What sets a good impact investor apart from the rest is targeting a meaningful allocation, says Will Nicoll, CIO, private and alternative assets at M&G Investments
The Nordic nations have long been known for their progressive approach to sustainability – leading the way when it comes to responsible living and sustainable finance.
The SDG Index, which measures a country’s total progress towards achieving the United Nations’ Sustainable Development Goals, ranks Finland, Sweden and Denmark as the top three performing countries. With this in mind, it’s no surprise that they are ahead of the curve on impact investing. Eighty-eight per cent of respondents to the One Initiative’s 2020 report on impact investors in the Nordics said that impact investing is very important to them, with 80% saying they think impact investments provide opportunities for a good return.
Investors across other parts of the world are already following in the Nordics’ footsteps by embracing sustainability. This is being accelerated by regulatory changes. In March 2021, the European Commission’s Sustainable Finance Disclosure Regulation (SFDR) came into force in a bid to boost clarity for investors. There is also a rising demand for strategies that put capital to work in solutions that offer positive impact.
The Global Impact Investing Network’s (GIIN) latest survey estimated the size of the market at $715bn in AUM as of the end of 2019, with 34% of impact capital invested in private debt. Interestingly, the One Initiative found that Nordic investors primarily use private debt (18%), private equity (32%) and direct investment (33%) to invest with impact.
While institutional investors globally are making good progress in this area, there is a lot they can learn from their Nordic counterparts. The first step is to look at what aspects of impact investment Nordic investors are doing well: impact measurement, diversification, ongoing analysis, and – importantly – having a meaningful allocation to impact investments.
Measurement and diversification
All investments have an impact on people and the environment, whether positive or negative, intentional or unintended. Impact investing involves setting impact objectives alongside financial return objectives and quantifying and measuring these over the period of investment. Defining the impact that is (or is not) wanted and constructing a portfolio to meet the objectives enables investors to seek both financial return at the same time as aligning capital with broader objectives.
Historically, measurement of impact and comparison of approach between investors has been hard to assess. This is changing. An increasing number of impact investors are using consistent terminology and working to build global consensus – through the Impact Management Project, for example.
Private debt impact transactions are often bilateral, so there is usually a close relationship between the borrower and the lender. Moreover, private debt often finances discrete projects or smaller businesses, meaning that it can be easier to identify and measure the overall impact from an investment.
Investing across a broad range of impact themes helps to maximise the investable universe and allows for a high degree of diversification – something that is important for any value-based, impact investment portfolio. This means focusing on different maturities, asset types, sectors, impact themes, risk/return profiles and structures. Asset sourcing and origination should be a priority, enabling investors to take advantage of the full breadth of opportunities across the private debt spectrum.
“To put it bluntly, if you think impact is the way to go, you need to target a meaningful allocation”
No matter how well-designed and diversified your portfolio is, you still need to make sure your investments are on track to deliver their expected financial and impact returns. This requires careful analysis and monitoring – particularly with regard to illiquidity.
Private debt impact assets are usually uncorrelated to public markets, but there is no active secondary market, so trading in and out of investments is not always easy. However, private debt impact assets do have the potential to pay a premium over similar-rated public assets to make up for this lack of secondary trading opportunity.
Bespoke private assets are often held to maturity. While this means there is the potential to influence the impact of the asset over the life of the investment, it also increases the importance of ensuring the initial impact analysis (and application of any exclusion policy) is thorough – as divesting may not be an option.
Are you allocating enough?
Taking all the above points into account, what really sets a good impact investor apart from the rest – once they have mastered asset sourcing, diversification, measurement and monitoring? To put it bluntly, if you think impact is the way to go, you need to target a meaningful allocation. A lot depends on your wider investment strategy, but this could mean between 10 or even 20 per cent of your private asset bucket.
It can take months of analysis, structuring and negotiation, to complete a single transaction, so the effort involved in building a diversified portfolio of private and illiquid assets should not be underestimated. Significant resource and expertise is required in a range of fields, to take advantage of the full breadth of opportunities across the private debt spectrum.
Ultimately, while impact strategies are becoming more mainstream, the approaches that countries like Finland, Denmark, Norway and Sweden take can serve as useful models for investors who are less active in this area.