Ready, steady, go. Impact investing, an asset field similar to that of the SRI (Sustainable and Responsible Investment) landscape is gaining traction with investors. It represents the opportunity to propel both private and public money towards investments that pinpoint measurable positive social impact alongside financial returns. It can help investors make a difference by directing capital to address urgent global challenges.
So, what exactly does impact investment entail? Is it an investment fad? And how does corporate governance fit into the equation? Our content series will explore how investors can tune their portfolios towards the future and still ensure a healthy return.
WHAT IS IMPACT INVESTING?
The term itself was believed to have been coined by The Rockefeller Foundation’s Bellagio Center in 2007. However, it has been in recent months that impact investment has grown into its own, with recognition from the World Bank and other key players. In 2018 The Financial Times declared that ‘Impact investing has become one of the hottest strategies in fund management’.
The Global Impact Investing Network (GIIN), a non-profit organisation that is dedicated to scaling impact investments globally defines impact investing as ‘investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return’. The market as of April 2019 was calculated by GIIN to be worth more than half a trillion dollars or $502 billion.
In its nascent state, impact investing is prised to meet some of the world’s most urgent needs now and in the future. Experts, like Waide Warner, a senior research fellow at the IRI, argues that, “the funding required to achieve the UN’s sustainable development goals substantially outstrips the financial capacity of the world’s governments.” As it stands, the United Nations Conference on Trade and Development (UNCTAD) says that there is an investment gap of $2.5 trillion, needed to achieve the Sustainable Development Goals in developing countries.
But there is a lot of unclarity surrounding the ins and outs of impact investing, particularly in so far as strategic and defined measurements are concerned. Questions arise too about the differences between Impact Investments and those in a similar vein; Ethical investments, Sustainable investments, ESG (Environmental Social and Governance) investments and Socially Responsible Investing (SRI). This content series aims to demystify the ins and outs of impact investing for all interested individuals who lack clarity about impact investments and need to know how investing is defined today.
WHY IS IMPACT INVESTING IMPORTANT TO INVESTORS NOW?
For Glenmede Investment Management (GIM) , an independent U.S. based investment management firm, their foray into impact investing began in 2001. They have since launched 4 large-cap strategies which were built to ‘align client values and investments’ which allow for the prospect of ‘competitive returns for their efforts’.
The demand for impact investing, as experienced by many asset management firms like Glenmede, is also incentivised by the sheer diversity and wealth of suitable investments available. Investments made in this sector are also not limited to what some commenters have deemed “progressive” causes. Investments can include the following areas to name a few:
- Health and well being
- Education
- Community development
- Support for small businesses
- Climate Change
- Sustainable agriculture
- Sustainable consumer products and fair trade
- Renewable energy projects
- Venture capital initiatives
- Exchange-traded funds and mutual funds focusing on sustainability
Impact investing as a field of asset management is also largely encouraged by female and millennial investors, with research finding that 64% of Gen Y respondents were interested or very keen to invest with impact. This generation is particularly active in making investments that reflect their values and drive social and governance outcomes. What is also encouraging for investors is the significant growth trajectory of this field. Between 2013 and 2017, the International Finance Corporation noted that impact investment grew fivefold.
OPERATING PRINCIPLES FOR IMPACT INVESTING
The International Finance Corporation, a World Bank group, together with 60 global investors who hold over $350bn dollars between them in assets, (Credit Suisse, IFU-Investment Fund for Developing Countries and Acumen Capital Partners to name a few) came together to adopt and launch the ‘Operating Principles for Impact Management’ in April 2019. These principles were developed for investors who wish to ‘generate a positive impact for society alongside financial returns in a disciplined and transparent way’, lending much-needed clarity and guidance to the process and reinforcing good practice of impact management.
A: Strategic Intent
- Define strategic impact objective(s), consistent with the investment strategy.
- Manage strategic impact on a portfolio basis.
B: Originating & Structuring
- Establish the Manager’s contribution to the achievement of impact.
- Assess the expected impact of each investment, based on a systematic approach.
- Assess, address, monitor, and manage potential negative impacts of each investment.
C: Portfolio Management
- Monitor the progress of each investment in achieving impact against expectations and respond appropriately.
D: Impact at Exit
- Conduct exits considering the effect on sustained impact.
- Review, document, and improve decisions and processes based on the achievement of impact and lessons learned
E: Independent Verification
- Independently verify the entire process to ensure performance accountability.
WHAT IS NEXT?
The Blackrock Investment Institute, a faction of BlackRock, the world’s largest asset manager, say that investors in 2019 need to understand one key thing: Sustainability is the future of investing. This is all thanks to sharper insights and more granular data available amongst a growing awareness of sustainability. As case studies and examples of impact show, investors can now better evaluate the financial performance and the social and governance outcomes of their investments.
Investors today need to know clear lines are drawn. Our next blog in this series will delve into new subjects to allow potential investors more insights about the challenges of impact investing, the importance of data and analytics, and essential tips from other key figures in the industry. Future reports will also share insights from around the world, including work being done by development finance institutions and initiatives like the Soros Economic Development Fund to advance global impact efforts.
THE CHALLENGES OF IMPACT INVESTING
Impact investing is not without its challenges in terms of credibility and industry recognition in its nascent stage. Investment experts have referenced its ‘immediate attractiveness’, noting that its lure can detract from some of the issues that it presents in the long term. So, what are industry experts noting as some of the challenges facing interested investors?
According to Andrzej Rapaczynski, a Professor at Columbia Law School, the costs of impact investment are considerable for the “health of the capitalist economy”. He argues that a more “complex corporate objective function…raises the potentially insoluble problem of aggregating the diverse interests of the shareholders and seriously weakens the ability of the shareholders to monitor management performance”.
