A remarkable transformation is underway in the corporate and investment world: an awareness among businesses and shareholders of the need to create a sustainable and resilient world, combined with a recognition that this can enhance, not detract from, long term portfolio returns. This is a significant opportunity for change, irrespective of the political forces that often seem to work in opposition to these interests, and is epitomised by the ability of the UN Sustainable Development Goals (SDGs) to capture the imagination of companies and investors.
The scope of the opportunity
The interest in long-term sustainability – for businesses and the planet – is indicative of a sea change in opinion on the role of environmental, social and governance (ESG) considerations in investment approaches.
No longer is it a case of portfolio managers arguing why they focus on ESG issues: they must now justify why they do not. For instance, to win an equity mandate from a European asset owner, a fund manager is expected to integrate ESG research into their investment process.
In an environment of modest nominal GDP growth, addressing the unmet needs of society – as represented by the 17 SDGs – is a substantial part of the beta of future demand and represents growth that is largely independent of unconventional monetary policy. The investment industry is in a unique position to influence the debate, given the scale of the assets it manages and its broad exposure to the global economy.
The concept of ESG-aware investing is now well understood, though it is delivered in varying forms. The investment industry, however, seems keen to go one step further and embrace impact investing, an approach well established in the philanthropic, family office, non-government organisation and social enterprise world, but less understood in the mainstream.
The Global Impact Investing Network provides the following definition: “Impact investments are investments made into companies, organisations, and funds with the intention to generate social and environmental impact alongside a financial return.” Existing social investors understand this concept well, but they also operate in a world where social returns generally rank higher than financial ones. In this issue of Sharpe Thinking, we ask: how readily can the impact philosophy be applied in public-equity strategies?
Impact investing is long-term in nature and focused on companies developing new capabilities that meet specific needs of society in a mission-led manner. It goes beyond best-in-class ESG practices or a well-developed corporate social responsibility programme, requiring investors to identify companies that are mission-led and which have a clear approach for delivering additional and measurable societal benefits that will endure over time. The three key concepts that traditional impact investing brings to the public domain are: intentionality, the intention of an investor to exert a positive social or environmental impact; additionality, fulfilling a good cause beyond the provision of private capital; and measurement, being accountable and transparent in reporting on the financial, social and environmental performance of investments. Implementing these concepts is challenging enough in private markets, but is even more onerous in public markets.
These ideas should not be allowed to fall into the too-hard basket, as they can bring significant benefits to the way traditional investors go about their business. Long-term thinking, and understanding and measuring the impacts – positive and negative – that all businesses have on society and the environment, are important aspects of investment success. This reflects the complex, interrelated nature of the ecosystem in which we operate as investors and our responsibility for sustaining that system for future generations.
Impactful: the UN sustainable development goals
Strengthening the purpose of capital markets
The concept of additionality, often seen as too idealistic for mainstream investors, is worth exploring, as it zeroes in on the purpose of capital markets. The accusations of short-termism and overintermediation levelled at the investment industry reflect the loss of a connection between capital and its commercial and societal purpose. Through additionality, impact investing can help restore that bond.
Investors can encourage and support companies to invest incremental capital, funded by shareholders if required, in long-term sustainable opportunities that address unmet societal needs in innovative ways. In doing so, these endeavours should have the potential to deliver attractive returns for all stakeholders. This is a lofty ambition, and is why impact investing in public markets should go beyond ESG investing and focus on a concentrated portfolio of purposeful companies demonstrating a commitment to long-term sustainable returns that bring real societal benefits.
Such companies will not only have a clear mission, but should also embody strong cultural values that embrace diversity and employee development, environmental awareness, and ensure that their mission is enforced repeatedly throughout their supply chains. These are features that are increasingly recognised as hallmarks of successful and resilient businesses. As such, additionality should underwrite behaviours that establish a holistic and long-term perspective that perceives short-term maximisation of profits as failure. The true goal of additionality is to encourage prosperity across society rather than create pockets of isolated wealth.
Engaging for impact
One of the most powerful forces in investment is the compounding of returns. It is why sustainability is the ultimate objective of business and forms the core of long-term value-creation processes within companies. Reporting and measuring on impacts achieved is essential to fostering strong relationships between companies and their investors. Active and collaborative corporate engagement, therefore, is an essential part of the approach and results in better alignment between all stakeholders in a business and encourages investors to take a truly long-term perspective.
Passive investors can also embrace this approach: through engagement and intelligent voting across their portfolios, they can help reduce negative behaviours and reward positive actions for the long-term benefit of society. Indeed, it can be argued that constructive corporate engagement that is aligned with the UN SDGs allows all investors to be impact investors.
Traditional equity strategies cannot put societal returns ahead of financial ones, as clients will not tolerate sub-par returns from listed equities or bonds. Impact investors, therefore, need to demonstrate that they remain first and foremost good investors who see the long term financial benefits from investing in impactful businesses, and allocate capital accordingly.
Creating investment themes linked to the detailed sub-goals of the SDGs, of which there are 169, illustrates the breadth of opportunity that impact investing represents. Access to clean water, sanitation and pollution management, food and energy security, urbanisation and climate change, preservation of biodiversity, improvement of healthcare and education, financial inclusion, promotion of a living wage and quality jobs, cyber security – and there are more – represent enormous opportunities, as well as challenges.