Commentary: How and why we allocate to impact
A pioneer in impact investing explains its approach
The financial crisis and its aftermath exposed a sector that had lost its way, first parting from and then hurting the real economy. Hence the financial sector, including pension funds, has to re-establish its social utility and regain trust. At its most basic level that is what PFZW – the €200bn pension fund for the healthcare and welfare sector in the Netherlands – and PGGM, its in-house asset manager, are trying to do: reconnect our investments to real world economic, social and environmental needs and aspirations.
Our vision is that in five to ten years it will be standard practice to characterise all our investments not just by their financials but also by their effects on society in terms of jobs generated, carbon emissions avoided or lives improved. That only seems far fetched until one realises that that is exactly how investment started: by specifically supporting desirable economic activity.
PFZW has long sought to minimise the negative effects of its investments through exclusions and active ownership (engagement and voting) by PGGM. In 2014 PFZW overhauled its investment policy and decided that in addition to ‘less bad’ it also wanted to do ‘more good’. Even before the United Nations launched the Sustainable Development Goals (SDGs), PFZW had already selected its four priority areas for investment in its solutions programme: climate and pollution, water, food and health (these roughly map to SDGs 2, 3, 6, 7 and 12).
To this point we have consciously avoided the word ‘impact’ as it tends to lead to some misunderstanding. Whereas impact investment is often understood as directly addressing underserved needs, pension funds are constrained in this regard. They are fiduciaries and have as their prime responsibility the payment of pensions that their beneficiaries expect. Pension fund managers simply are not allowed to trade financial returns for social or environmental impact. That means that for PFZW a great social need does not necessarily make a good investment opportunity.
If this sounds harsh, we believe that the SDGs need investments that can ‘scale’ – meaning that they must be financially sustainable too, at least in the long run. PFZW and other providers of patient capital have a role to play in making such investments. Indeed, market-rate financial returns and positive social or environmental impact can and sometimes do coincide. Seeking out these opportunities, PFZW is backed by the vast majority of its beneficiaries, according to our surveys.
Within its fiduciary constraints, PFZW aims to have €20bn of investments in solutions to climate, water, food and health challenges by 2020. To date we have €12.4bn, of which one-third is in primary, illiquid markets (mainly private equity, infrastructure, real estate, real assets) and two-thirds in secondary, liquid markets (mainly listed equities and bonds). Recent examples of the former are direct investments in rail infrastructure, public transport and solar power. On the liquid markets we invested in companies such as Vestas, Unilever and Novo Nordisk, and green bonds issued by, for example, KfW (the German development bank) and the government of France.
In primary markets, capital provided by PFZW can be decisive in making specific investments happen. In such cases, certain companies, projects or activities might not have advanced without PFZW’s allocation – although, with the current abundance of capital, claims of ‘additionality’ are dubious even in private markets. In secondary markets, there is no additionality as a mere change of ownership of a security does not translate into change on the ground.
In order to achieve its €20bn target PFZW fires on all cylinders. We align ourselves with the impact created by companies and bond issuers in secondary markets, and generate real impact through our investments in primary markets. In listed equities we have issued a separate, actively managed €2.5bn mandate with an investment universe of 350 impactful companies. Their impact is being quantified and assigned to PFZW in proportion to the share of total equity we hold.
Green bonds, private equity, infrastructure and other direct investments in solutions are evaluated as any other investment, without concessions to return expectations or other financial requirements. The only difference is that investment teams are looking harder into investment opportunities that substantially contribute to PFZW’s priority areas: climate, water, food and health.
Obviously, there is more real impact in primary markets, yet the bulk of our investment in solutions are purchased in the secondary market of listed equities. Here we merely align with the priority areas and corresponding SDGs. At times derided, that is nothing to sniff at. First, we signal to the market our preference for companies with a substantial, positive impact on the SDGs. Second, we build the necessary expertise, experience and confidence for investing in important megatrends. Thus impact alignment may actually serve as an on-ramp for more direct impact investments.
Most importantly, PFZW insists that impact alignment requires impact measurement by the companies, funds and projects in which we invest. This allows us to communicate our social utility in tangible terms to our beneficiaries and stakeholders. Impact measurement is also essential to counter the danger of greenwashing – ‘SDG washing’ – that lurks behind a simple labelling of existing allocations as contributing to one SDG or another.
This is why PFZW, PGGM and various partners are working to establish impact indicators and a methodology that is fit for purpose for institutional investors in particular, in other words, that is both credible as well as practical. PGGM and external investment teams are conducting engagements with companies and funds on the measurement of tangible impacts. This lies at the heart of the old-fashioned yet newfangled idea that companies can be expected to articulate and quantify their contribution to the common good. This, we believe, also cuts through the debates around ‘intentionality’ and ‘additionality’.
Still, impact measurement is not easy and will take time. There are excellent frameworks such as the one developed by The Impact Management Project to guide investors to distinguish between the impact by the investee and the contribution of the investor, and to be increasingly demanding with regard to the various dimensions of impact – what, how much, who, and so on.
While PFZW gradually improves its account of the positive, tangible impact of our investments, our prime objective of generating market-rate financial returns means that we cannot also manage for maximum impact – even if data availability and quality would allow us to do so, which they do not. In the current PFZW campaign ‘The capacity to make a better world’ we also try to convey a realistic message that we contribute to but can hardly guarantee a ‘better world’.
Back to why
Finally, back to PFZW’s motivation behind all this. PFZW wants to be prepared for the investment opportunities in the priority areas we identified and mapped to the SDGs. The SDGs reflect the megatrends that are shaping the world’s future, and indeed the future of our investments. Our beneficiaries want to save for pensions with a purpose, and that’s exactly what PFZW aspires to be known for. Besides, we find that investing with impact attracts and motivates investment talent. It inspires innovation and keeps us on our toes.
Peter Borgdorff, is managing director of Pensioenfonds Zorg en Welzijn (PFZW), the Dutch pension fund for the care sector. Piet Klop is senior adviser, responsible investment, at PGGM, PFZW’s asset manager