Attitudes are changing fast when it comes to the environment. Impact investing can no longer be ignored by advisers as clients’ objectives are increasingly recognising the inevitable move towards sustainability. Ben Constable-Maxwell, Head of Sustainable and Impact Investing at M&G highlights why impact investing is set to become mainstream in the very near future
The world is facing a rising tide of societal challenges, from the potential chaos associated with the breakdown of our climate, to ludicrous levels of waste and pollution, to vast and growing social inequality. Governments around the world lack the resources needed to deal with these challenges on their own, and hence responsibility is increasingly falling to the private sector, and investors, to help do something about them. Impact investing, specifically, is starting to drive the flow of much-needed capital towards solutions to the critical social and environmental challenges we are facing, but there is much more to be done.
Impact in brief
Impact means investing in companies that aim to deliver meaningful societal outcomes by addressing the world’s major social and environmental challenges, while at the same time producing a financial return. These investments can be made in both emerging and developed markets and target a wide range of impact areas, which can include climate solutions, accessible healthcare, the circular economy and quality education, among others. These impact investment areas are increasingly being mapped to the United Nations Sustainable Development Goals (SDGs), which provide a framework against which impact can be assessed and measured.
Why is impact necessary?
Recent campaigns, including the activities of Extinction Rebellion and the school strikes initiated by Greta Thunberg, have helped to highlight some of the real and present challenges the world is facing. With 20 of the past 22 years having been the hottest since records began, the world’s leading climate scientists warned last October that we only had a dozen years left to keep global warming to a maximum of 1.5C. The report, from the UN Intergovernmental Panel on Climate Change, said that beyond this, even half a degree would significantly worsen the risks of drought, floods, extreme heat and poverty for hundreds of millions of people.
It is not only the challenges associated with climate change we are facing though. The world generates two billion tonnes of waste annually, and by 2050 it is estimated that if we carry on as we are, there will be more plastic in the oceans than fish (by weight).
Social factors, including education, employment status, income level, gender and ethnicity, have a marked influence on how healthy a person is, with health inequities having a significant financial cost to societies, according to the WHO. As an example, the European Parliament estimates that losses linked to health inequities cost around 1.4% of gross domestic product (GDP) within the European Union — a figure almost as high as the EU’s defence spending (1.6% of GDP). Meanwhile, last year the World Bank said that more than 260 million children worldwide were out of school, while more than half of those actually in education were not learning. The list goes on.
It was to tackle these kinds of societal challenges that the aforementioned SDGs were introduced in 2015. These represent a universal call to action to end poverty, protect the planet and ensure that all people enjoy peace and prosperity – with a timeframe that runs to 2030.
The 17 Goals (with 169 key performance indicators or sub-goals) build on the Millennium Development Goals, while including new areas such as climate change, economic inequality, innovation and sustainable consumption among other priorities. The SDGs also provide a framework for delivering sustainable outcomes, and are increasingly being adopted by both investors and companies as a means of framing their sustainable, or impact, activities. It is also possible to create specific impact targets focused on key investible impact areas, which can also be mapped against the SDGs. This provides a robust investment and measurement framework, and helps impact investors to stay focused on the most pressing issues facing society and the planet we live on.
To meet these goals, it has been estimated that some US$6 trillion a year will need to be spent, but government alone cannot foot this bill – in fact, we are looking at a funding gap assessed to be in the region of some US$2.5 trillion. This is why investment capital is vital, and part of the reason why so much focus is being put on impact investment.
Challenges and opportunities
The challenges represented by the SDGs are huge, but so too are the associated opportunities, and the potential rewards.
A report by the Business & Sustainable Development Commission found that achieving the SDGs in just four economic areas could open 60 market ‘hot spots’ worth an estimated US$12 trillion by 2030 in business savings and revenue. The report highlighted that, for example, achieving the single goal of gender equality could contribute up to US$28 trillion to global GDP by 2025, according to one estimate by the McKinsey Global Institute. The overall prize, it said, was enormous, and impact investors are at the vanguard of capitalising on these opportunities.
Looking closer at impact
Historically, impact investing consisted primarily of private finance to fund specific, impactful projects. Because of this, it sat chiefly within the sphere of institutional or high net worth investors, with little access for the general public and more limited capital available. But that is not to say the demand isn’t there.
Impact investment has become one of the fastest-growing areas of responsible investment (albeit from a low base), attracting interest from a wider set of investors than seen previously. In 2018 the Global Impact Investing Network (GIIN) survey found respondents collectively managed over US$228 billion in impact investing assets – up from US$114 billion reported in the 2016 survey.
A portion of this growth is driven by the emergence of listed equity funds with impact remits. These can provide liquid, open-ended investment vehicles, which allow for the ‘democratisation’ of impact, giving a stake in the game to ordinary people who want their investments to make a difference, or who realise the vast opportunities offered by investing for the good of society.
Different to ethical or ESG
Impact investing is fundamentally different from traditional ethical investing or environmental, social and governance (ESG) investing – even if the difference may seem subtle on the surface.
Ethical investing has been with us for decades, and some would say longer. It had its origins in the Quaker movement and was originally a matter of negative screening, put in place to match the values of individuals or the public institutions and foundations representing them. ESG investing takes a broader approach and incorporates environmental, social and governance considerations alongside – or within – financial analysis. It looks to integrate issues such as shareholder rights, stakeholder considerations and reputational risk into the investment framework. Often, these strategies still have some basic exclusions but the focus is on identifying the ‘extra-financial’ risks and opportunities a company is facing within the more traditional financial analysis.
Impact funds in the listed equities space, meanwhile, need to invest in companies that have the explicit intention of addressing a range of societal and environmental issues the world is facing, again, increasingly framed by the SDGs. Along those lines, there are several areas that impact investors have to consider, beyond the financial investment case for a business.
One element that investors need to consider is the idea of ‘intentionality’. This is when a company specifically sets out to deliver a particular impact, with that goal being part of the company’s mission statement, strategy and actual day-to-day operations (inadvertent impact doesn’t count). There is also intentionality from the investor’s viewpoint; that is, the intention to generate positive social or environmental impact through an investment. To achieve this, investors must actively pick stocks because of their positive impact, rather than screening out companies or picking the least bad from each sector.
In traditional impact investing, the ‘additionality’ of the investment is also considered — identifying and reporting the resultant impact of every pound, euro or dollar invested in a project. For example, a specific amount invested allowed a company to build social housing for 10,000 people, which otherwise would not have been built. This is the additionality of the investment. As listed equity impact funds are generally dealing in secondary markets, and the directing of that funding is often not possible, additionality is considered in other ways, generally focused on understanding the additionality of the company. To do that, we might ask how the world would be different if that particular company did not exist or if it were not adequately funded, or how replicable its products or services are.
Another key differentiator between impact and other forms of responsible investment is ‘measurability’. This is one of the central tenets of impact investing, and also one of its most challenging aspects, especially so for investors in public equity markets where measurement can be less clear. Quality of data and measurability of intangibles are key challenges here, but they need to be overcome for public market impact investors to be effective.
Given the scale of the challenges the world is facing today, we need to invest now to help protect the future of the planet and our place in it. Impact investment should increasingly help drive solutions, and can do so while delivering attractive investment returns to investors.
Ben Constable-Maxwell is Head of Sustainable and Impact Investing at M&G
Ben joined M&G in 2003 as an Investment Specialist in the Global Equities team. He is a founding member of M&G’s Responsible Investment Advisory Forum and has been central to the development of ESG at M&G, leading on sustainability issues for M&G and supporting the development of ESG client solutions.