Investors are people with needs and wants: they need to make money to pay their members’ benefits and more and more of them want to make the world a better place while doing it. Enter impact investing, which is designed to achieve both, and is looking less like a niche strategy.
Indeed, £58bn is working to make positive impacts in the UK, according to research by accountancy giant EY and the Impact Investing Institute, an organisation that promotes such investment strategies. Impact investing should not be confused with ESG, says Sarah Gordon, the Impact Investing Institute’s chief executive.
ESG identifies risks to a company’s financial health, while impact investing targets a financial return from making positive and measurable changes in society and the environment. “ESG is often passive, with a focus on avoidance, whereas impact investing intentionally seeks to deliver a positive benefit,” Gordon says.
Eric Cooperström, managing director of impact investing at Manulife Investment Management, describes the strategy as a “sub-set” of ESG that focuses on producing “desirable ecological or social outcomes”. “ESG and impact investing are not separate asset classes,” he adds. “They are investment strategies and styles that overlay existing asset classes like private equity, public equities, timberland, etc…”
Gordon advises that those looking to adopt an impact strategy to define the outcome they want to achieve, which can be measured “to hold yourself to account”. “There is a rapidly growing number of investors, including large asset owners, who want their investments to contribute to solutions to, for example, the climate crisis, which is extremely encouraging,” Gordon says. “Measuring, managing and reporting impact is vital to create positive change for people and the planet.” And more capital is being allocated to this goal than ever before. The assets held by European impact funds grew by 50% during 2021.
Absolute flows to impact funds in Europe increased 44% to €31.6bn (£28.2bn) during 2021, up from €21.9bn (£19.5bn) the previous year. This, according to a report published by Morningstar and Zeb, a consultancy, is in response to rising greenwashing in the sustainable fund market. These funds would have traditionally flown into equities, but exposure to debt is growing. The share of fixed income within the impact fund sector increased to 24% in 2021 up from 20% a year earlier, according to the Association of the Luxembourg Fund Industry.
Coming of age
Impact investing looks very different today compared to when Cooperström started working in the industry almost 15 years ago. “I have seen investor interest, and importantly pipeline opportunities, evolve in scale to become much more mainstream,” he says. In the early days, family offices, foundations and small institutional investors were investing in small-scale projects, such as social housing and eco-tourism.
These strategies are now targeting a wider range of asset classes and industries, while the types of investors seeking to make positive impacts has also changed. “The largest private equity groups in the world often have billion dollar-plus impact investment funds,” Cooperström says. “Clean tech investment is seeing a second wave of popularity. Sustainability is quickly becoming, if it has not already, table stakes [the norm] for investing in many asset classes and industries.”
Impact investing has traditionally been a strategy where investors work to make a difference in a particular geographic area. For Cooperström, this is another element of the investment strategy that has evolved. “Through my career, I’ve seen impact strategies evolve from smaller, often local opportunities like low-income housing to touch on a variety of asset classes that have more of a regional or even global impact,” he says.
Manulife Investment Management’s work in timber and agriculture is an example. Everything within these sectors, whether it be a forest or farm, starts at a local level. “Given natural capital and natural assets importance to fighting climate change, the work we are doing here has regional and global impacts from carbon sequestration and biodiversity perspectives,” Cooperström says.
Another aspect of these strategies that has matured has been access to adequate projects. “10 to 15 years ago, deal-flow was much more sporadic and not of institutional quality,” Cooperström says. The returns on offer were another deterrent, as was the lack of sufficient data monitoring the progress of investments that were not just seeking a financial return. “Once you get into a variety of impacts that might be more qualitative, that data tracking and management becomes a bit more complicated,” Cooperström says. “Again, we have seen a broad evolution here.”
Strong pipelines
The impact pipeline is more institutional-friendly these days and Cooperström is optimistic that this trend will continue. “Individual deals have scaled in terms of size and quality,” he says. “When I look at how investors might be remunerated for investing in impact, I see a lot of tailwinds. “For instance, in forestry, the protocols and the registries to provide structure for carbon returns have been established and evolved for 20-plus years,” he adds.
