By: Harry Penberthy, Head of Marketing at Triple Point
With the enormous socio-economic pressures brought on by the coronavirus pandemic, impact investing is set to answer some of the most significant challenges our economy and society faces. In this article, Harry Penberthy, Head of Marketing for Triple Point explores the key characteristics of impact investing and its objective as an investment approach – marrying positive societal and environmental outcomes with long term financial returns.
We are living in a world where governments, institutions and individuals increasingly expect investments to deliver more than financial returns. This is demonstrated across the globe from the increasing public awareness of climate change, the UK’s commitment to become net zero by 2050, and the pledges from some of the world’s largest companies to pursue broader stakeholder value rather than merely shareholder value.
We are all aware of the surge of support for ESG in recent years, yet the purest and most comprehensive form of Responsible Investing (‘RI’) is impact investing. It involves applying the same scrutiny as traditional investments, to produce quantifiable social or environmental benefits with the aim of generating financial returns. As such, impact investing fuses traditional investment processes with sustainable objectives and additionality.
And impact investing is on the rise! Following the most rigorous sizing of the market to date, in the summer of 2020, the Global Impact Investing Network (GIIN) estimated that over 1700 impact investors managed over $715bn in impact investing assets worldwide. What’s more, over 50% of active impact investing organisations made their first investment only within the last ten years.
The increasing interest from investors is supported by the evidence that impact investing withstands the same scrutiny as traditional investing and focuses on the resilience of services that our society cannot live without. In a GIIN survey conducted in June 2020 some 88% of impact investors reported meeting or exceeding their financial expectations.
Understanding impact investing
But, for many retail investors, whose contribution to environmental and socially beneficial investments could be significant, this is an industry still in need of demystification.
Although impact investing comes in a variety of forms, it is important to establish what it is not. Unlike other subsets of responsible investing, impact investing does not describe attempts to reduce harm by avoiding certain sectors, such as tobacco firms. Instead, impact investing takes an active role, targeting investments with real purpose to benefit society and deliver returns.
Interestingly, impact investing is currently more common in venture capital, private equity and private credit because closed-end funds deploying patient capital can invest in long term opportunities such as infrastructure, clean water or social housing.
The logic is that the long-term risk-adjusted returns are superior because the investment approach is in tune with the forces shaping the global economy: for example, tackling climate change, addressing inequality, or expanding global access to healthcare and education.
There is also now growing evidence that companies successfully adopting strategies to create profit-driven social impact can deliver superior returns. Indeed, research carried out by the London Business School found that companies which decided to improve sustainability in a material area to their business, delivered higher returns over time than peers who ignored it.
Perhaps the most common form of Responsible Investing is the use of environmental, social and governance (ESG) criteria. An example might be choosing between two energy stocks according to ESG criteria: in which case the manager might choose the company that produces more renewable energy.
Operating a strategy according to ESG factors involves the idea that they can affect investment returns while outperforming. Indeed, if we take Governance as a factor, then it is likely that a company that is well managed will do better than one that’s not. ESG criteria can also help with risk assessing investments – for example, evaluating whether a business’ operations are actually sustainable in the long term if they are causing significant environmental damage.
Hence some investment managers now assert that integrating ESG factors into a strategy can improve returns, either through reducing risk or selecting stocks that perform well. This in turn supports the view that ESG is not the product of moral investing but rather, portfolio optimisation.
The importance of impact measurement
But there is quite rightly a growing demand for managers and pension schemes to have clear and standardised social impact investment tools. Indeed, greenwashing is a key threat to the wider adoption and success of RI: declaring an investment strategy green or ESG compliant just to secure more customers and investors, prevents genuine solutions to the challenges the planet faces.
Frustratingly, most of the due diligence burden to establish whether investment products are actually compliant is borne by investors, but regulators are working to establish harmonised codes of conduct. These include the 2019 proposals from EU negotiators to agree a deal to establish common European rules over what can be considered a green investment. This categorisation system is to be included in a rule book, which will cover all types of energy sources including nuclear, and will inform how investors treat a range of assets from green bonds to bank loans and investment products.
Whilst this is a step in the right direction, these systems are still broad, and are more of a benchmark than a strategy. Impact investing is different from other RI approaches because it is concerned with developing best practices for impact measurement, management, and reporting. Indeed, having a clearer approach to measurement and reporting encourages investors to demand better insight into the investments made on their behalf and ensures the capital they commit has the maximum positive impact.
The good news (and the silver lining to the terrible effects of COVID-19) is that RI will continue growing as it reflects broader sustainable concerns among investors – factors only further enforced by the pandemic. There is now urgency for investors to see their values reflected in investments. This means more asset managers are having to think about their own RI policies. And whilst there are many variations and applications of RI, arguably impact investing remains the most capable approach of meeting a growing investor demand driven by both values AND macro-economic risks.