CPD: Impact investing and SDGs – a client conversation primer

From

Investors are increasingly seeking out investment solutions that allow them to earn both a financial and a social return.

Introduction

Since the start of 2020, investment markets around the world have experienced a surge of activity. But while most headlines focused on the influx of boredom-fuelled retail investors into equity markets, other investment categories have also witnessed a growth in interest and activity.

One such category is the impact investing market, which has continued to mature and is now worth more than $1 trillion globally[1]. Motivated not by boredom, but by an increasing awareness and desire to act in areas such as climate change, access to healthcare, and racial and gender inequality, investors are increasingly seeking out investment solutions that allow them to earn both a financial and a social return.

In Australia, the potential demand from investors over the next five years for impact investment products could be as high as $100 billion[2], and with 9 in 10 Australians[3] believing it’s important for their Financial Adviser to offer responsible or ethical investment options, now is an ideal time for advisers to prepare for these client conversations by deepening their understanding of impact investment offerings, in particular those aligned to Sustainable Development Goals (SDGs), the most widely used framework for measuring and communicating impact.

Sustainable development goals explained

In 2015 the United Nations issued a landmark agenda designed to propel the globe into a more prosperous, sustainable and environmentally friendly future by the year 2030.

The Sustainable Development Goals (SDGs) are 17 objectives for improving human society, ecological sustainability and the quality of life. They cover a broad spectrum of sustainability topics, ranging from eliminating hunger and combating climate change to promoting responsible consumption and making cities more sustainable.

All countries – no matter how rich or poor – have agreed to work towards achieving the 17 SDGs by 2030, thereby establishing a 15-year timeframe for progress.

Critically, these weren’t goals left in the hands of governments alone to initiate, and the UN called on business, corporates and individuals to also play their part.

Measurability

The 17 goals have 169 underlying targets and 232 approved indicators, which are used to track progress towards achieving them. For example, the targets for SDG 3 (good health and well-being) aim to end premature mortality, halt the spread of communicable diseases such as malaria and HIV/AIDS, and promote the attainment of affordable universal health coverage. The indicators measure such factors as a country’s child mortality rate, the number of new malarial or HIV infections, and the number of people covered by health insurance.

In terms of tangible investing, health care companies can contribute to SDG 3 by developing drugs that combat certain diseases, or by improving people’s access to affordable medicines. Conversely, some companies may negatively contribute to the SDGs, by producing harmful products such as tobacco or firearms.

Investing with impact via the SDGs

Impact investing is the process of intentionally making investments with the aim of creating a measurable beneficial impact on the environment or society, as well as earning a positive financial return.

Impact investing has three key components:

  • intentionality: an investor sets out to exert a positive impact
  • return: it should generate a positive return on the investment
  • measurability: the benefits should be measurable and transparent.

Some investors believe that impact investing should also incorporate the concept of ‘additionality’, which involves only allocating to businesses that they would not otherwise have chosen to invest in if they were not seeking to achieve a positive social impact.

Once considered a niche form of investing, the high measurability of progress towards the SDG goals, along with the obvious appeal of investing in ways which can make a positive difference across so many different facets of life (not just single issues like climate change), have seen SDG aligned investment products become an important and growing sub-category of impact investing.

How SDG aligned investing is different to ESG investing

SDG aligned investing seeks to make a difference ‘on the ground’, for example through the eradication of poverty (SDGs 1,2) and reducing inequalities in society (SDGs 5,10) through investment capital rather than charity.

ESG investing, on the other hand, applies environmental, social and governance (ESG) factors in a way intended to minimize the negatives that come with all corporate activity.

This can be done by avoiding companies with poor environmental records or involvement in corruption. But it doesn’t necessarily have to make an impact on the ground; finding the companies with the highest ESG score compared to peers won’t directly contribute to education or health in Africa. Most notably, a tobacco company can have a very high ESG score – for example for having good governance practices and gender diversity – but clearly contributes negatively to SDG 3 for good health and well-being.

