Institutional investors looking at impact strategies should take a holistic view of their portfolio, argues Jane Ambachtsheer
At a glance
• Impact investments include both at- and below-market return opportunities.
• There is a strong growth in investors considering how to ‘do good’ versus ‘avoid harm’ through screening.
• The UN Sustainable Development Goals (SDGs) and Paris Agreement set out a sensible global framework for considering an investor’s impact on the world.
• Investors should consider their total fund approach, rather than limit their focus to a small portion of their portfolio.
The term impact investment has gained prominence over the past few years. It is most often used to describe a set of investments that create intentional and measurable positive impacts, for which investors may, but not always, accept a below-market rate of return. This traditional definition of impact investment includes financial instruments in both developed and emerging economies, such as social bonds or investments in microfinance institutions, and would typically represent a small portion of an investor’s asset allocation – most often within the endowment, foundation and high net worth market segments.
Yet – as with many questions of terminology regarding sustainable investment concepts – such definitions are blurry. The spectrum between ‘sustainability themed’ investments, which seek to achieve attractive risk-adjusted returns through investing in high-growth, innovative companies providing solutions to social and environmental challenges, and ‘impact investments’, which seek to create positive social and/or environmental outcomes, can be wide or narrow, depending on the investor. For some, the concepts are the same.
A number of years ago, I wrote a paper1 which discusses the fact that global codes and conventions – such as the Universal Declaration on Human Rights – generally do not articulate their relevance to, or expectations from, investors. This is evolving. For example, the Paris Climate Agreement was achieved in part because of active involvement by ‘non-party stakeholders’ such as investors, cities and companies, many of whom – including Mercer – have now committed to the Paris Pledge for Action2 . However, exactly how investors should interpret investment risks and opportunities (let alone obligations) relating to the Paris Agreement is still unclear to many.
The UN Sustainable Development Goals (SDGs), launched in 2016, were also developed with active input from ‘non-party stakeholders’. The SDGs are globally applicable and aim to “end all forms of poverty, fight inequalities and tackle climate change” over the next 15 years. They provide a good framework for investors to utilise when considering how their investments do – or don’t – generate positive social, environmental and governance impacts, and to measure these accordingly. Numerous research firms, asset managers, asset owners and civil society groups have begun to focus on how investors can utilise the SDGs as a way to frame their investing activity.
Investors who want to contribute to the achievement of the SDGs are likely to want to measure their impact. This is not always easy, however. Standardisation of metrics, measurement approaches and methodology is a key issue to address. For example, providing accurate and comparable data on clean energy generation is relatively simple. Measuring poverty reduction is more complex. Mercer has found challenges with this issue in considering the impact of investments made within our sustainability themed private markets strategies. In particular, we have found large inconsistencies with the impact reporting quality and depth across investment managers. This makes the current aggregation of ‘impact’ across a portfolio challenging.
Efforts are underway to develop and align impact reporting with the aim of establishing a standardised approach. For example, the Impact Management Project is taking a top-down approach, focusing on bringing together stakeholders to establish a set of impact expectations before eventually defining common frameworks and approaches3 .
In the Netherlands, Dutch financial institutions have launched a platform for SDG Investing and are working to identify a small number of consistent financial metrics alongside each SDG. Others, such as the Global Impact Investing Rating System (GIIRS) are focusing on developing the methodologies and tools to quantitatively assess investment impact4 .
Developments in both top-down and bottom-up thinking are required. Mercer believes that impact reporting should be developed collaboratively, and should operate more like an international accounting standard – in other words, universally across all users. We have one set of SDGs and we should have one impact reporting framework alongside it. This approach will drive consistency in reporting for managers, which means they will be more likely to provide the information. It will drive comparability across investment strategies, which will make the lives of asset owners easier. It will also drive ease of comprehension by users, and allow for clearer tracking of how the financial sector is (or is not) contributing to a future aligned with the Paris Agreement and the Sustainable Development Goals.
In the 19th century, Quakers began to avoid investments in sectors – such as alcohol and tobacco – which violated their values. The practice of negative screening is still widely employed, although approaches and issues avoided vary widely by country and type of organisation.
Impact investing takes the opposite approach, and reflects a growing interesting in actively ‘doing good’ with investment portfolios, and measuring the results. This is part of a growing trend. A recent report5 found that a number of European asset management firms are beginning to focus on evaluating and improving the social and environmental impacts of their investments and stewardship activities. While only two of the surveyed firms could disclose detailed information, around half could provide at least some basic information about tools and metrics they use.
In Mercer’s 2015 Investing in a Time of Climate Change report, we introduced the concept of ‘future takers’ and ‘future makers’ to distinguish between investors who may consider climate change in the investment context versus those who will contribute (both directly and indirectly) to the future degree of global climate action.
The world has seen a growing number of investors behaving as future makers on climate, through investment commitments to renewable energy deployment and energy efficiency technologies; the adoption of carbon footprinting and other portfolio climate risk management techniques; the filing of and support for climate related shareholder resolutions; and engagement with policy makers and the G20 calling for policy action in line with the Paris Agreement.
Whilst reduced uncertainty around climate change will benefit investors and is a driver for the above mentioned activities, there is a growing body of evidence suggesting that improved diversity and reduced inequalities will also benefit global society and capital markets. There is therefore a ‘future maker’ argument for investors to be active around a broad set of societal challenges.
The truth is that all investment has impact. As investors move towards a more intentional approach with some of their assets, it makes sense to also consider the impact (positive or otherwise) created across the portfolio. A number of asset managers in the listed equity space, as well as ESG research providers, have developed, or are in the process of developing investment strategies and research platforms along these lines.
When considering if and how they adopt the growing trend towards impact investment, we encourage investors to discuss the following questions:
• Have you developed beliefs about how ESG factors can influence investment risk and return, and evolved your investment processes and portfolio appropriately?
• If you haven’t, you should.
• In addition, have you considered how your actions and investments influence ESG outcomes and if you would like to be more intentional?
• The answer here is less likely to be yes. This will change, as investors begin to take more action, inspired by financial and non-financial reasons. This year is a good time to put it on the agenda.
Jane Ambachtsheer is partner and chair, responsible investment, at Mercer
Special Report: Investing for Impact
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