Sustainable investing: trends in 2021

It is safe to say 2020 was not the year any of us expected. COVID-19 shocked virtually every aspect of society, with serious consequences for individuals, families, as well as businesses and the markets. The challenging market conditions brought about by the global pandemic have served to further emphasize the value of sustainable business practices, resulting in a seismic shift in the way capital is allocated.

At UBS, our conversations with investors have seen an increased interest in sustainable, inclusive growth and financing the transition to a lower carbon economy. We are deeply aware that staying ahead of these dynamics, while also identifying and allocating to important new opportunities, enables the better management of portfolios in the face of 21st century challenges. So, at the UBS Group, we have compiled a paper exploring the ten trends we expect to see in sustainable finance in the year ahead. There is much to suggest that in 2021, the importance of sustainable investing will continue to further still.

Why ESG matters more today

The relationship between sustainable business practices, the economy and corporate financial performance is one that investors have come to recognize as crucial, particularly when forced during a pandemic to reassess portfolios. The increased focus on sustainable investing strategies reflects an acceptance that greater transparency – including insights into material non-financial factors – matter as much to performance as traditional financial analyses.

As investors have re-assessed their portfolios during the crisis, we found they have broadly added to sustainable investing strategies, a move clearly reflected in the data. Assets in sustainable mutual funds and ETFs hit an all-time high of USD 1.2 trillion at the end of Q3 2020, with flows outstripping the overall market.[1] It is particularly striking to look at the percentage of sustainably tagged ETFs in the last few years. In 2017, they accounted for just 1% of European ETF inflows; in the 11 months to November 2020, that figure had shot up to 41%.[2] This major jump shows that investors have largely put to bed the concern that a focus on sustainability may compromise returns.

There is mounting evidence to suggest that sustainable investing, in fact, has a positive impact on returns, particularly in the active space. A 2020 study of more than 700 European sustainable funds showed that over one, three, five and ten years, the majority of those funds outperformed non-ESG funds.[3]

The growth of sustainable investing has been compounded by changing social values where the COVID-19 crisis and an increased concern for the climate have highlighted the importance of ESG issues across investor groups. Furthermore, growing regulatory pressure, especially in the EU, is driving institutional client demand towards greater ESG compliance. According to a recent study by PWC, up to 77% of institutional investors plan to stop investing in non-ESG products by 2022.[4]

How can better ESG practices increase impact?

In order to drive better reporting practices and greater transparency, we believe active investor engagement is vital. When asset owners collectively demand better sustainability data, the increased transparency enables stronger investment decisions - in line with fiduciary responsibilities. Often more impactful than regulatory requirements, it is this engagement that leads to greater disclosures and even action. An example of this was seen in late 2020 when eight leading Canadian pension funds, with USD 1.6 trillion in assets under management, called for the adoption of TCFD and SASB disclosure standards.[5] The reasoning was that this data disclosure was necessary in order for them to honor their fiduciary responsibilities.

It is inspiring to see this pressure growing across the market, with major industry groups coming together to demand greater transparency. A good example of this is ClimateAction100+, a coalition of 545 investors representing USD 52 trillion of assets under management that are collaborating to drive better disclosure. UBS was also proud to join the Net Zero Carbon Alliance, a group of 30 asset managers overseeing a combined $9 trillion of assets, that supports efforts to limit global warming by running carbon-neutral investment portfolios by 2050 or sooner.[6]

In 2021, we expect coalitions like these to support further escalation strategies for companies not showing enough progress using tools like shareholder resolutions, public letters, AGM statements and votes against management. When long term shareholders collaborate to address sustainability challenges, working together to create clear playbooks of expectations from corporates, we believe this is a recipe for impact.

Key trends in the year ahead

While it is encouraging to see a growing number of countries and companies setting net zero emission goals for 2050, we think minimizing carbon emissions will require tapering off new investment in the fossil economy, targeting carbon reduction sooner than 2050 wherever possible, and channeling more investment towards essential adaptation measures. We expect to see a significant increase in the pace of capital re-allocation, moving investments out of the fossil sector toward clean energy projects.

In planning for an expensive energy transition it is important to consider the valuable role that the oil majors will continue to serve. The technical and financial complexities of building and managing new energy systems, is virtually inconceivable without the skill-sets of the existing players. We believe it may be overly simplistic to write off oil majors, when there is immense opportunity to make them part of the solution, leveraging their decades (in some cases, centuries) of experience in the energy sector.

With increasing regulatory pressure, growing focus on net zero targets and a more engaged investor community asking for greater disclosure, the capital markets look set for transformation. The escalating market demand will determine the pace of progress, not just in sustainability reporting, but in achieving real world sustainability outcomes. We may just be witnessing a quiet revolution.

Read more about the ten trends we expect to see in sustainable finance in 2021.

[1] Morningstar (October 2020), Global Sustainable Fund Flows: Q3 2020 in Review

[2] UBS, Etfbook December 2020.

[3] https://www.ft.com/content/733ee6ff-446e-4f8b-86b2-19ef42da3824

[4] pwc (2020), 2022 The growth opportunity on of the century

[5] https://apnews.com/press-release/pr-newswire/business-government-business-and-finance-ontario-investment-management-financial-services-f15671b8cb55e92545439ba2660f12c6

[6] https://www.bloomberg.com/news/articles/2020-12-11/fidelity-ubs-join-investors-making-9-trillion-net-zero-pledge