Listed Equity: A public role
New indices and ETFs apply impact investment to liquid equities. But corporate reporting and investor focus are central, according to Liam Kennedy
At a glance
• Last year saw the launch of two global equity impact indices and several ETFs.
• Investors and managers are seeking to apply impact investing to public equity strategies and some are developing their own frameworks.
• Companies like DSM have integrated impact goals and metrics into their reporting.
Growing focus on impact investing is encouraging a few large institutional investors to think about how to expand the approach to listed assets. But can impact investing in public equity markets strike out in its own right without becoming yet another product fad for asset managers or a niche offshoot of ‘mainstream’ ESG investing?
According to one large institutional investor, PGGM, impact investing can be credibly applied to liquid asset classes: what counts is the impact, not the financing method, as long as portfolio companies are selected carefully and impact is established and measured credibly.
Mainstream asset managers see impact investing in listed asset classes like equities as a key driver of future asset growth, not least from a soon-to-be affluent cohort of millennials, for whom social and environmental values are commonly thought to drive consumption behaviour.
Yet although the US-focused Domini Impact Equity fund, based on proprietary impact metrics and sub-advised by Wellington Management, has been around since 1991, mainstream interest in listed equity impact strategies is much more recent.
Last year saw the launch of two indices, the MSCI ACWI Sustainable Impact index and the Stoxx Global ESG Impact index. These two products, based on distinct methodologies, mark a watershed for impact investing as it develops away from being a specialist private market activity with endowments and family offices as the main actors.
And this April marked the first anniversary of BlackRock’s iShares impact investing ETF, which replicates the MSCI index. It is one of 18 clean, green and impact ETFs and ETPs, according to ETFGI, the London-based ETF advisory firm, and was followed in June 2016 by the launch of the FlexShares Stoxx Global ESG Impact ETF based on the Stoxx index of the same name.
FTSE Russell’s group head of sustainable business, David Harris, says the firm’s Environmental Market indices can also be classified as impact indices as they include companies providing tools and products to enable a transition to a green economy. This serves to underline the fluidity of terminology in the emerging sphere of impact investing; indeed, of the 18 ETFs and ETPs on ETFGI’s database, the vast majority are clean energy strategies.
MSCI’s index is based on its ESG sustainable impact metrics, which distil the 17 UN Sustainable Development Goals (SDGs) into five actionable investment themes – basic needs, empowerment, climate change, natural capital and governance. When the index was launched MSCI identified 123 companies that derived a majority of revenues from activity relating to sustainable impact themes.
The Stoxx index calculates an aggregate ESG score based on carbon emissions targets, women on the board, independent directors, child labour policy and golden parachute pay agreements, and excludes coal mining, companies that violate the UN Global Compact and controversial weapons.
These indices produce concentrated portfolios, with the MSCI index’s top four holdings all coming in at over 4% as at early April 2017. These were Tesla Motor (4.48%), the France-listed energy multinational Schneider Electric (4.07%), the US pharmaceutical firm Abbvie (4.04%) and the UK-listed education provider Pearson (4.%).
By comparison, the largest holding of the iShares MSCI All-Countries World dollar ETF is Apple at just under 2%. The Stoxx index is slightly less concentrated, with top holdings including Apple (4.5%), Microsoft (3.6%), General Motors (1.8%) and Bank of America (1.7%).
For John McKinley, director and founding member of the BlackRock Impact team, the concentrated nature of these portfolios is an important part of the impact, as is the reporting to the end-investor about the capital that is contributing towards positive outcomes related to the SDGs.
Speaking at the Impact Summit Europe in The Hague in March, McKinley spoke of an “inflection point” in impact investing. Theo Clément, senior adviser for ESG and impact investing at UBS Asset Management, shares McKinley’s enthusiasm, believing that impact investing will soon become mainstream. Both he and McKinley are keen to point out how sustainability is now embedded in their research and portfolio management activities.
Whereas the smaller scale of private markets investing may lend itself to more straightforward measurement and reporting against impact goals, this is clearly more challenging in public equity markets. McKinley expands: “We are by no means saying what you can achieve in the private markets [by] direct investment is the same [as] you can achieve in public markets, so it’s within the public markets that we’re trying to find the most innovative ways to enable more investors to align capital to the most impactful companies.”
Robust indices will help provide a credible underpinning to listed equity impact strategies, either passive or benchmarked active, even if isolating and measuring the impact of the diverse economic activities of modern corporations is challenging.
Clément says UBS has been working with the Harvard School of Public Health and City University of New York, together with PGGM, to develop a quantitative framework to measure the external impact of companies for a global equity mandate managed against a customised benchmark. “We manage in principle two dimensions: on the one side ESG and the other of course financial objectives,” Clément says. “But we report at portfolio level the impact, the way we define impact, and that is the future. The next steps will be, and that is I think also the exciting part for the industry, the innovation part.”
Clément sees ESG as an interim measure: “What we consider the impact is something we want to know, not only what is happening within the walls of a company but what is the impact on the environment and society.”
Companies, their interactions with the wider world, and they way they report this, is therefore fundamental. While CSR (corporate social responsibility) reporting is nothing new, some firms are seeking to integrate impact metrics in their sustainability reporting.
For the Dutch listed corporate DSM, specialising in health, nutrition and materials, sustainability is a strategic and business growth driver. The company has focused on three UN SDGs aligned with its business activity in a new sustainability report – nutrition, climate change and energy, and resource scarcity. This is intended to emphasise the company’s positive attainments from an impact perspective.
Thijs van der Heide, investor relations manager, explains: “We use our scientific competences to come up with solutions in nutrition, in materials that are safer, especially from a value chain point of view. But we want to make sure that people are curious about it, so we also try to make sure that our products are balanced so the innovations are not only creating a better product but they also have a better environmental footprint or are sustainable.”
Yet Van der Heide is frustrated that investors are still more focused on the financial aspects rather than the long-term drivers of sustainability or impact. “Of course we like to attract the longer term investors who share our beliefs,” he says. “But I’m sure we have some investors that aim to be more sustainable and are looking at these things, but if you talk to the managers, if you talk to the analysts, you’re basically discussing the financial reporting results not the longer term goals, especially when the financial performance hits a bit of downward spiral. The first thing they say is, it’s nice that you have these sustainable hobbies but could you please focus on your financial results?”
Listed impact equity strategies will no doubt help to bring impact investing more to the centre stage of institutional investing and to raise awareness. Ideally, greater investor interest would spur listed companies to improve their reporting, leading to more meaningful information on impacts. Large pension funds, asset managers and index providers all have a clear role to play, but standardised measurement and reporting metrics that also allow investors some leeway to select and benchmark relevant societal impacts will be needed before these strategies can call themselves anything more than a niche. And for pension funds in particular, relevance to and engagement from members will play a key role.