Cooperström is also seeing new markets emerge that have impact as a core focus, such as biodiversity. “The British and Australian governments have emerging programmes that could provide biodiversity crediting and payments to managers. We are seeing a broad evolution of how investors realise
impact returns,” he adds.
What’s in it for me?
Many asset managers have told me that one of the most common questions they are asked by asset owners when setting an ESG strategy is “will I have to sacrifice return?” Yet one of the reasons to pursue an impact strategy is to earn a return. It is part of the deal, but, like all investments, it is not guaranteed.
Returns investors can collect from investing for impact vary, Cooperström says. “That’s reflective of the diversity of asset classes and strategies that could fall under impact investing. “Historically, there was more of a trade-off between returns and impact, especially given the smaller scale and less institutional focus of past deals,” he adds. “Now the lines have been blurred between impact and returns.”
Cooperström uses the firm’s work in forestry as an example. “We have been sustainably managing timberlands for more than 35 years. As we have expanded into impact investments, which have a more intentional focus on carbon sequestration, it’s not a clear trade-off because you are changing the risk-return profile as carbon prices, not timber value, are the main value driver.
“Depending on where carbon prices go in the future, you could have a different range of potential returns compared to traditional timber investing. And those returns could also be higher,” he adds.
And for one pension scheme, their impact returns are indeed higher. Clwyd Pension Fund had £2.4bn in assets under management in March, with 4% of those allocated to impact investments. The returns from the impact portfolio were more than three times greater than the fund average in the first quarter. Its total assets and private market assets returned 13.3% and 26.4%, respectively, while the fund’s impact investments yielded 40.3%.
Guiding light
On the data side, more frameworks are being developed to help managers’ report on impact’s progress and outcomes. The UN’s Sustainable Development Goals feature heavily in these frameworks. There is GIIN’s (Global Impact Investment Networks) IRIS standard, the Global Reporting Initiative, the Sustainable Accounting Standards Board and the Task Force for Climate-related Financial Disclosures. “We are seeing more consistency in the data reporting,” Cooperström says.
The increasing capital flowing into impact funds, larger players entering the market and the growing number of frameworks show that the market has matured and is on its way to being a mainstream strategy. “The trend clearly shows that we are moving away from traditional investing focusing on returns only, towards impact investing focusing on positive environmental and social outcomes as well as financial returns,” Gordon says.
Cleaning up
To create real change, impacts have to be made in the sectors and companies which are most responsible for harming the ecosystem and the climate as well as making people’s lives harder. And investors are working to make impacts in unethical sectors, Cooperström says, adding that they are trying to influence change through the threat of divestment in an attempt to make capital raising more difficult and ultimately more expensive.
Gordon is also seeing shareholders using their influence to create change in the extraction industries. “Companies in these sectors require investors to support and drive their transition out of fossil fuels, and shareholders have a huge responsibility here,” she says. “We believe that divestment is a “last resort” after other methods of engaging with investee companies to drive change have proved unsuccessful.
But, of course, policymakers and regulators have an even more important role to play here. It is only by acting together that we will drive the change in these industries that needs to happen.”
Other approaches include investors pursuing direct shareholder activism through voting for who sits on the board, while others try to harness the skills and equipment within industries like oil and gas to help make a positive change.
Extraction companies have the expertise and technologies needed to build a sustainable future, such as offshore operations which could be used to expand wind power in the energy mix. “We are seeing some of that already,” Cooperström says. “There is a willingness to either promote investment outcomes through certain strategies like divestment or to work with those companies directly.”
Heading into the mainstream
Cooperström has seen impact investing become a more established approach for institutional investors over the past 10 to 15 years and he is seeing signs that this is likely to continue. “We are seeing an influx of high caliber talent into the impact investing space,” he says. “That is in part reflective of younger professionals wanting to have an impact component integrated with their career.”
For Gordon, these trends are part of what she believes is a move to impact investing becoming the norm. “Impact investing acknowledges the shortcomings of an approach to investing that is under high scrutiny and is addressing them,” she says.
“Of course, there is still a lot of work to do, but we believe that in the future, all investments will eventually become impact investments as companies will have to report and be held accountable for their positive and negative impacts.”
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