As the world continues to rebound from the COVID-19 pandemic, the recovery trade is playing out in real time, presenting shifting patterns of opportunity and risk. Our view is that this unique landscape will eventually transform into a more familiar one: a lower-return world subject to downside risks that threaten to derail carefully laid investment plans.

This challenge calls for creating portfolios that can deliver a more favorable return sequence that better positions investors to pursue their long-term goals, including stable growth and efficient income. One goal growing in popularity is purpose: ensuring investments exhibit good environmental, social and governance (ESG) behaviors—and even targeting investments to advance ESG-aligned causes. Since 2015, ESG equity funds have seen cumulative inflows of US$256 billion, while non-ESG active equity funds have seen outflows of US$2.6 trillion, based on Emerging Portfolio Fund Research Global and Bernstein Research data.

Why ESG Integration Is Critical

Because ESG considerations and management quality are so tightly interwoven with financial considerations, it’s challenging to invest responsibly through large-scale blanket exclusions of issuers or segments, or through a passive screening based on quantitative metrics. ESG considerations are, in fact, financial considerations and can often emerge quickly. So, as we see it, they must be integrated with traditional fundamental analysis.

A case in point is a company that’s a heavy carbon emitter, bringing exposure to costly carbon taxes and possibly higher operating costs from legally mandated equipment upgrades. It’s a mistake, in our view, to approach the financial and ESG ramifications independently. So, whether investors are analyzing an issuer for a large-cap growth or high-yield bond strategy, ESG can’t be treated separately from the investment process—and must be informed by direct engagement with issuers.

Beyond ESG Integration to Purpose-Driven Solutions

More and more investors are moving beyond issuer-level ESG integration to purpose-driven solutions. These strategies offer diverse ways to access equity beta, with choices of markets and approaches to refining universes in alignment with specific purposes. Sustainable strategies, which seek to invest in issuers that can meet present needs without compromising future well-being, are one such solution.

One way to tackle the sustainability aspect is pursuing durable growth through issuers whose products and services align with long-term themes, such as the United Nations Sustainable Development Goals. The SDGs (Display), introduced in 2015, are an aspirational view of what the world could look like by 2030, and they consider the role the private sector must play to get there.

By using the SDGs and related targets as a framework to identify products and services that will address the world’s challenges, investors can create a universe of issuers supporting worthy goals. Through in-depth research, it’s possible to assemble a portfolio of quality businesses that are helping make the world a better place—in addition to providing differentiated opportunities for sustainable growth.

Impact solutions—another purpose-driven category—can enable investors to channel money into securities that make measurable social or environmental impacts on themes such as clean water and deforestation. Bond markets—notably US municipal bonds—offer plentiful impact opportunities, because many muni issues underwrite projects intended to reduce societal disparities (Display). In fact, as much as 35% of the US$3.9 trillion muni market could offer impact opportunities.

A list of sample focus sectors for municipal impact investing.

No One-Size-Fits-All in Post-COVID-19 Investing

Whether it’s investing for purpose, stable growth or efficient income—or, most likely, a mix of all three—there are many building blocks and formulations at investors’ disposal. In designing a strategy with a better return path, portfolios don’t have to be one size fits all—and there are many design facets.

When investing for purpose, for example, in addition to integrating ESG, investors should clarify up front not only the specific purpose or purposes they’re targeting but also what constitutes success. It’s also important to understand how applying purpose-driven rules alters portfolio beta. If investors can get the design right, we believe they’ll be much better positioned to pursue better outcomes.

Want to learn more about post-pandemic portfolio construction? Download a copy of AB’s white paper, A Guide to Investing in the Time of COVID-19…and Beyond.

Richard Brink is a Market Strategist in the Client Group at AB, Walt Czaicki is a Senior Investment Strategist for Equities at AB, and Brian Resnick, CFA, is a Director and Senior Investment Strategist for Alternatives and Multi-Asset at AB.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

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