InvestmentsOct 31 2018

A closer look at impact investing

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A closer look at impact investing

It is an investment approach that aims to make a positive contribution to society or the environment, alongside an attractive financial return.

In that time, impact investing funds have amassed more than $228bn (£176bn) under management, according to the Global Impact Investing Network.

For the UK impact investing market, which is seen as one of the most vibrant in the world, it feels that we are at a point in time where the fundamentals are changing, and impact investing is moving from a specialist strategy to a fully fledged investment style.

Building an impact-focused investment portfolio

While ESG investing has been gaining in popularity, it has its limitations. This approach typically selects companies whose operations across environmental, social and governance matters is better than industry peers, irrespective of the impact of its product or services.

As an aside, it is worth checking your so-called ‘ethical’ or ‘sustainable’ portfolios for exposure to sectors such as fossil fuels, arms and tobacco. 

Key Points

  • Impact investing makes a positive contribution to society
  • Better data is available to understand impact
  • Companies held by positive impact portfolios are growing faster than FTSE100

Impact investing goes a step further by identifying companies whose products and services are helping to tackle various social and environmental problems, naturally avoiding companies with harmful core activities.

Measuring impact

The most prominent feature of impact investing is its focus on measuring the social and environmental return that it generates. However, evaluating the impact of the products and services produced or provided by these companies has proved to be quite challenging.

Thankfully, impact reporting has taken a huge step forward in the past couple of years, with better quality data and shared insight. The likes of Impax, WHEB and Threadneedle have been leading the way with their own impact reports.

The important thing is to show how every investor can make a positive impact through how they invest their money. Key to this is presenting the social and environmental results generated by the investments they make, and we at EQ Investors share these findings in our annual impact report.

Sustainable development

Following on from last year’s inaugural report, we have once again adopted the UN Sustainable Development Goals as a framework for identifying and reporting on the impact achieved. 

The SDGs are a collection of 17 global goals set by the United Nations Development Programme and shine a spotlight on some of the world’s biggest challenges.

The SDGs cover social and economic development issues, including poverty, hunger, health, education, global warming, gender equality, water, sanitation, energy, urbanisation, environment and social justice.

The United Nations estimates that achieving the SDGs by 2030 will cost between $5tn (£3.8tn) and $7tn (£5.4tn), with an investment gap in developing countries of about $2.5tn (£1.9tn). Impact investing is one approach that will help fill the gap. The goals represent a huge opportunity for forward-looking and innovative companies – just the type we want to capture within the portfolios.

Long-term returns

Claims that you have to surrender returns in impact investing are flawed; in fact we see evidence to the contrary. Rather than hinder, companies making a positive impact should be good for investor returns.

Whether you look at revenues or profits, companies held by some positive impact portfolios are growing significantly faster than the FTSE 100 companies. 

Over the past five years, companies in our adventurous portfolio have, on average, grown their revenues by 60.4 per cent (annualised at 9.9 per cent a year).

Meanwhile revenues for companies in the FTSE 100 Index have, on average, only increased by 10.3 per cent (annualised at 2.0 per cent a year). Moreover, research and development spend by companies within the portfolios has led to employment-led growth.

New opportunities

Growing demand has led to a flurry of new fund launches since the start of the year. One such funds is the Hermes Impact Opportunities Strategy launched in February and managed by Tim Crockford. It has a target of 500bps on a rolling five-year basis and is indexed against the MSCI World Index. 

There is also an exciting new investment trust due to launch this month. The Global Sustainability Investment Trust is targeting high-impact opportunities within less liquid asset classes such as private equity or micro-finance. Having been involved in the design of this vehicle over the past year, it is exciting to see new launches like this come to market. The trust will invest across a range of areas that are able to deliver the SDGs.

Next steps

It is clear that there is strong investor demand for impact investing. Looking ahead, as impact reporting continues to improve, it raises the prospect of a broader group of investors being brought in to the sector, attracted by greater clarity on how better social and environmental outcomes for society are fulfilled by their investment actions.

Damien Lardoux is portfolio manager at EQ Investors

 

Q&A

What is impact investing?

Impact investing is an exciting and rapidly growing industry powered by investors who are determined to generate a social and environmental impact as well as financial returns.

How does it differ from ESG investing?

An ESG framework is a valuable tool that can be used to evaluate how certain behaviours negatively affect a company’s performance, and subsequently drive investing decisions. Most fund managers have now integrated ESG into their mainstream investment process.

Impact Investing takes an active approach to generating positive impact by investing in companies whose products and services integrate positive impact creation rather than just negative impact avoidance. Impact investing also adds another element: the ability to measure the positive effect of the investment.

How big is the market?

According to this year’s annual member survey from the Global Impact Investing Network, respondents collectively manage over $228bn (£176bn) in impact-investing assets, a figure which serves as the latest best-available ‘floor’ for the size of the impact investing market. In 2017, this figure stood at $114bn (£68bn).

Do investors have to sacrifice returns to make an impact?

It is a common misconception that investors have to give up financial returns to make a positive impact. A benchmark study published by Cambridge Associates found that impact investing can capitalise on long-term social or environmental trends to compete with, and at times outperform, traditional asset class strategies.

Indeed, impact investing favours those companies that are trying to do good and run their businesses in a sustainable manner. 

Such companies avoid fines and other penalties; they are often considered to have stronger relationships with their customers, suppliers and employees. 

Furthermore, they tend to operate in emerging sectors with high-growth potential.