Impact investing: What is your money really funding?

Data from the Global Sustainable Investment Alliance gathered in 2019 shows that the amounts invested in sustainable finance have more than doubled in past seven years, to over US$30tn (with the vast majority of investors coming from Europe and the US). 

Popular wisdom holds that this trend is being driven by socially conscious millennials seeking more than just fiscal returns with their investments and pension pots.

And while that is undoubtedly true, there are several other factors which have arisen, since 2015 in particular, that have only added to the desire of investors to look, in detail, at what their investments are funding. 

UN goals

After all, 2015 was the year that the United Nations General Assembly set out its 17 Sustainable Development Goals (SDGs).

The SDGs have since been universally adopted as aspirational standards not only by governments (for which they were designed) but also by the impact investment community.

The danger of over-reliance on labels is very reminiscent of the trust placed on credit ratings prior to the last credit crisis.

That, combined with the ever worsening and visible effects of climate change, has further added to the desire for investments to have a positive ‘impact’ as well as a monetary return. 

Impact investing is here to stay and the past perception that, in order to have a positive social or environmental outcome, an investor must sacrifice financial performance has also been challenged by the current pandemic.

Recent well-publicised reports, stated that many funds with an explicit ESG or sustainability focus have been able to produce better results than their sector average and benchmarks in both the UK All Companies and Global sector.

Performance record

That produced great headlines but dig a little deeper and some have argued that this can be largely attributed to a single factor – an extremely low exposure to energy companies and a commodities sector that has suffered so much in the first half of 2020.

As with so many financial instruments, it is important to understand what is happening behind the headline or label.

Indeed, the fact that the sector has been expanding so rapidly has raised concerns from seasoned players that new entrants seeking to pile into the sector are engaging in “impact-washing”.

This derivative of the more established term “green-washing” describes the PR ‘spin’ which seeks to persuade a naive investor that a particular investment is in fact delivering some ‘good’ alongside its financial returns, when, upon closer inspection, that is not the case, at least in any meaningful sense.

This has become more of a danger as investments have moved away from the traditional world of private equity investing in developing countries and into mainstream financial markets.

Impact investing is here to stay.

Consider, for instance, the following pension funds labels and what is actually included among their top 10 holdings.

A fund labelled ‘ESG emerging markets’ is filled with sovereign debt issuances of Latin American, Middle Eastern and East European countries; another with ‘ESG’ in the title includes issuances by UK airports, telecoms groups and supermarkets; and one labelled ‘social’ invests in large UK banking groups and water companies.

All of the companies and countries invested in by such pension funds may have great ESG credentials but that is not immediately apparent from the information available to investors.

It may also be the case that an investor buying into these funds on the basis of the name alone would not necessarily associate investments in large established corporates and banks as ‘impact’ or ‘ESG’ investments.

It is not what naturally springs to mind and there is a difference between the investment itself having a positive impact and the company being invested in having a positive impact in a general sense. 

The problem is exacerbated by the fact that the terms used within the ESG world have vague, ill-defined meanings.

That is not to say that is necessarily possible, or indeed desirable, to have a single ESG label for any particular instrument or company, given the plethora of ESG-related financial instruments available, the broad scope of the SDGs and the universe of areas of impact.

Data

What is in demand is more data.

The latest research from Peregrine Communications shows that there is “significantly more demand for content around the topics of measurement and materiality, supply chain transparency, active ownership and product-specific content than is currently being provided by the market”.

More standardisation is likely to come with time and more entrants are seeking to provide data and analysis in this area.

In June, The European Bank for Reconstruction and Development and Warsaw Stock Exchange partnered to support Polish and CEE listed companies in their ESG reporting and in July, both HSBC and Refinitiv launched ESG portfolio reporting services for investors.

Is more regulation in this area the answer?

Unsurprisingly, given the location of many ESG investors, the EU is leading the way recently - particularly in relation to the ‘E’ limb as part of the European Green Deal - with the disclosure requirements in the EU’s ‘Regulation on Sustainability‐related Disclosures in the Financial Services Sector’ coming into force next year and the recent Taxonomy Regulation on disclosures of ‘environmentally sustainable’ economic activity.

More standardisation is likely to come with time and more entrants are seeking to provide data and analysis in this area.

In the bond markets, the International Capital Markets Association has established a number of principles relating to green, social, sustainability and sustainability-linked principles which are being widely adopted by investors.

The market is clearly still evolving, and it is still too easy to rely on names or ratings without understanding what they really mean.

The danger of over-reliance on labels is very reminiscent of the trust placed on credit ratings prior to the last credit crisis.

In the impact investment space, as in many parts of life, let the buyer beware but also let him be informed.

Andrzej Janiszewski is a counsel at Reed Smith