The growing impact investment market provides capital to sectors such as sustainable agriculture, renewable energy, conservation, microfinance, housing, healthcare, and education.
As the world grasps the reality that our modes of production and consumption threaten our ability to prosper and even exist, the momentum to implement solutions has never before been higher. This article from GSFM’s investment partner Redpoint Investment Management explores the investment thesis for impact investing.
Current means of global production and consumption are unsustainable. Greenhouse gas emissions from burning fossil fuels, food production and industrial processes are causing lasting damage to the atmosphere and permanently changing the earth we inhabit.
Deforestation, pollution, pest control and unsustainable food production – along with climate change – is devastating the earth’s biodiversity. On the current trajectory, up to 50% of all plant and animal species will become extinct by the end of this century.
This environmental devastation severely challenges the ability of humankind to maintain its current standards of living, let alone prosper. That includes adequate healthcare, equality, education, poverty and diversity.
The traditional construction of a diversified portfolio does not consider the structural change that needs to take place to avoid permanent and catastrophic impact on the planet’s ability to support life. It does not consider the damage done by the current economy to the future economy, the planet and its inhabitants. As explored later in this article, this is of particular interest to a growing cohort of investors looking to invest in the solutions.
The opportunity defined
Life and industry will change dramatically in the coming years as we push up against the hard planetary boundaries that sustain life. Genuine sustainability will be a key driver of company, industry and market success until these problems are solved. Capital is being reallocated in an increasingly fertile regulatory and societal environment determined to see change.
Over 100 countries have committed to net zero carbon emission targets. Over 160 of the world’s largest banks and asset managers, totalling over $93 trillion have made the same commitment, including dedicated green investments to kick start real decarbonisation. The UN has set 17 Sustainable Development Goals to ensure prosperous life beyond 2030. The largest investors have recognised the primacy of a functioning society and its reliance on the environment[1].
These profound and structural changes will create winners and losers in a future that barely resembles today’s economy. The solution? Impact investment.
What is impact investing?
Impact investments are generally defined as “…investments made with the intention to generate positive, measurable social and environmental impact, alongside a financial return[2].
The growing impact investment market provides capital to address the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services including housing, healthcare, and education[3].
Impact investing challenges the long-held views that social and environmental issues should be addressed only by philanthropic donations, and that market investments should focus exclusively on achieving financial returns (see figure one). It’s also an attractive alternative for investors who think investing in companies creating positive impacts is more desirable than not investing in companies who pose ethical issues.
Advocates believe impact is the only sustainable investment strategy that intentionally considers the real world outcomes resulting from the products and services a company provides. Impact investors are active owners and stewards that continually drive portfolio companies to solve the world’s biggest problems.
An investment manager’s approach to impact measurement will vary based on their objectives and capacities, and the choice of what to measure usually reflects investor goals and investor intention. In general, components of impact measurement best practice for impact investing include:
- establishing and stating social and environmental objectives to relevant stakeholders
- setting performance metrics/targets related to these objectives using standardised metrics wherever possible
- monitoring and managing the performance of investees against these targets
- reporting on social and environmental performance to relevant stakeholders.
The impact investing market offers diverse and viable opportunities for investors to advance social and environmental solutions through investments that also produce financial returns.
Solving the world’s biggest problems is the world’s biggest investment opportunity.
Why now for impact investing?
We are in the midst of a climate crises: the concentration of carbon in the atmosphere is the highest it has been at any time during the last 800,000 years. While we have recorded fluctuations in the past, the increase experienced since 1950 is more than twice the increase we have ever recorded from trough to peak (see figure two).
Since 1950, the average temperature rise across the globe has been a little over 1*C, resulting in mass coral bleaching events and the collapse of Antarctic ice sheets. We are also seeing changes in rainfall patterns, cyclones, sea level rise and bushfires. This is having an impact on insurance losses, human mortality rates, agricultural productivity and is driving the loss of entire ecosystems and biodiversity.
However, the movement is underway. We have the global framework – after many years of stuttering, The Paris Agreement was born in 2015. It provides the mechanism for countries to ratchet up their commitments in a transparent way. The pathway to meet the ambition of the Paris Accord requires the enormous deployment of capital, leadership, policy and technology.
The size of the challenge is enormous; we need to cease emissions growth and rapidly curb it downwards. Current policies see emissions peak in 2060, current pledges and targets see flat lining emissions for the next decade. The ambitions of stated policies are not anywhere near the level needed to avoid dangerous levels of global warming.
The disruption that will be caused when policy intervenes to prevent an existential disaster is enormous, creating opportunities for those investors who can identify the winners from the global transition to a sustainable net-zero economy.
