Sustainable investing as an approach which aims for market rate, or better, financial returns while contributing to sustainability outcomes is far from done, according to CIO. (ddp)

The question itself may have created some anxiety for investors who are wagering that focusing on sustainability will pay off over the long term. But as the saying goes “all publicity is good publicity.” Or at least it might be for those investors who have a framework in place that allows them to focus on truly what matters.

“ESG” as a catch-all label might well be on its way out. But in our view, sustainable investing as an approach which aims for market rate, or better, financial returns while contributing to sustainability outcomes is far from done.

The heightened pitch of ESG criticism both indicates that the space is maturing, and is going to drive further innovation and transparency in sustainable investing. In our view this is directionally positive if we look beyond short-term challenges. More focus, attention and criticism is likely to accelerate the process of the market understanding three points:

First, investors are realizing that ESG scores and data can be useful inputs into investment views, but are not the be-all end-all of investing. An EY study of the largest global asset managers found that most use multiple ESG data providers, and are moving to develop in house research capabilities.1 In the Sustainable InSIghts reports (”The cost of transition” and “Can the sustainability movement be sustained?”) we demystify ESG data and its use cases.

Second, integrating ESG in the investment process is becoming recognized as table stakes to investing. Consensus on terminology is uneven on this point, and investors may disagree on the extent or purpose of looking at ESG metrics in investment decisions. However, if you look beyond the term “ESG”, consideration of climate or human capital risk is already underway. For example, home insurance rates in the US increased by over 12% last year as of July 2022, and more in natural disaster prone states according to Policygenius.2 Market participants are already beginning to price-in sustainability-related risk.

As ESG integration becomes mainstream, we continue to expect the shift in investor focus toward sustainability-focused and impact investing strategies which provide explicit exposure to companies leading on sustainability or providing solutions to challenges. See “Sustainable investing: ESG and beyond” for more.

Third, the market will increasingly recognize that there is no “one-size-fits-all” approach to sustainable investing. Beyond exposure to best-in-class companies or thematic solutions, investors focused on sustainability should be interested in investing in companies with improvement potential or strategies that engage poor performers as well. These distinct approaches should be beneficial to portfolio diversification and performance as well as to people and the planet.

This last point is why UBS developed the Sustainable Investing Strategic Asset Allocations, which serve as a framework through which investors can construct diversified portfolios comprising a number of SI strategies across asset classes, each of which considers sustainability information differently via investments while being additive to portfolios. Having a framework should benefit in two ways:

First, by providing stability as the market gyrates through different business cycles and strategies go in and out of favor. Second, by allowing investors to sift through headlines and noise, and identify what sustainability means to them—hence decide which exposures should belong in their individual portfolio.

For a short description of the building blocks, and for more please see: Sustainable Investing Asset Allocations (February 2023).

Main contributors - Amantia Muhedini

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

Original report - All press is good press…if you have a framework, 15 February 2023.