Rachel Whittaker

In its annual outlook, Robeco expects a considerable brightening of the return outlook for major asset classes during 2023, but not before inflation, interest rates and the US dollar hit major peaks first. While these peaks are in sight, they have yet to be reached. Central banks are still battling to bring inflation back and their second-to-last hike of the tightening cycle is pending. Short-term sovereign bond yields remain above official rates and the dollar continues to reign supreme. The last leg of a steep climb implies short-term pain as exhaustion and capitulation take hold across the multi-asset spectrum.

As we enter 2023, Robeco expects an earnings per share drop of 20-30 per cent, making high yield valuations look more attractive than those of equities. Yet, as real rates are expected to come down, and the earnings recession gets fully priced into 2023, a major inflection point in risky asset valuations is to be expected towards 2024. Robeco believes that mid-2023, when unemployment surges towards five per cent and disinflation accelerates, will likely create good entry points for long duration in fixed income, followed by decent troughs in risky fixed income and equity markets. It could be an especially good year for emerging market equities, excluding China. Not only do they typically outperform their developed counterparts in a dollar bear market, the downturn in the earnings cycle in emerging markets is also more mature because its central banks have pre-empted developed markets central banks in combating inflation.

In addressing the energy crisis in 2023, Europe will face a trade-off between efficiency and economic security. Increasing energy efficiency will not be enough for the region to wean itself off Russian gas. Price caps to ensure energy security for lower-income households may also increase demand, intensifying the energy crisis. On the other hand, necessity is the mother of invention, and we expect to see energy transition goals lining up with accelerated energy security and reduced carbon footprints.

Robeco expects to see sustainable investing strategies again grow as a proportion of assets under management in 2023 as investors continue to seek solutions to the multiple challenges facing humanity, including climate change, the cost of living crisis and income inequality.

Colin Graham, head of multi-asset solutions: “We think the belief in central bankers’ ability to prevent cyclical downturn and engineer a soft landing in 2023 is flawed. Instead, we expect a hard landing. Moreover, as recessions tend to be highly disinflationary, we believe this will take the sting out of inflation. Once the three peaks in inflation, rates and the US dollar have been reached, 2023 will ultimately contribute to significantly better returns across all major asset classes.”

Rachel Whittaker, head of SI research: “We believe there are several reasons why sustainable investing will grow AuM faster than the industry – one is that there is evidence that integrating ESG considerations alongside financial analysis can support financial returns over the long term, for example through reducing unanticipated environmental or social risks, or identifying new growth opportunities. Additionally, greater societal awareness of sustainability challenges is leading more investors to align their portfolios with their values, while the growing range of sustainable strategies available is making it possible for more investors to target both sustainable and financial goals.”

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Rachel Whittaker

Sustainable investing has become mainstream, but it’s not a perfect science, with many challenges that practitioners must face. In the first of our new series of SI Dilemmas, Rachel Whittaker, Head of Sustainable Investing Research, outlines one of them – whether to put greater emphasis on the environmental or social factors.

The Sustainable Development Goals (SDGs) are described as “a shared blueprint for peace and prosperity for people and the planet”, placing humanity at the heart of the sustainable development. Social goals slightly outnumber environmental goals, as well as appearing earlier in the sequence. Yet sustainable investors could be forgiven for thinking that solving environmental issues is a higher priority than solving social issues.

Share of investor attention

The majority of SI funds still take a wide range of environmental, social and governance (ESG) issues into account. As the market for sustainable and impact investing has matured, environmental topics such as climate change, water scarcity, ocean health and biodiversity are now receiving a much higher share of investor attention compared to social issues such as human rights, workplace conditions and access to finance, education and healthcare.

For example, a quick search of one of the numerous databases of sustainable and ethical funds reveals a typical pattern: 12% focussed exclusively on environmental issues and just 3% exclusively on social issues. The pattern is not new – MSCI launched its first environment themed equity index in 2009 – but it was 2016 before an index focussed on social issues (the Women’s Leadership index) appeared in its ESG index family.

Green bond issuance

In the bond market too, the first ‘official’ green bond was issued in 2008 (by the World Bank), with proceeds committed solely to environmental projects. The International Capital Markets Association (ICMA) introduced the green bond principles in early 2014. Although social bond guidelines followed just two years later, the volume of green bonds dwarfed that of social bonds until 2020, when social bond issuance finally took off (buoyed by the Covid-19 pandemic). Green bonds continue to make up the majority of assets in the combined green/social/sustainability bonds market.

There are various theories for the popularity of environmental investments compared with social. It can be argued that environmental problems, such as emissions or water use, are easier to define and measure than social issues such as health or well-being. This makes it easier for sustainable investors to incorporate environmental data in a systematic way into their investment processes. It can also be easier to identify investable technical solutions for many environmental problems, while solutions to social problems may rely more on behavioural changes, and the definition of success can vary between different cultures. This makes the environmental factor a popular topic for thematic investors with an interest in product impact, particularly when there is a political support for green industries.

Pace of regulation

Yet, while we can argue that investors might be driven by the pursuit of returns, it is harder to make that argument for regulators. SI regulation has proceeded faster for environmental investing than for social. Despite the long history of SI focussing on a range of ESG issues, work on the EU Sustainable Taxonomy began in 2018 focusing almost exclusively on environmental issues, with social issues relegated to a brief mention of meeting minimum standards on human rights.

Work on a Social Taxonomy finally began in 2021. Ongoing discussions about whether the taxonomies should be separate or combined illustrate that even the experts are struggling with the same question that all investors face – how to balance all of the issues competing for our attention?

Nevertheless, some social themes are quietly gaining momentum, even as environmental themes hog the limelight. Gender equality has been rising in importance over the last decade as an investment theme, from just five focussed public markets funds in 2012, to over 50 in 2019, and total assets under management of USD 11 billion by the end of 2020.

Interconnectivity between E and S

Recently, the gender lens investing community has begun to look closer at the interconnectivity of gender equality with environmental challenges. Investors have been asking whether an investment or impact strategy focused on gender equality is truly meeting its goals if it does not also address the climate-related inequalities.  The United Nations recognised the link between gender equality and climate change more than a decade ago.

Women and girls are often more vulnerable to the effects of climate change, as they form a large proportion of the world’s poor, and are more likely to be dependent on local natural resources that are impacted by climate change. They are less likely to be involved in decision making, have fewer financial resources to fall back on, are and more likely to be responsible for domestic needs such as clean water, food and fuel. All of these issues will be made more difficult by climate change, particularly in developing countries. However, the latter responsibilities also makes women critical participants in adopting the lifestyle changes necessary to adapt to a changing environment.

Driving positive change

This interconnectivity between E and S exists across the entire scope of sustainability challenges. The worst effects of climate change will be disproportionately borne by the poorest in society; good health for all cannot be achieved without understanding that climate change and access to clean water affect patterns of disease. Likewise, eradicating hunger is inextricably linked with managing the impact of climate change and biodiversity on agricultural productivity. Trying to entirely disaggregate E and S issues and weigh up their relative importance could ultimately be a distraction from the goal of driving positive change and identifying attractive investment opportunities.

Examining our investment choices through a specific E or S lens can help investors to align with particular set of values or goals. But an effective investment or impact strategy must acknowledge that no sustainability challenge or opportunity can be tackled in isolation. Sustainable investors can also play a role in ensuring that an adequate focus on social challenges remains high on the agenda of companies, regulators and governments, through voting, engagement, and involvement in financial industry initiatives.

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