CIO believes that investing sustainably will provide compelling opportunities for the decade ahead. (UBS)

In 2023, we see pockets of opportunities for sustainable investing strategies. Investors should identify sustainability exposures alongside our global investment views for 2023, being mindful of portfolio diversification to advance investment and sustainability objectives. We believe that investing sustainably will provide compelling opportunities for the decade ahead, offering strong performance on an absolute and relative basis.

Add defensives and value

CIO expects the healthcare and consumer staples sectors to continue to outperform in the months ahead 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. In our view, these allocations also help diversify broader sustainable investing exposures to balance out potential overallocation to themes such as climate-related technologies.

We also think that value stocks will continue to outperform growth. Inflation above 3% in the US has historically favored value stocks relative to growth, and we only expect inflation to fall below 3% toward the end of 2023. CIO continues to like the energy sector, which has been the best performing global equity sector year to date through October. Its valuation is at a meaningful discount to the MSCI ACWI and if oil prices trend higher for longer, as we expect, energy stocks still look like an attractive investment. However, we continue to see outright exposure to traditional energy without a transition lens being challenging for those investors focused on sustainability A structural underweight to any energy exposure could affect relative financial performance in the near term.

We do believe that investing in energy is not necessarily inconsistent with sustainability objectives as long as there is a clear rationale and approach to support the thesis, for example focusing on investments that have been assessed as advancing the just and timely transition to a low-carbon economy. In particular, investors can get exposure to traditional energy through ESG improvers and ESG engagement strategies, as well as select ESG leaders within the sector. In our view, the focus should continue to be on companies’ commitment and delivery against decarbonization targets.

Seek income opportunities

Yields have risen significantly over the past year, broadening the opportunity set for investors focused on income. 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.

Within riskier credits, CIO finds that for now the immediate outlook for high yield credit is unattractive, which applies to sustainability-focused high yield strategies as well. However, for more risk-tolerant investors with an interest in sustainability we see targeted bondholder engagement in high-yield bonds as still instrumental in supporting material environmental and social improvements within issuers in this part of the credit spectrum.

In equities, we like “quality income,” i.e. companies with a high return-on-equity, low earnings variability, and a low debt-to-equity, alongside attractive income metrics. These companies can often be found in ESG leader equities strategies, in particular, as good governance and superior diversity metrics tend to correlate with quality. While exposure to quality income through the ESG leader strategy is possible, being selective with implementation is important as ESG leader strategies also correlate with the growth factor.

Shelter in safe havens

In fixed income, CIO likes high quality bonds, particularly with the move higher in rates creating a more attractive entry point. These bonds can rally in times of slowing economic growth. As mentioned above, within sustainable investments, we recommend tilting toward better sustainability characteristics, or focusing on thematic sustainable investments benefiting from long-term secular trends.

While outright currency strategies do not carry explicit sustainability purpose, in our view, we note that currency exposures are essential to achieving risk and return objectives. Therefore, even for investors who seek to allocate most of their portfolios in sustainable investing strategies, traditional currency strategies have an important role in the portfolio, as we discuss in the Year Ahead 2023 report. This is particularly relevant when investing in or lending to companies that operate in emerging and frontier markets.

Uncorrelated alternative investment strategies.

Putting capital to work in private markets in the years after a market downturn has historically proven to be a rewarding strategy over the long term. Within private equity, investments in climate technologies and breakthrough healthcare solutions, such as medical devices and genetic therapies, could offer opportunities to investors to drive incremental and measurable positive impact – or what we refer to as “impact investing”. In addition, sustainable infrastructure, such renewables, energy storage and smart mobility, will continue to be instrumental in advancing sustainability objectives. In our view, select impact private market investments in 2023 and beyond can help drive sustainability objectives while offering the opportunity for competitive financial returns in the long-term.

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

See the full report - Sustainable Investing Perspectives: The Year Ahead, 12 December, 2022.

Watch the UBS Trending episode: The Year Ahead - Sustainable Investing.

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