Could looking beyond return and more towards the difference capital is making be the future of investing? Mark Dunne takes a look.
Impact investing is not another name for ESG. Although they come under the responsible investment label, they are different strategies. ESG is about backing sustainable companies, especially where the environment or society is concerned, or working with management to improve a corporate’s behaviour, which is not the aim of impact investing.
“The idea of impact investing is to create positive change, mainly to the products and services companies offer,” says Marie-Geneviève Loys Carreiras, head of social business investment at BNP Paribas Asset Management.
Although a niche approach, creating a positive change is a sizable market worth more than $700bn (£505bn), according to the Global Impact Investing Network (GIIN), a body which promotes the industry.
“We are seeing an evolution from negative screening towards more intentionality,” says Eric Cooperstrom, managing director of impact investing and natural climate solutions at Manu- life Investment Management.
This shift is seeing more funds invested in building affordable homes, supporting under-represented groups, providing access to clean drinking water or making electric cars.
“In general, you are looking for a project that needs financing and could make a meaningful impact, that could make a difference,” says Andreas Fruschki, managing director and head of thematic equity at Allianz Global Investors.
Despite ESG and impact offering investors different outcomes and risk-reward profiles, the two strategies can work together. “They are complementary because you cannot do impact investing without considering the ESG analysis, but you are looking for something different,” Loys Carreiras says.
“It is in addition to financial analysis but goes further than just an analysis tool: impact investing defines the whole investment strategy and process,” she adds.
Social change
The disruption to our lives caused by the pandemic and the inequalities it has highlighted, show that investors need to do more than simply engage with companies to persuade them to reduce their harmful gas emissions.
“From a natural resources point of view, the pandemic has highlighted our dependence on nature, not just climate,” Cooperstrom says. “We are seeing a direct link between deforestation, habitat destruction and interaction between humans and disease carrying animals.”
Climate change has traditionally dominated responsible investment decisions, but the events of the past 18 months have highlighted how important the social element of responsible investing is.
“Social issues are more visible since the pandemic,” Loys Carreiras says. “It has also impacted the economy and employment in such degrees that people say they want to invest in the real economy.”
The pandemic aside, there are other reasons why more capital needs to be allocated to impact strategies. “There has been a surge of companies committing to a net-carbon future, but there is a limited amount of funding going towards climate solutions,” Cooperstrom says. “Something like 2.5% of global pandemic stimulus funds have been dedicated to green solutions.”
Indeed, more action needs to be taken to create the positive change needed to achieve such targets. A rise in such allocations could be on the way. Fruschki believes that investing for impact could be the next stage in responsible investing’s evolution.
“The early days of sustainable-led investing were about exclusions,” he adds. “It was the Church wanting to avoid being accused of hypocrisy by putting their money in companies they publicly disapproved of.
“That evolved into ESG, where investors incorporated non-financial KPIs into their decisions to better assess a company’s overall preparedness. So, they would not only look at a company’s earnings, but its risk exposures, too. The next level is looking to achieve something through an investment beyond a financial return.
“For many investors, ESG investing is mainly about reducing risk, but impact investing goes a step further in wanting your money to make an impact in real life for the better, with ideally a direct link between your investment and the actual improvement,” Fruschki adds.
Did it work?
Impact investing is in its infancy and, like many new markets, is having teething problems. Top of the list is the accuracy in showing if the goal of the investment has been achieved or not. “Institutional investors are not only looking to make an impact; they are looking for more measurement, too. What can I measure? Can I report on the change I contributed to?” Loys Carreiras says.
This is not easy. “Conclusive measurement of the causality between an investment and the chain of events that followed is a challenge to calculate exactly,” Fruschki says.
Measuring the success of an impact investment is different than for a traditional strategy, where performance can be assessed by looking at IRRs and multiples on invested capital. “How should you view a gallon of clean water compared to a tonne of carbon dioxide sequestered?” Cooperstrom asks. Manulife has re ned its approach in this area. “It is important to measure what matters and to focus on the metrics you can calculate accurately and consistently,” Cooperstrom says.
Manulife Investment Management, for example, looks at the level of CO2 emissions and removals and carbon credits generated by timberland investments – metrics which are meaningful to such strategies.
The market might be young and niche, but it is maturing, especially in terms of investor expectations. “There has been a shift from simply gathering and reporting impact data to providing meaningful information,” Cooperstrom says.
An example is Manulife Investment Management’s timber business, where it monitors the approximately 1.2 billion trees it has planted since its inception in 1985. “We are tying that directly to carbon dioxide removal, so we can show that our timber business has generally been net zero,” Cooperstrom says. “That matters in the context of climate change.”
It is clear that for impact to attract more capital, work on the market’s infrastructure is needed. “We lack indicators, we lack quality data and lack the same process for computing data. So, it is hard at a portfolio level to compute and aggregate the data,” Loys Carreiras says.
