The fanfare that meets laudable global initiatives such as the Paris Agreement on Climate Change, or the United Nation’s Sustainable Development Goals (SDGs) is not always met by action, despite investor interest building.
But no matter how much meeting initiatives such as the SDG is promoted, it requires a lot of work when creating portfolios.
Meeting the requirements of such agreements means taking impact investing to the next level and primarily by being able to measure contributions made by companies towards the SDGs, but without losing sight of generating returns.
At the heart of all this is ensuring environmental, social and governance (ESG) factors are financially material, to the company, country or security. This is not about charity or philanthropy, but about using investments to make a difference.
The definition of impact investing is investments made in companies, organisations and funds, with the intention of generating a social and environmental impact alongside a financial return, and there are three key elements to it.
First, it should display ‘intentionality’ – the investment should intend to create a positive social and/or environmental impact, which in the case of the SDGs means directly contributing to the attainment of one or more of them.
Second, the investment is still expected to generate a financial return. Third, the intended and non-intended impacts need to be measured and reported on, which requires specific metrics to be applied, especially when funds are constructed with the SDGs in mind.
Before investing, investors must check the fund’s intended impact and expected risk and returns are clearly defined. Based on this, measures for impact can be monitored. It is very clear when investing in a clean tech fund or a microfinance solution, for example, that this kind of investment directly contributes to sustainable development.
It becomes less clear, however, when investing in large companies with multiple products and a global footprint.
- An impact or ESG investment must have a financial return and its positive impact quantifiable.
- ESG integration can have benefits in both equity and fixed income investing.
- One of the biggest challenges is getting all signatories of the UN SDG to take the matter more seriously.
Three steps to fund building
Making a tangible impact on the SDGs fundamentally means picking the right securities to begin with. Fund managers must find out what a company produces, and whether this contributes positively or negatively to the SDGs.
Positive contributions include companies making medicines, assisting with clean water supplies, or improving healthcare. Negative examples would be those involved in shale gas or high carbon-intensive utilities.
Second, they need to analyse how a company produces its goods or services. This could include looking at its previous business conduct, labour relations records and any red flags for human rights. Checks should also be made for any known controversies, including surrounding pollution episodes, bribery allegations or mis-selling, and then be given ratings accordingly.
Finally, impact investing does not stop with investment. Another way of helping to meet the SDGs is through engagement – talking directly to companies to get them to improve their contribution to sustainable development. It goes without saying that engagement only works when a structural dialogue is put in place and progress is measured.