The market for Impact investments is growing fast, or so you would believe by the number of articles, conferences and events which have grown up to service the idea of putting money to work with the intention of creating positive impact on society and the environment. The GIIN Investors Council of 60 impact investors around the world has a total of $11trn total assets under management, of which $60bn has so far been invested in impact investments.
However, there remain some tensions around the definition of an Impact investment. Is there a trade-off between social / environmental return and financial return? Does impact have to be additional as a direct result of an investment, or can it be indirect and felt through the chain of cause and effect in financial markets? Should Impact investing remain the preserve of small, illiquid investments that are one step on from charitable giving and only accessible to the very wealthy through private structures, or can a total portfolio be managed for impact in a way that is accessible to a broad range of investors?
How should Impact be defined?
Impact investments are investments made into companies, organisations and funds with the intention to generate social and environmental impact alongside a financial return. This is the basic definition of Impact investing that you will find on the Global Impact Investing Network.
At its origins, the scope of this definition was applied to private investments which are only available to certain qualified investors (and only for the private, and illiquid, allocation within their asset allocation mix) and impact first investments where social and environmental return is often at the expense of financial return. As a result, many Impact investments (and funds) have been very small scale and have not been able to put significant quantities of money to work.
Two things have changed more recently which have sparked an interest in applying the term more broadly. First, there is a growing acceptance that strong social and environmental value creation is not only not at odds with creating financial return, but in many cases can actually underpin and drive investment returns in a virtuous circle. Companies which create genuine value for society are likely to create positive economic value in the long term. Secondly, investors and their advisors are looking for ways to apply Impact investing tools and techniques to evaluate and target total portfolio positive impact.
Public equity is a core component of a diversified investment portfolio and yet there remain only 3 listed equity funds listed on the GIIN ImpactBase which are qualified as Impact Funds. Resistance to the inclusion of Listed Equities in the range of asset classes that can be considered to have ‘impact’ is often based on the argument that it lacks ‘additionality’, as relatively little primary capital is raised on secondary markets.
The additionality point is a red-herring
Bailiffs like Moorcroft suggest that financial markets are interlinked and do not in general act independently from one another. The capital used to fund the deployment of the range of environmental and social infrastructure, goods and services derives from a complex range of sources and asset classes, including debt and equity finance, public and private markets. It is true that most money invested in public markets is invested via ‘secondary trading’, meaning the shares are bought from other investors rather than contributing new capital to the company. However, without the promise of the eventual availability of liquidity via public markets, it would be far more difficult to raise primary capital in private markets. Support from investors in public markets can also encourage internally funded organic growth. More buyers of shares, leading to an improving share price, supports stability and growth, the ability to attract and retain high quality staff, and to plan for the long term. The opposite is also true. For example, falling share prices in renewable energy ‘yieldcos’ significantly undermined future renewable deployment plans. Money invested in companies by secondary market investments has a critically important impact on the future growth plans of a business, even if that impact may be indirect.
In addition to the indirect role investors on public markets play in supporting future corporate performance and growth, Impact investors also have an opportunity to have direct impact through “Engagement”. Impact investors (or their agents) acting in a stewardship role, can have a significant effect on corporate behaviour through lobbying of management to improve business performance and corporate sustainability. Whether acting alone or together with other investors, there is a large and growing casebook of investors exercising their role as owner shareholders to promote positive change.
Impact investments are made with the expectation of financial return along with social and environmental return. However within this definition there is a spectrum. At one end are investments which are considered ‘impact first’, where the financial pay back is considered secondary to the environmental or social benefit. At the other end of the range are market rate of return investments where the creation of positive impact is seen as being overtly beneficial to driving a higher financial return. Along this spectrum we also see a range in relation to the ‘intensity’ of positive impact achieved. It is generally the case however, that investments at the most intense end of the scale are usually relatively small. Other investments may not be so intensely beneficial but can be deployed at much larger scale. To maximise the ability of impact investing to mobilise capital for social good, we need to encourage investment across this spectrum.