We already have the technology to get us a long way down the path to avoiding dangerous climate change – about 80% of the emissions reductions we need to achieve by 2030 come from existing, commercial technologies such as renewable energy, electric vehicles, green buildings, mass electrification and low emissions food production.
These technologies are well-established, commercial and scalable. A systematic impact investment approach can pick stocks in industries developing these technologies, that are ready to scale up.
Innovation will remain critical. By 2050, almost half the reductions will come from technologies currently at the demonstration or prototype phase, including hydrogen, carbon removal technologies and advanced battery cell technology.
The economy is not distinct from the climate, the biosphere, biological diversity or humanity. It is all wrapped up together. The path to net-zero is as critical as the destination, and not just in terms of the rate we reduce our carbon emissions.
Decarbonisation will be disruptive. And for it to be politically implementable and effective, the broader sustainability challenges need to be tackled in concert. Overlaying the push to transition with the global sustainable development agenda – that is tackling poverty, improving education, equality, and dealing head on with the other existential environmental challenges. These include preventing a biodiversity extinction crises and the sustainable management of water resources, both which are equally necessary challenges to solve. Impact investment can contribute to the solution.
How do impact investments perform financially?
As well as making a measurable social or environmental impact, impact investments also deliver a financial return. According to the Global Impact Investing Network’s (GIIN) 2020 Annual Impact Investor Survey, investors have diverse financial return expectations.
According to GIIN’s report, some intentionally invest for below-market-rate returns, in line with their strategic objectives. Others pursue market-competitive and market-beating returns, sometimes required by fiduciary responsibility. Some investors believe considering the structural change that needs to occur to put the global economy back on a sustainable footing is a source of out-performance. Most investors surveyed for GIIN’s annual survey pursue competitive, market-rate returns.
Respondents to the GIIN survey also reported that portfolio performance overwhelmingly meets or exceeds investor expectations for both social and environmental impact and financial return, in investments spanning emerging markets, developed markets, and the market as a whole.
Why should advisers consider impact investing?
In a recent report[4], the Responsible Investment Association Australasia (RIAA) revealed Australian investors are increasingly concerned about social and environment issues; they want their investments to ‘do well by doing good’. Importantly, investors expect their service providers to invest in line with their ethics.
The research found that Australians are putting these values into practice, with more Australians investing responsibly than ever before, led by Gen Xers and Millennials. While the baby boomers are generally regarded as Australia’s wealthiest cohort, Gen X and Millennials are in the box seat to be the likely recipients of the looming intergenerational wealth transfer, which is expected to pass on $224b a year by 2050[5]. Gen Z also indicated an increasing propensity toward responsible investment.
Redpoint believes that when most investors express a desire to invest responsibly, they are seeking real world sustainability outcomes. Pleasingly we note that investment managers are improving and broadening their reporting to highlight how their strategies are positioned in this respect. Impact investment managers, by definition, will report these environmental and social outcomes. As this practice grows, the visibility of the focus on real world outcomes is expected to further increase the demand for such investment products.
Interestingly, 74 percent of respondents to the RIAA research said they would consider moving to another provider if their current (superannuation) fund was investing in companies engaged in activities inconsistent with their values. This is especially true of the younger generations, who are the most likely to agree with this: Gen Z 87 percent, Millennials 82 percent, Gen X 71 percent.
Younger generations such as Gen Z (83 percent) and Millennials (75 percent) are more likely to be motivated to save more if their investments are making a positive impact. Younger generations care more about social and environmental issues. Those providing financial advice to the younger age cohorts need to be able to meet their clients’ objectives with respect to both financial and responsible investing outcomes.
The RIAA research found:
- Millennials are the most concerned generation, with 80 percent of them caring about environmental and 83 percent about social issues
- Gen Z is the second most concerned generation, with 79 percent concerned about environmental and 78 percent about social issues
- Gen X is more concerned about environmental issues (71 percent) than social issues (67 percent)
- Baby Boomers are equally concerned about the environment (69 percent) and social issues (68 percent).
A final and important finding from RIAA’s research was the number one expectation Australians have of financial advisers in 2022:
- 64 percent expect their financial adviser to know about responsible investment
- 47 percent expect their adviser to provide responsible investment recommendations
- 43 percent expect financial advisers to know which responsible or ethical products are independently verified or certified.
Australian investors want their investments to ‘do well by doing good’. At the same time, they want a financial return on their investments. Impact investing provides the opportunity to support companies that positively contribute to solving the significant problems our world currently faces, both environment and social. Impact investing can help advisers act in a client’s best interests when it comes to meeting their financial and responsible investing objectives.
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