Which SDGs are companies and investors attracted to?

While contributing to the SDGs presents a clear opportunity for businesses and investors, some goals pose more challenges than others, and as a result, opinions differ on the preferred goals to invest in.

In Australia, a survey of investors[5] (shown in Figure 2, below) revealed that, while impact investments were spread across all 17 SDGs, there were some clear standouts, with SDG 7 – affordable and clean energy (10%), SDG 11 – sustainable cities and communities (9%), SDG 3 – good health and wellbeing (8%), and SDG 13 – climate action (8%), ranking the highest.

How to assess companies for SDG aligned portfolios

Some companies, by their nature, will be more attuned to making a contribution to SDGs than others.

For example, there can be no doubt that a company producing solar energy is contributing to SDG 7 (affordable and clean energy). Similarly, a business creating educational materials for schools is directly contributing to SDG 4 (quality education), while a firm that actively works to promote women in leadership roles is advancing SDG 5 (gender equality).

But theoretically there is no reason why a business in any sector can’t explicitly map their corporate activities to the SDGs, incorporate them into their strategic objectives, and transparently report on their progress.

One such example is South 32, a Perth based resources company spun out of BHP in 2015. On their website, they set out the 11 of 17 SDGs they are committed to, and the action they are taking to meet them. Examples are shown in the Case Study, below.

However, such alignment between corporate goals and activities and SDGs – and such transparency – is still the exception rather than the rule, and investors seeking to assess individual companies in terms of their SDG contribution face a number of challenges.

Some companies, for example, have negative impacts on the SDGs. This might be obvious in some cases, where harmful products such as cigarettes are produced. But other companies may contribute both positively and negatively. How should investors categorize, for example, an energy utility that uses both wind power and thermal coal?

Even more complex challenges arise with the creation of products or services that advance SDGs but simultaneously generate negative externalities. For example, mining metals that are crucial for the manufacture of electric cars or wind turbines, also adversely impact ecosystems and emit greenhouse gases.

For these reasons, investors must rely on various models and frameworks to assess the overall SDG merits of individual companies when deciding on their inclusion in equity or corporate bond portfolios.

A number of methodologies have evolved in recent years, including the SDI Asset Owner Platform, developed by Dutch Pension Funds APG and PGGM. This methodology breaks SDGs down into investible sub-goals and then measures how much of the company’s operations contribute to these investible subgoals. They do this by using financial or operational metrics such as the proportion of revenues derived from a certain SDG-friendly activity.

Another framework is that developed by international asset manager, Robeco.

Their proprietary SDG Impact Framework[8] provides research for bespoke investment strategies targeting all 17 goals.

The methodology uses a three-step process to ascertain companies’ sustainability credentials:

  • Step 1: What does the company produce? Analysts look at what the company produces to determine whether this contributes positively or negatively to the relevant SDGs, using specific key performance indicators and thresholds.
  • Step 2: How does the company produce? Here, analysts examine how these goods and services are produced and whether these companies advance SDGs in their operations, or whether there are any flipsides to apparent good intentions, such as poor governance.
  • Step 3: Has the company erred? Checks are made to see whether the company has been involved in any controversies. Examples include pollution incidents or the mis-selling of services.

Scores are then assigned to assess a company’s overall impact. These range from +3 (highly positive) to -3 (highly negative). Robeco can then make investment decisions for its SDG aligned products based on these scores.

Figure 3 Below represents this approach more graphically.

How can individuals invest in SDGs?
Individuals wishing to invest in SDGs have a number of options available to them, including equity or credit strategies that exclusively target the SDGs, and more thematic strategies that target a theme related to the SDGs, such as renewable energy.

The number of SDG specific offerings is currently small, but growing, in line with accelerating demand for these kinds of strategies. Such offerings are based on portfolios of bonds and equities of companies that are demonstrably making a positive contribution to achieving one or more of the 17 goals, as assessed through one of the methodologies discussed above.

