Once a niche investment solution, impact investing has entered the mainstream. Here, we look to the future and the opportunities that potentially await.
A quick recap
Overall, we’ve seen growing awareness of the potential economic impact from environmental and social risks. Indeed, the World Economic Forum’s annual risk report for 2020 was illuminating. It included a survey of global risks perceived as the most likely and the most damaging. Over the last decade, economic risks such as asset bubbles have been overtaken by environmental risks. And, for the first time, climate-related issues dominated the top-five most likely long-term risks. In the 2021 report, Covid-19-related worries understandably entered the top five. Nonetheless, risks around extreme weather and biodiversity loss remained at the fore.
Moreover, there’s increasing recognition that environmental and social risks are intrinsically linked to economic issues. This linkage has been reflected in financial markets, which over recent years have moved "ESG" from a box-ticking exercise to a mainstream investment approach.
As more firms appreciate how environmental and social risks can translate into serious legal penalties or customer losses, there’s also been a noticeable shift to "greener" investments and companies seen as ESG leaders. In many cases, this is driving valuations.
Is ESG a bubble?
Comparing ESG to previous secular themes, ESG is still quite early in terms of "bubble territory" relative to the dot-com or US housing bubbles. Moreover, tangible policy support underpins demand expectations. According to analysis by Bloomberg New Energy Finance, the world’s top 50 economies are investing US$583 billion to boost green efforts. This makes us optimistic ESG isn't a bubble. On the contrary, we believe there’s a fundamental shift in how the market perceives ESG risks, and rewards ESG opportunities.
Investing for impact
We believe impact investing goes beyond mere responsible investing. This is because it aims to have a positive environmental and/or social outcomes alongside a financial return. We think that by allocating capital to address significant environmental or social issues, companies providing solutions to these underserved needs are tapping into unmet demand. To investors, this offers the attraction of a potential double bottom-line: measurable positive impact alongside potentially sustainable returns.
Over the years, we’ve seen greater industry efforts to promote impact investing. This includes the work of the Principles for Responsible Investing (PRI), the Global Impact Investing Network, Bridges Ventures and many others. These efforts to educate and create common language are starting to bear fruit. And there’s growing market realization that, while issues like climate change are material risks, they are also opportunities.
This has led to surging demand and inflow of capital, particularly in the public equity sector, where impact investing is more established.
We believe the ESG trends we’ve seen in recent years will accelerate.
Seeking to generate sustainable returns
In our view, impact investing is a potential source of alpha. Further, we believe the ESG trends we’ve seen in recent years will accelerate. Not only because ESG investing is the "right thing to do" but also because there’s material financial incentive. This includes through regulation, shifting consumer patterns, or industry evolution to proactively respond to the social and environmental risks we face.
The numbers support this view. Take, for example, the 2020 Global Impact Investing Network investor survey. It gauges the opinions of almost 300 leading impact investors who collectively manage more than $400 billion of impact investing assets. Of the survey respondents, 88% said financial returns were in-line or ahead of expectations.
Measure for measure
Hurdles remain. Two of the most pressing are measurement and reporting, and the extent to which these vary across asset classes.
With listed equities, investments are aligned to companies whose products or services are contributing to positive change, either environmental or social. Compared with private markets or "green bonds," investors have less say over what impact metrics are targeted and reported. Rather, they rely completely on corporate disclosure and regular engagement.
Furthermore, there’s no consensus on how to measure and report on impact. This means different impact strategies ask for different impact metrics. Companies often fall short with the data they supply. That’s why we believe the industry needs to standardize disclosure and ask for better — not necessarily more — data.
But this is a major opportunity. While private market impact investors typically exert more influence or control over an investment’s strategy, listed equity impact investing can challenge and change the way established companies think and behave. Regular meetings with management, ongoing feedback, and active voting can all help improve disclosure, hold corporations to account and effect change.
Active versus passive — there’s no screen for impact
One big question around impact investing is whether to adopt an active or passive approach. To us, the answer is clear. Impact investing not only aims to avoid harm and benefit stakeholders, but it also seeks contribute to positive solutions. So, the level of analysis required means that there are no screens for impact. It can’t be done passively.
Impact investing in any asset requires in-depth analysis of global issues and the identification of potential solutions. It also involves continuous monitoring of an investment, from both a financial perspective and to ensure impact milestones are met. Robust impact measurement is vital, as is careful consideration of ethical divestment.
Engagement is also a crucial part of any impact strategy. We believe this includes encouraging listed companies to improve their governance or approach to environmental and social issues. And active management helps investors to use voting power at general meetings to exert influence.
As the landscape changes, the investment industry is better prepared to adopt impact investing and to recognize that companies providing solutions to the multitude of global risks have the opportunity to profit. Challenges remain, but, as the world seeks to meaningfully address these, we believe impact investing will cement itself as one of the cornerstones of sustainable investing.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Among the risks presented by private equity investing are substantial commitment requirements, credit risk, lack of liquidity, fees associated with investing, lack of control over investments and or governance, investment risks, leverage and tax considerations. Private equity investments can also be affected by environmental conditions / events, political and economic developments, taxes and other government regulations.