How can impact investing – with its roots in private equity – be achieved through public markets investment?
Impact investing aims to be a win-win concept – investors enjoy potentially attractive financial returns while simultaneously having a positive effect on society and the environment.
The roots of impact investing lie in venture capital and private equity but as this investment approach moves further into the mainstream, there has been considerable debate around how impact can be truly achieved via publicly listed equities and corporate bonds.
In addition, there remains a lack of industry-agreed impact investing standards in listed assets. Given this backdrop, we address the primary issues we believe investors need to consider when it comes to impact.
Is there a trade-off between impact and financial returns?
We believe there can be a trade-off when companies implement strategies with a short-term mindset, by looking for temporary uplift in financial returns or societal impact.
But when an intention to create positive impact is genuine and embedded into a company’s offerings and practices, we believe this promotes better corporate health and can also potentially lead to improved long-term returns for investors.
Firms will give themselves a better chance at being amongst the long-term impact winners by focusing on the UN 2015 Sustainable Development Goals (SDGs) and addressing the unmet needs of society, and pioneering accessibility for their products and services – here they can establish significant profitability moats. By promoting solutions and acting responsibly, they are creating important loyalties among key stakeholders and are better preparing their business for a resource-constrained future.
How should impact investors deal with poor and inconsistent disclosures?
A lot of discussion around impact investment focuses on the availability – or lack thereof – of backward-looking performance measures. But good performance disclosure alone does not in itself resolve global issues around climate change, or water scarcity or lack of healthcare provision.
Due to some local market norms, many companies are not leaders in disclosure. Sometimes these are due to such reasons as commercially sensitive data, evolving internal methodologies in measurement or the disclosure burden for smaller companies. We do not believe that disclosure alone should be an impediment to investing into firms which can otherwise be assessed to be impact leaders. We would rather own companies which we judge to generate the best societal outcomes than invest in those with the best disclosure of standardised impact key performance indicators (KPIs).
Nevertheless, we believe that impact investors need to be accountable to their clients and impact leaders to demonstrate a clear willingness to implement the monitoring and disclosure of relevant impact-related performance data, with an understanding of its links to the SDGs.
What role should third-party data providers play?
Third-party research companies and index providers can offer a range of valuable impact data sets which can be an insightful tool for asset managers. While the quality needs to improve, we’re confident this will happen over time, and methodologies used by these businesses will become ever-more sophisticated. However, for the time being, we would question the merits of overly relying on such data sets or using them in isolation. The very subjective nature of what constitutes an impact company should logically impair the credibility of a tool that looks to systemise impact assessments across a broad range of thousands of companies. This issue is magnified, too, when you consider the lack of standardised impact disclosures across many companies.
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Instead managers should dig deeper and leverage what information they can on company revenue compositions, as well as ESG scores, assessments and many other factors.
Are impact investments just another way to package emerging and frontier market strategies?
Many of the SDGs have a clear focus on targeting challenges for low-income countries. The UN Conference on Trade and Development World Investment Report for 2014 estimated that an annual $5-7tn investment would be required to meet the SDG 2030 goals with roughly two-thirds of this needing to be invested into the developing world.
However, it is worth noting that investing in developing-market listed companies is not the only way to have exposure to business activities in low-income countries. Presently, nearly a quarter of the revenue from MSCI All Country World Index-listed firms are earned in emerging markets. Ultimately, everyone globally benefits from the advancement of solutions that address chronic health issues, climate change and resource scarcity – whether it comes from a developed or emerging market company.
To what extent should negative externalities rule out companies as candidates for inclusion in an impact portfolio?
Negative externalities should be considered for all investments. It is very difficult to net-off positive and negative outcomes, especially if they are in different areas. For example, how do we weigh the fact that a business may be driving adoption of insect repellent use in India but may also be reliant on palm oil in its production? The electric vehicle industry is fraught with debate given the reliance on coal-based power generation and exhaustible raw materials, though the end goal is clearly worth striving for – better technologies, powered by renewable energy, increased equipment standardisation and recycling.
We believe that the assessment of net societal outcomes cannot be done through an equation. It is a matter of judgement. Albeit such judgements need to be backed by data and documented.
Which listed asset funds deserve an impact label, and which ones don’t?
Right now, there is no regulatory oversight policing impact labels. In addition, there is no broad agreement within the asset management industry around what defines an impact fund.
However, there are initiatives looking at agreements around taxonomy and minimum standards and such projects should help promote better understanding and common terminology – hopefully they may eventually deliver a definitive impact fund label. But for now, it is essential that asset managers collaborate to move this forward and pay attention to changing industry norms.
This article first appeared in Funds Europe magazine