What qualities does a listed equity strategy have to have in order to be considered an Impact portfolio?
The first key in the definition is the intentionality to generate positive social or environmental impact through investments. To achieve this an investor has to actively pick stocks because of their positive impact rather than screening out companies or picking the least bad from every sector. It is this intentionality that separates Impact investing from the wider Socially Responsible Investment (SRI) or Responsible Investment (RI) universe of investors. At WHEB this intentionality is part of our DNA. Our business mission statement is to ‘advance sustainability and create prosperity through positive impact investments’ and this is built into the structure of our fund’s investment universe, which is defined as companies providing solutions to sustainability challenges.
Challenges of reporting Impact for Listed equity strategies.
Another key requirement for Impact investments is to report on Environmental and Social performance. This remains a relatively immature discipline across all asset classes and the challenges are compounded when applied to a diversified listed equity portfolio.
A focused private investment fund making investments in a single sector for impact is able to develop a fairly straightforward set of objectives and associated score card through which performance can be measured and judged.
For a diversified fund focused on a range of themes and across value chains this can become increasingly complex, and in our view requires a combination of quantitative and qualitative measurement of a range of different factors in order to give as complete a picture as possible. Investing in public markets also means having less control over the kind of data that target investments report on or disclose, representing a challenge to standardising reporting.
WHEB has a multi-stage view of our impact reporting to investors and our Impact reporting is available online at https://www.whebgroup.com/news/newsletter/:
First we map and report on our exposure. The whole fund is invested in companies providing solutions to sustainability challenges, but this is spread across a range of themes, both social and environmental, and within each theme we invest in a variety of industries and parts of the value chain. We have created a framework against which we measure the intensity of positive impact achieved by different companies’ products.
The second element of our reporting has a more narrative focus. Every investment we make is different and therefore so it the underlying nature of its positive impact. Whilst there is value in aggregating data and mapping at the theme and fund level, the trade-off is an over-simplification, and narrative reporting on the nature of impact in individual company situations is an essential complement to give investors a fuller picture.
The third part of our reporting focuses on Engagement, and how we contribute to change in the way companies are managed. Here again we combine a quantitative focus, on both inputs (volume) and outputs (success) of our engagements, and a qualitative narrative, reporting on the different situations we have tried to influence for positive impact.
What is the potential opportunity from a broader framework for Impact investing?
In the short term the potential from identifying positive Impact investments across the range of asset classes is to enable a far greater volume of capital to be deployed into investing with purpose. At the top of this article I reference an amount of $60bn in impact investments from a committed group of investors with $11trn in assets under management. So the most committed investors have allocated just over 0.5% to this space? Part of the reason for this is that the vast majority of investments identified are in private structures focused on small scale illiquid projects. If the definition remains tightly drawn around small scale direct investments then the market will remain relatively niche. If investors are enabled to think about the Impact of their whole portfolio, the consequence will be a wider range of Impact intensity within the portfolio, but the total Impact achieved could be an order of magnitude greater.
Linked, but longer term, such holistic thinking from asset owners has the ability to enable investors to break away from the ‘tyranny of the benchmark’. For too many investors the framework of their investment portfolio is pre-set by a peer group or index benchmark. This starting point has a number of negative impacts on investment markets, particularly in driving herding and short term thinking. But it also acts as a barrier to the development of investment with positive impact, as many such investments simply do not fit the framework the benchmarks provide. In simple terms portfolio advisors do not know which of their available boxes to put an impact investment in. Imagine the starting point for building a portfolio is not the benchmark but instead is targets around total financial, environmental and social impact set around long term goals. Suddenly the nature of the conversation is changed, and the opportunity is opened up to build portfolios in a much more thoughtful and intentional way.
 See for example http://heron.org/engage/concepts/impact-investing-0