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Sustainable investing has become a major force in the global economy, with assets hitting over $30tn last year, according to the Global Sustainable Investment (GSI) Review.
Until recently, the market was dominated by a negative-screening based investment process, which involves screening out unwanted companies such as those involved in fossil fuels, tobacco, or weapons. But a more positive method, called impact investing, is now gaining ground rapidly. This approach aims to invest in firms that have a positive effect on society, such as in clean energy, while also providing a financial return to the investor.
Consumers increasingly want to make ethical or sustainable choices with their investments – just as they do with their day-to-day spending – and the ever-growing influence of values-led millennials means this trend is set to continue.
“The most significant problem is understanding what they are investing in.”
But there is a lack of consensus around how to populate portfolios with sustainable investments and what impact they will have. The most significant problem – especially for private individuals – is the number of different categories and definitions on offer, which make it hard to understand what they are investing in.
Should they invest in so-called ESG funds, which support companies that meet certain environmental, social and governance criteria – or avoid ones that don’t? Should they choose sustainable responsible investments (SRI), which seems to be a catchall definition for all types of ethical investments? Should they opt for impact investing? Or should they invest in one of the many other different shades of ethical investing available?
To add to the confusion, some funds that are labelled ‘impact’ or ‘ESG’ have very broad criteria and their investments do not meet the strict definitions of those categories. Unfortunately, they do this as a marketing tool to ride the wave of ethical demand.
Which categories they choose will depend on the individual’s aims. But we believe impact investing is the strongest of these categories, because it has the clearest definition. We use the Global Impact Investing Network (GIIN)’s definition, which is: ‘investment in organisations or funds with the intention of generating measurable beneficial social or environmental impact alongside financial return’.
In contrast, ESG investments are too often based solely on negative screening, while SRI is too subjective.
“We think impact investing is a good alternative or complement to giving.”
The financial return element is important because it separates impact investing from charitable giving – a distinction that also sometimes confuses investors. With a donation, you are giving your money to a charity with no return.
The lack of clarity leads some wealth managers to advise their clients to donate rather than invest for impact. But we think impact investing is a good alternative or complement to giving, as it incentivises the organisation to run itself more efficiently.
We also like impact investing because funds have a clear framework for measuring impact in the UN Sustainable Development Goals (SDG), which were introduced in 2016. Impact investments can go into any sector, but the main sectors we choose for our clients are energy, technology, housing, and micro-financing, which involves lending to very small companies.
There are still many challenges in the impact-investing market. One is that, despite the SDGs, there is still a lack of measurement information available and many firms and funds still use their own tools, methodology and terms.
It is challenging to find sophisticated investment opportunities because of the social component. The companies tend to be smaller and unlisted, so it is harder to allocate large amounts of capital. Plus, there is a lack of education among private investors.
One misperception is that impact investing generally underperforms non-impact. That is changing as the market matures and many impact investments have gained a track record showing outperformance of non-impact funds over five years or more.
More unlisted opportunities will become listed; companies meeting the impact criteria will increase; and the market will become more liquid.”
According to GIIN statistics, 91 per cent of respondents said their impact investments have met or exceeded their expectations for financial performance; and 97 per cent said they had met or exceeded expectations on impact.
Currently, impact investing represents less than 2 per cent of total sustainable assets, according to the GSI Review. But we anticipate that more unlisted opportunities will become listed; companies meeting the impact criteria will increase; and the market will become more liquid.
As measurements and definitions become clearer, larger investors such as pension funds will allocate more to impact investing, making it more mainstream. And as the market absorbs the message about outperformance, impact investing will keep growing rapidly, taking money from the ESG sector and from new investors.