His argument joins those of fellow impact investor analysts who too, are sceptical of this field. Paul Sullivan, a financial journalist with the New York Times noted that impact investment in the short term, “can be hard for any investor, particularly for those who hew to an exacting standard”.
Yet, fund managers, private foundations, various forms of financial institutions along with NGO’s and individual investors who are currently involved in this field of investment understand many of the challenges facing impact investments but are still increasingly interested in pursuing new and varied investments. This can be linked to those most interested in impact investments; mainly millennial and female investors, who are considered more socially and environmentally conscious in the scope of their portfolios with Forbes reporting that ‘85% of millennials are very interested in impact investing’.
Some other challenges involved in impact investment can be connected to industry wide misperception, with some deterrents involving heavily marketed and publicised campaigns. Some of these activities have irked investors who believe it is still a philanthropic niche. Yet it is correct to assume that at present, while progress has been made it is still difficult for interested investors to quantify, measure and achieve a solid return at present.
MAKING A RETURN: WHY DATA AND FOCUS IS KEY
Blackrock, one of the top global investment manager firms, have advice for investors about how to improve sustainable investment processes to overcome many of the challenges associated with the filed. What is paramount for Blackrock is the influence and necessity of clearer data insights so that investors are ahead for the sustainable investment industry boom.
- Their key client insights demonstrate their support for sustainable investments and financial returns. Here is why:
- Blackrock affirm that enhanced data and insights make it possible to create sustainable portfolios without compromising financial goals.
ESG (Environmental, Social and Governance) friendly portfolios could be more resilient in downturns as their research shows that ‘ESG-focused indexes have matched or exceeded returns of their standard counterparts, with comparable volatility’.
What is certain is that greater data insights in this sector will both evolve and in turn drive greater financial returns for investors. It is Worthing noting the growth trajectory so far as according to data from the International Finance Corporation note that ‘the industry grew fivefold between 2013 and 2017’.
MSCI, through their investor guide for ESG investments have highlighted the most common use cases for sustainable ESG impact metrics. Here are their four key tips for investors:
- Set parameters: Investors should determine their objective and approach and following that their minimum revenue threshold. Investors should then ‘require minimum ESG standards for qualifying companies in addition to revenue and theme requirements.
- Company identification: MSCI note that for investors who wish to achieve a high financial return and minimum ESG standards, ‘relatively few companies will qualify’. The MSCI ACWI 2019 index features companies with revenue exposure to sustainable impact themes.
- Portfolio Reporting: The MSCI’s Sustainable Impact Portfolio Snapshot tool will allow investors to calculate portfolio exposure to Sustainable Development Goals. Investors can define potential revenue exposure by theme.
- Universe Definition, Stock Selection, Product Creation: the MSCI index and Blackrock are both examples of investment companies finely tuning key metrics and reporting standards via data indexes to meet the challenges of historical data analysis gaps. Investors can take advantage of these metrics to fine tune their portfolios.
KEY TIPS OF FELLOW IMPACT INVESTORS
Amit Bouri, CEO of the Global Impact Investing Network
“The 3 most robust areas for impact investing were private debt, private equity and real assets like land or rental properties. GIIN have developed themes that people can invest in, like clean energy and affordable housing.”
Andrew Lee, head of impact investing and private markets at UBS Wealth Management
“While there are sets of metrics by sector that are accepted, it is difficult to aggregate across the portfolio,” he said. “You have to keep it by sector.”
Erika Karp, founder and chief executive of Cornerstone Capital Group
“One of the things Cornerstone believes is, to really have impact on the world, we need to move trillions of dollars,” she said. “To do that, you need to evolve the standard of what is the discipline of impact investing.”
Guillaume Mascotto, VP & Head of ESG investment stewardship at American Century Investments
“As one might expect, factors like investment returns and fees remain top considerations when determining how to invest money. The significant increase in the percent of investors factoring societal impact into the decision-making process, particularly among younger investors, confirms our view that investors do not need to choose between impact and returns.”
CONCLUSION
Impact investing is no longer a niche trend. It has become a growing force within the investing industry, promoting both economic development and social or environmental change. Impact investors continue to seek new investment opportunities across asset classes. As a result, the impact investing market is growing rapidly. It is supported by institutional investors, private sector players, and private foundations such as the Ford Foundation and the Melinda Gates Foundation. By deploying investment capital for specific purposes, these players provide critical funding to support social enterprises and innovative solutions.
An annual survey of impact investors shows that assets under management are rising. This reflects an increased commitment to generating financial returns alongside environmental benefits. For asset owners and fund managers, understanding the terms of use, common terminology, and the importance of impact measurement is essential to delivering results effectively.
In today’s investment market, impact investing can offer both a high return on investment and meaningful corporate social responsibility outcomes. Whether you are an institutional player or a retail investor, it is important to understand how impact investing fits into your strategy. Development finance institutions and mission investor exchanges continue to drive the field forward. Those who are willing to learn and apply this growing information will be better positioned. They will benefit from the evolution of impact investing.
A FINAL WORD
Corporate governance, and indeed well-established governance is essential to mitigate investment risk. Investors need to be clear that before any kind of sustainable investment be it impact investing or ESG investment, leading indicators of failing governance should be examined. Luis A. Aguilar, Commissioner for the U.S. Securities and Exchange Commission notes that key indicators to track before investment include; exit of the CFO or company secretary, resignation of independent directors or auditors and regulatory inspection or settlement.
