Written By: Emma Powell
Emma Powell discusses with senior professionals the growing popularity of impact investment and its relationship with ESG
The outbreak of Covid-19 has intensified the spotlight on impact investment, as investors allocate capital towards dealing with the social and economic devastation caused by the pandemic. Companies and governments globally have issued around €60 billion in Covid-19 bonds in March and April alone, according to Axa Investment Management, which forecasts that the figure could reach €100 billion by the end of the year.
However, even prior to the coronavirus outbreak, impact investing has been steadily growing in popularity. The number of impact investments made by the 79 repeat respondents surveyed by the Global Impact Investing Network (GIIN) grew by 9% a year between 2015 and 2019, and the volume of capital invested grew by an annual rate of 12% during the same period, from $14 billion invested in 2015 to almost $23 billion last year.
The terms “impact investing” and “environmental, social and governance (ESG) investment” are often used interchangeably, but the difference is that the former refers to those made specifically with the intention of generating a measurable, social and environmental impact alongside a financial return.
One distinction between impact investment and ESG strategies would be to think about the “what” and the “how”, says head of sustainability and ESG at Impax Asset Management, Lisa Beauvilain. Beauvilain says: “Impact investing is focused on the what – what are their products or services? What is the impact they provide?” Meanwhile ESG focuses on identifying companies that are doing the “how” in a better way than peer companies in the same sector, she adds. It is important to identify what improvement a particular product is providing to the marketplace, for instance, the level of CO2 that has been avoided or saved, she says. However, investors can also think about engagement as an impact, she says, how transparent is a company around human capital?
“You have to show that these were intended and delivered an incremental improvement that otherwise wouldn’t have happened,” says head of responsible investment at Newton Asset Management, Andrew Parry. Impact investing used to be viewed through the perspective of managing risk, he says, but increasingly it is being viewed through the lens of what social or environmental improvements mean for the growth prospects of revenue income for the company.
Impact investing is also growing in popularity among mainstream fund houses. In July last year, Schroders became the first European fund manager to make a major move into expanding into the impact investing market, purchasing a majority stake in BlueOrchard Finance. The specialist boutique focuses on managing microfinance debt investments, aimed at boosting growth in the developing world. Meanwhile Swiss investment bank UBS has pledged to raise at least $5 billion for impact investments linked to the UN Sustainable Development Goals – 17 sustainability targets for tackling issues including poverty, inequality and climate change – by 2021.
The areas that investors have been allocating capital to include energy, infrastructure and education. While food and agriculture accounts for a relatively small proportion of assets under management, it is the most common sector for impact investment. Just over half of respondents to the GIIN survey, which captures data from 294 of the world’s leading impact investors that manage $404 billion of impact assets, had some allocation at the end of last year, while the highest proportion of respondents planned to increase their allocation to the sector over the next five years.
Bank of America estimated that the food security market was worth $200 billion in 2019 and is set to grow to at least $300 billion by 2025. That involves investing in technologies to cut food waste and improve crop yield.
However, the fastest growing sector among repeat respondents was water, sanitation, and hygiene (WASH), with investors growing their capital allocation at a compound annual growth rate (CAGR) of 33% between 2015 and 2019 and to financial services (excluding microfinance) at a CAGR of 30%. Half of respondents plan to increase the volume of capital allocated to WASH over the next five years.
Measuring your impact
But given the aim is to have a measurable impact, just how do you demonstrate that your investments have played a role in providing environmental or societal improvement?
Many investors still fear “impact washing” – projects being labelled as impact investments to benefit from the favourable attributes linked to these strategies – still presents a challenge to the industry, with 66% of respondents to GIIN’s 2020 survey believing “impact washing” will be a significant problem over the next five years.
Over the past decade, most investors have switched to using external systems, tools and frameworks for impact measurement and management (IMM). The most commonly used IMM resources are the UN Sustainable Development Goals, according to GIIN. However, the Impact Reporting and Investment Standards (IRIS) Catalog of Metrics, IRIS+ Core Metrics Sets and the Impact Management Project’s five dimensions of impact convention are also used by investors.
“I’ve seen the phases in the type of things the market thinks are important,” says Majedie head of responsible capitalism, Cindy Rose. “However, there has been a change in the level of awareness among the public and investors, particularly since the outbreak of Covid-19, about the fact that we do have some issues about the living wage, diversity and how companies treat their employees, she adds. The question is whether this will endure over the longer-term.”
Rose says that visible signs that a company is making progress in improving their environmental or social practices influences the asset manager’s conviction level. “It’s not like once a company has done something that they’re finished, that’s a step in the evolutionary process,” she says. However, the extent to which a management team is willing to engage also helps determine the asset manager’s conviction level, she says. “Sometimes when you talk to a company, if you talk about issues of ESG then the automatic response has been this is our carbon emissions and they provide an answer,” Rose says. But sometimes the asset manager has to “roll back”, she says, and explain that it has other concerns about a company’s practices, such as supply chain management or issues around diversity.
“I think if you’re willing to put the time in and if you’re willing to see how that turns out a couple of things might happen. They might come back and say I’m happy to give that to you,” she says. Alternatively, it may take further engagement.
Virtue versus returns
But do investors have to sacrifice performance for pursuing impact goals? Beauvilain argues that impact investors are investing in companies that are providing a service that is unmet within society at present.
“Hence if you can have a product or service that can help with that, you’re more likely to have tailwinds behind your activity or business model,” she says. Those tailwinds can take the form of favourable regulation or increased consumer awareness and demand for certain products or services, Beauvilain adds.
That is a sentiment echoed by Parry. “If you find a way of tending those underserved needs then you’re going to see good sales growth,” argues Parry.
For pension schemes, the long-term nature of impact investments can be additionally useful in matching their long-term liabilities, as well as growing demand among individuals for ESG principles to be integrated into their personal investments. Private equity investments generated the greatest return since inception for those targeting risk-adjusted, market-rate returns, according to GIIN’s 2020 annual impact investor survey, at 18% in emerging markets and 16% for developed markets. What’s more, 88% of respondents reported meeting or exceeding their financial expectations.
Other challenges remain. More than half those surveyed by GIIN said they believed the top challenge was the lack of “appropriate capital across the risk/return spectrum”. Finding unlisted companies that fulfil the idea of an appropriate mission and provide a financially suitable place to allocate capital was named as the top concern by institutional investors and consultants in a survey carried out by Ireland-based investment management group, KBI Global Investors.
However, the economic collapse caused by coronavirus, and movements such as “Black Lives Matters” which have pushed diversity and equality issues up the agenda and further into public consciousness, have provided additional impetus for an impact investment trend that was already gathering significant momentum.