We look at the differences between impact investing, ESG factors and sustainable investing, and how to get started.
Impact investing has attracted increasing attention in recent years from socially conscious investors looking to build wealth at the same time as creating concrete social or environmental benefits.
Led by younger investors, impact investing is more than just putting money into a company that supports positive environmental and social policies and values. The investment itself has a measurably positive impact on society. According to The new face of wealth and legacy report, 73 percent of younger* generations in the UK say they have more opportunities to tackle societal issues through impact investing. This compares to 44 percent of *older generations.
Responsible investing has been around in some form or another since at least the 1960s and 1970s. The Sullivan Principles, for example, was created to challenge apartheid in South Africa by asking signatory companies who wanted to do business in the country to follow a code of conduct that included non-segregation and equal pay regardless of race. It was expanded in 1999 to promote global corporate social responsibility on issues like human rights, workplace diversity, social and economic justice.
Still, around the era when these expanded global principles were unveiled by the United Nations, the prevailing view was arguably more sceptical that socially responsible investing could compete with traditional investing.
Today, environmental, social and governance (ESG) screening factors into many investments, with regulatory policies speeding up the weight these measures carry for companies.
“The biggest opposition to it in the past was if you use ESG data, then performance will be affected,” says Stephen Metcalf, associate global manager research at RBC Wealth Management in London.
With attitudes changing, Metcalf believes sustainable investing using ESG data will increasingly become more normalised.
“It’s going to become this fundamental thing that everyone does … like credit analysis or simple, traditional investment techniques.”
In Europe, some of that change will likely also be propelled by legal requirements like the Disclosure Regulation, which comes into effect in March 2021 and demonstrates the growing importance of ESG factors in business decisions. It harmonises disclosure requirements for certain types of investments including those that have social or environmental targets.
“I think we’re sort of at the beginning of the journey for education and impact investing,” says David Storm, who heads the multi-asset portfolio strategy at RBC Wealth Management in the British Isles.
“Three, four years ago, no client had heard of ESG. They wouldn’t ask for it unless it was a very specific constraint that people had … ‘I don’t want to invest in tobacco, alcohol.’”
There is much more interest now, according to Storm, who says most clients have some level of exposure to impact investing. He adds that about 30 percent of his clients have expressed a significant interest in ESG, with a three percent subset who are thinking specifically about impact investing. Soon, it will also be a regulatory requirement to include ESGs in all discussions.
There is also a financial argument for impact investing in particular, says Metcalf.
“The need to come up with solutions for climate change, also creates an opportunity to make money,” he adds. As an example, Metcalf points to companies that develop the best batteries, the best solar panels or other renewable energy products: “It’s a good investment as well as a good impact investment, so you are not necessarily sacrificing any returns … those are going to be valuable companies.”
Storm describes many of these companies as strategic forward thinking firms.
“Bluntly, you should see bigger growth in them as a company … you shouldn’t have to give up financial performance at all to create a positive impact in that market,” he says.
But Storm adds there is definitely a spectrum on the quality of financial returns. For investments with a specific and dedicated objective—solutions to stop malnutrition in Africa, for example—the return is less important and investors may be willing to give up some of those returns to increase impact.
Attitudes are clearly changing, yet this kind of responsible investing still remains a tiny fraction of the overall financial market.
That is expected to change in the years ahead, especially considering the impending wealth transfer that will occur, with the more socially and environmentally conscious Millennial and Generation Z inheriting that wealth.
“There’s some credence to that I think, so I suspect over time, impact investing will become more popular,” said Metcalf.
With the growing interest in this space, an important starting point is understanding the different types of investments and terminologies.
A common mistake inexperienced investors in this sector make is conflating impact investing with ESG investing. Broadly speaking, the latter is about using ESG data to inform investment decisions. A high ESG score might result in better financial returns, for example.
Sustainable investing uses that data to help investors make better decisions around asset performance and improve long term results. It does not necessarily take an ethical stance or represent investor values.
Socially responsible investing goes further. As an investor, you are making proactive, investment choices using ESG data that align with your personal, environmental, or social values and beliefs. If you are interested in healthcare, for example, you may decide to invest in funds that include medical companies and avoid those that invest in companies like tobacco.
Impact investing tries to actually tackle social or environmental issues while generating financial returns for investors. It uses empirical data and looks at actual impact data when building an investment portfolio or investing in a project. There is a commitment on the investor’s part to actively manage that investment.
For most people, impact investing means putting money into publicly listed equity companies or public funds. These often focus on environmental impact, since there is greater consensus around climate change, whereas social issues are a more diverse space, Metcalf says. “The environment space is the most vibrant one at the moment.”
For those looking to make more substantial investments, it could mean investing directly into a company that is working on something with wide social or environmental benefits.
“Private might be the equivalent of buying a small company … owning it privately, running it privately,” says Storm, adding that the bar for investors to qualify for private investment is much higher from a regulatory perspective.
You may need to be an expert in your field or prove you have experience or have three or four projects under your belt. In a private market deal, you typically need at least £1 million, with the average amount around closer to £5 million—for one specific opportunity, according to Storm.
As this type of investing becomes more popular, what are some key ways to evaluate their impact?
Storm points to a framework by Impact Management Project (IMP), on impact investing, that he says is a useful guide. IMP is a forum for thousands of investors and enterprises to build a global consensus around how to measure and manage impact.
He describes the framework as the “ABCs” of impact investing: A is avoiding harm, such as regulatory requirements for companies to reduce carbon emissions. B is benefiting stakeholders—investing in something that will have a positive impact on the world while sustaining long-term financial performance. C is contributing solutions. This final one is targeted more at investors with the financial means to look at private equity impact investing.
“So there are different levels of impact,” Storm says. “For us, the starting point, particularly for the way that we’re looking at investing, is really around measuring the impact of the portfolio.”
Impact investors should be sceptical and ask plenty of questions, including how impact is being reported and measured, making sure the claims are reasonable. Scrutinize the details. Be wary of “impact washing”—some companies may portray a product as having more impact then it actually does. Transparency is key. This may mean collaboration with a third party and getting expertise, external verifiability and validation on the data as opposed to relying on a company to come up with their own measures.
For investors, asset managers and organisations looking for ways to evaluate impact, the United Nations’s Sustainable Development Goals (UN SDG) serve as a template for their own investment goals. These include eradicating poverty, hunger, reducing inequalities; ensuring environmental protection and restoration; and building better, more innovative and sustainable cities.
“The majority of major global asset managers have signed up to the United Nations principles of ESG investing,” Storm says.
Despite the small space ESG and impact investing currently occupies within investing, he believes that will quickly change.
“When you’ve got managers like BlackRock and Larry Fink talking about it, it’s coming and it’s going to be pretty rapid. I’d say within the next five years, it’s just a given.”
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*Younger generations include Millennials and Generation X. Older generations are defined as Baby Boomers and those in the Silent Generation
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