Markets Fed an outlier in the drive toward sustainability

The central banks around the world may have their hands full tackling inflation in a slowing global economy, the Fed is increasingly in the minority as more policymakers are laying the financial framework for sustainable investing (SI). Despite a lackluster showing in the past year, the long-term returns of sustainable investments remain strong on an absolute and relative basis. We continue to believe the secular trends driving long-term SI performance remain intact.

Japan to consider green transition bonds in new fiscal year. Japan’s Ministry of Finance said on Wednesday that it is considering issuing green transition bonds in the second half of the coming fiscal year, as part of plans to push climate change efforts. It looks to issue 1.6 trillion yen of such bonds focusing on maturities of 10 and 20 years. We believe that diversification across sustainable asset classes, for example by including sustainable bonds and multilateral development bank bonds, may help drive better risk-adjusted portfolio returns.

Other central bankers favor more climate-friendly monetary policies. European Central Bank board member Isabel Schnabel has said the ECB should step up its efforts to make its monetary policy more climate-friendly, possibly by harnessing its multitrillion-euro stock of bonds. The head of the Monetary Authority of Singapore Ravi Menon has said central bankers should do much more to help the economy reduce its emissions than just focusing on the risks. “We need to get a lot more imaginative and creative if we want to make sure that what we do is consistent with the global objective of getting to net zero,” he said.

Governments have already made strong capital commitments toward sustainable goals, including the EUR 300bn REPowerEU plan and the USD 370bn US Inflation Reduction Act. This has strengthened our conviction that sustainability will be a key long-term driver of investment returns.

Australia to tighten emission rules. The government on Tuesday detailed reform proposals for its “safeguard mechanism” rules, seen as key in meeting the country's 2030 carbon emission reduction target. Under the new proposal, Australia's top 215 emitters in the energy, mining, and manufacturing sectors must reduce their total greenhouse gas emissions by at least 28% through 2030—or nearly 5% a year. While the use of carbon credit offsets will not be limited, their value will now be capped at AUD 75 per ton of CO₂. Carbon pricing is also a key tool in the EU’s plan to reaching lower emissions, and we see prices reaching EUR 100 per ton by 2025.

So, we continue to believe that investing sustainably will provide a key opportunity in the years to come. In 2023, we see a range of opportunities for sustainable investing strategies, including in value-oriented companies, sustainable bonds, and ESG improvers—companies that demonstrate consistent improvement on issues like emission reduction, which can also affect their financial performance. At the index level, ESG improvers have outperformed broader equity markets by nearly two percentage points a year over the past five years.

Main contributors - Mark Haefele, Patricia Lui, Vincent Heaney, Jon Gordon

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

Original report - Fed an outlier in the drive toward sustainability, 11 January 2023.