Instead of taking a targeted SDG approach, some impact funds target a specific issue or theme, such as reducing plastic pollution. The investor is therefore contributing to its associated goals – in this case SDGs 11, 12, 14 and 15.

Three examples of investment strategies that target an issue rather than a specific SDG, can be seen in themes that are gaining traction in environmental protection: renewable energy, the circular economy, and green bonds.

In Australia, the total value of impact investment products as of 31 December 2019 that are widely offered to Australian investors had grown 249% to $19.9 billion (including $8 billion in foreign domiciled products), over the previous 2 years. This was represented by 111 products[10].

Busting the performance myth

Whilst sceptics maintain the line that responsible investing comes at the cost of performance, the data belies this, showing it really is possible to ‘do well by doing good’.

Respondents to the 2020 Australian Impact Investment Survey report that overwhelmingly (92%) their impact investments are meeting or exceeding their financial return expectations[11].

And nor is this because of lower expectations. The same survey found the financial return expectations among Australian impact investors are high, with three quarters of investors expecting competitive or above market rates of return on their impact investments.

In 2015 Cambridge Associates, in collaboration with Global Impact Investment Network (GIIN), introduced the Impact Investing Benchmarks. Together they produce quarterly reports that specifically capture the performance of private equity and venture capital funds that target risk-adjusted market-rate returns in the impact investing space (as opposed to funds that target concessionary returns that are perceived to be below market rate).

According to the GIIN’s 2017 study, ‘Evidence on the Financial Performance of Impact Investments’, socially responsible funds generated aggregate net returns in a range that was similar to that achieved by conventional investing[12].

Reinforcing these findings are the trends seen when comparing traditional equity indices with socially responsible investment indices.

The MSCI KLD 400, which was founded as the Domini Social Index, was established in 1990 and consists of 400 companies that meet rigorous standards for environmental excellence and social responsibility. Over the past 30 years, it has tracked performance of these companies against the S&P 500. As can be seen below, the social index has consistently outperformed traditional stocks for the past 25 years. And this gap continues to grow.

Adviser implications

Growing investor expectations for investments to make a difference continue to drive strong growth in demand for impact investment solutions. An important, and increasingly popular form of impact investment is SDG aligned investing – credit and equity products aligned to the United Nation’s 17 Sustainable Development Goals.

The growing range of SDG aligned solutions includes those targeting specific SDGs (e.g., health, education, climate control) and those that are more thematic based (e.g., reducing plastic pollution). More products are being introduced to the market regularly.

In light of this, financial advisers need to:

  • understand and be able to explain the concept of SDG aligned investments to clients and prospects
  • understand the methodologies used by fund managers in assessing SDG contributions of individual companies when constructing equity and credit portfolios, and
  • understand the performance expectations and experiences of active impact investors.

 

Take the FPA accredited quiz to earn 0.75 CPD hour:

 


 
———

References:
[1] https://probonoaustralia.com.au/news/2020/06/global-impact-investment-market-tops-1-trillion/
[2] https://responsibleinvestment.org/wp-content/uploads/2020/06/Benchmarking-Impact-2020-full-report.pdf
[3] Ibid.
[4] https://sdgs.un.org/goals
[5] https://responsibleinvestment.org/wp-content/uploads/2020/06/Benchmarking-Impact-2020-full-report.pdf
[6] Ibid.
[7] https://www.south32.net/sustainability-approach/sustainable-development-goals
[8] https://www.robeco.com/au/key-strengths/sustainable-investing/sustainable-investing-research/robecosam-sdg-score.html
[9] https://www.robeco.com/au/essentials/sdg/
[10] https://responsibleinvestment.org/wp-content/uploads/2020/06/Benchmarking-Impact-2020-full-report.pdf
[11] Ibid.
[12] https://www.mycnote.com/blog/does-impact-investing-have-lower-returns/
[13] Ibid.

You must be logged in to post or view comments.