CIO predicts that investing sustainably will provide compelling opportunities for the decade ahead, offering strong performance on an absolute and relative basis. (UBS)

In the “year of inflections,” the UBS Chief Investment Office (CIO) expects turning points for key macroeconomic variables, which should provide a more supportive backdrop for risk assets in the later part of the year. How can investors position in 2023 to address opportunities stemming from secular trends such as the transition to a low-carbon economy and a more equitable future?

CIO predicts that investing sustainably will provide compelling opportunities for the decade ahead, offering strong performance on an absolute and relative basis. Pockets of opportunity should be available throughout 2023 as well. Key questions for sustainable investing in 2023 center around central bank action, regulatory trends, and two short-term risks to sustainable objectives.

Will central bank action on rates influence investment in sustainability solutions?

Higher interest rate expectations as central banks around the world entered rate hike cycles were a key contributor to weak market performance in 2022. Sustainable investing strategies followed “conventional” strategies with relatively weak performance over the year, with some sustainable themes and more growth-oriented Environmental, Social and Governance (ESG) leader strategies in particular underperforming broad equity benchmarks.

One risk of a high-rate environment is that it might stifle additional corporate investment in areas that advance sustainability objectives. Despite market headwinds to further corporate investment, we believe that capital expenditure will continue in key areas such as energy efficiency and green infrastructure, thus benefiting pockets of the market that are exposed to this longer-term resilient spending. The Inflation Reduction Act in the US and the RePowerEU program in the EU further support this thesis, with USD 369bn and EUR 300bn investment respectively keeping momentum up on scaling solutions to climate challenges and energy independence.

How might regulatory action evolve?

2022 was eventful on ESG regulation, and 2023 is likely to see further attention from regulators on both corporate and investment advisor transparency on sustainability. Some jurisdictions will likely provide more clarity on existing guidance, move toward approval of proposals, and likely develop more granular requirements which impact companies and investors alike. A focus on corporate disclosure requirements is likely to continue as well into next year, as more stock exchanges make ESG disclosures compulsory.

Over the longer term, guidance from regulators on both investment and corporate disclosure should be positive. In the near term, however, we expect continued differences in what is considered “sustainable” by various stakeholders across different regions. Therefore, investors should continue to be diligent in their selection of investments. We recommend moving beyond labels and assessing whether an investment strategy's process and objectives match asset owners' own expectations with regard to sustainability.

What might derail investor and corporate focus on sustainability?

CIO expects to see continued investment in opportunities tied to people and planet driven by a financial profitability thesis, independent of interest in advancing sustainability objectives. In 2023, we will monitor two short-term risks to the acceleration of sustainability objectives—that a focus on energy reliability may slow down the Net Zero transition, and that continued focus on climate may limit investor attention and capital on other environmental, social and governance topics.

In CIO's view, corporate and government spending will continue in areas like energy source diversification, energy efficiency, and electrification. We also see new opportunities emerging in tangential areas, like investment in the circular economy—for example, plastics alternatives, resale models and waste management. In a downside risk scenario where growth fails to re-accelerate and energy shortages continue, focus could turn to meeting short-term energy needs including further use of fossil fuels, including coal. Climate and associated investments, meanwhile, have dominated headlines and capital commitments this year, and emissions reduction and climate resilience are likely to remain a priority next year, continuing to attract investment and spur innovation.

Pockets of Opportunity

In the months ahead, CIO expects the healthcare and consumer staples sectors to continue to outperform as economic growth decelerates. Sustainable investments tend to have a high structural allocation to both health and food-related investments, which will continue to support risk-adjusted financial performance in 2023.

Within fixed income, CIO likes investment grade bonds, and given slowing growth, we focus on more resilient issuers. Green, social, sustainable and sustainability-linked bonds can help build resilience in portfolios, particularly across high- and investment-grade issuers. Within this category, we see opportunity particularly in sustainable bonds with shorter tenors and somewhat higher credit risk than benchmark indexes.

In private equity, investments in climate technologies and breakthrough healthcare solutions, such as medical devices and genetic therapies, could offer opportunities to drive incremental and measurable positive impact as well.

Main contributors: Andrew Lee, Antonia Sariyska, Amantia Muhedini, Michelle Laliberte

Read the original report, Sustainable Investing Perspectives: The Year Ahead, 12 December 2022.

This content is a product of the Chief Investment Office (CIO).