“Innovation is needed to create the products that fit the wish for impact. Is it easier to compute the data in the non-listed sector,” she adds. “It is a smaller universe, with direct contact to the company. Listed assets is a broader universe, and it is difficult to engage with a company to ask for new indicators.”
Teething troubles
Accurately measuring outcomes is not the only issue in what is a market that was only labelled around 15 years ago. Defining what is an impact investment is high on the list.
“How many years did we debate the environmental taxonomy?” Loys Carreiras says. “You could say that it is less subjective than social subjects. To define what is poverty, to define what is good employment – it is more subjective and varies from country to country.”
Scale and experience are other issues. “Historically, impact deals have been small and promoted by transaction sponsors whose track records are more limited than institutional investors would expect, but that is changing,” Cooperstrom says. The geographical focus could be another issue with strategies not offering enough exposure to developed economies.
“Risk return targets for certain impact investments have been misaligned with mainstream investor strategies,” Cooperstrom says. “Often, they have been focused on emerging markets, which might not fit with certain mainstream developed market investors.”
Yet the risk-return profile of some investments could halt the progression of such strategies. “Historically, the impact investing market has been skewed towards private foundations, high net worth individuals and family offices that may have higher risk appetites than some institutional investors,” Cooperstrom says. “So, it has been harder to scale. That is changing and is evolving rapidly with major asset managers and private equity houses launching impact investing products.
“Historically, the impact investing market has been skewed towards private foundations, high net worth individuals and family offices, who may have higher risk appetites than some institutional investors,” Cooperstrom says. “So, it has been harder to scale. That is changing and is evolving rapidly with major asset managers and private equity houses launching impact investing products.”
Rise of the millennials
There is a factor that means impact investing is unlikely to be a passing fad – millennials. They are taking over decision-making bodies, a trend that Fruschki believes will lead to a rise in impact mandates.
“That generation has different attitudes towards saving the planet and certain social norms. They are also keener to see things happen,” he says.
“Baby boomers would have been the generation that said their opinion is one thing, their investment portfolio is another. Generation X did not want to be caught out as a hypocrite for saying one thing publicly and doing another privately, but for the next generation it is not good enough to simply walk away from bad practice investments.
“We are seeing so much interest in impact investing because it resonates with what this new generation of investors think their money should be used for,” he adds. Fruschki is not alone in expecting millennials to push impacting investing into the mainstream.
“There is greater scrutiny, greater tech connectivity and greater consciousness among millennials as to where they want to put their wealth,” Cooperstrom says.
The cost of impact
Using your capital to make a positive impact on the environment or society clearly has merit. The question is, could such strategies be positive on your pocket?
“Return is an issue the impact space has always grappled with,” Cooperstrom says. “In timberland management, for example, you could aim to maximise financial return through timber harvests in one strategy or maximise impact by limiting harvesting in another. Obviously, the risk/return profiles are different.”
It is understandable that there is a conflict, as these strategies are about achieving non-financial goals as well as making a financial return. “Pursing non-financial goals does not mean giving up performance, but you should not spend 100% of your time on non-financial return considerations alone,” Fruschki says. “You probably would not be making much of an impact if you did. You are pursuing environmental or social alpha in addition to financial alpha.”
But solutions are appearing to help stewards of capital make a return without potentially limiting their impact. “In the timberland investment space we are seeing a movement to add carbon projects to strategies, which could be accretive depending on the price of carbon,” Cooperstrom says. “So, you are looking at the price of carbon not just the price of timber.”
Perhaps investors should think longer term when setting expectations of when such investments will produce a return. “Companies that contribute to solving environmental problems or alleviating social pressures are companies who have a bright future,” Fruschki says. “Those are the areas we expect investment to be prioritised.
“You might find yourself in a niche of the market where companies could solve an environmental or social problem, giving you the ability to participate in the above average growth that these businesses are likely to experience,” he adds.
So, impact investing should be part of a diversified investment strategy. Loys Carreiras says: “If there has to be a compromise on the financial returns, it is to match with the intentionality of the investors but not because impact investments are less profitable. If there is a financial performance, do you want to take it, or reinvest it in the project and make more of an impact?”
Proactive impact
The outlook for such strategies is positive. “We are seeing larger asset managers with proven track records enter the space while institutional investors are adjusting their asset allocations to include impact investing,” Cooperstrom says.
“Impact measurement and reporting is becoming more accurate, detailed, meaningful, intentional and standardised,” he adds, pointing to the sustainable development goals and GIIN as guiding frameworks.
To attract more capital to strategies that seek to make positive impacts, corporates must be willing to do the work needed in reporting the progress of certain projects. “Impact investing is easier when the intentionally is shared between companies and investors,” Loys Carreiras says, adding that this might require investors to show some patience. “If we wait for the perfect context, we will never do it.”
One issue is clear, with the next generation taking over corporates, pension schemes and other decision-making bodies, and with governments and investors having to meet tough decarbonisation targets, impact investing could become a bigger part of the institutional investment conversation.
