making, risk management and long-term strategy.

It contributes to transparency, accountability and a healthy corporate culture – elements that give investors confidence. Companies with weak governance are more prone to scandals, mismanagement or strategic missteps.^[5] Examples include perverse remuneration structures, inadequate cybersecurity or unclear communication with stakeholders.

In the context of double materiality, good governance is therefore twofold: on the one hand, it influences financial performance, and on the other, it determines the extent to which a company has a negative or positive impact on people and society. The structural inclusion of governance indicators in investment analyses enables investors to make informed choices that support both. Our research therefore focuses on indicators with a strong link to good governance (Figure 1). We look at the MSCI World (except for OHSA, where we only consider US equities) for the period between 2010 and 2025, and use (sustainability) annual reports, policy documents, website data, language signals, machine learning and earnings transcripts.

The indicators developed are tested in a regression framework to evaluate their (statistical) relevance and strength as a signal within an inclusion strategy. Portfolios are created with an inclusion strategy in which the relevant indicator is used for tilts versus the benchmark. This allows us to measure the impact of such a strategy on cumulative returns and the average improvement in the relevant indicator score.

The analysis shows that strategies with good governance indicators demonstrate improvement in both financial and governance areas. For example, higher language complexity in earnings calls is associated with lower future profitability, while simpler language signals a more positive outlook. The model achieves an Information Ratio (IR) of approximately 1.22 for the Russell 3000 and 0.8 for the MSCI World. In addition, lower complexity correlates with better governance indicators, such as higher MSCI Governance Controversy Scores (0.10 improvement versus the benchmark) and better Audit Tax Risk Management scores, indicating a more favourable sustainability profile. The indicators may have dual materiality that could be interesting for inclusion strategies.

^{[1] https://ir.blackrock.com/governance/governance-overview/default.aspx of Aguilera, R.V. (2023), “Corporate Governance in Strategic Management,” Oxford Academic. https://academic.oup.com/book/39240/chapter/338768105
[2] Khan M, Serafeim G, Yoon A. Corporate sustainability: First evidence on materiality. Accounting Rev. 2016;91(6):1697-1724. doi:10.2308/accr-51383. However, other studies point to potentially poor financial performance in the shorter term. Raghunandan and Rajgopal (2022) find that ESG funds underperform traditional funds on average during periods of market stress. This is partly explained by sector bias (e.g. underweighting of energy or defence) and higher valuations of ESG stocks, which make them more vulnerable to corrections.
[3] Exclusion can also be driven by financial materiality, for example when an investor is convinced that an entire sector (e.g. oil and gas) offers an unattractive risk-return profile in the long term.
[4] “FOMO in equity markets? Concentration risk in sustainable investing”, June 2025, Andreas Brøgger, Joren Koëter and Mathijs van Dijk, Rotterdam School of Management, Erasmus University
[5] Emerald Insight (2024). “Corporate Governance and ESG Controversies: A Quantile Regression Approach}