The Rise of Impact Investing

Posted on 11 May 2020

Impact investments are "investments made with the intention to generate positive, measurable social and environmental impact alongside financial return".  Investors have increasingly been looking to drive positive change to create a more sustainable future, manifested in the growing trend for impact investments.

With a shift in focus to environmental and social governance (ESG), leading to sustainable and responsible impact investing (SRI), regulatory standards and standards of care expected from investors and lenders alike have been transformed. An increasing number of investment indices are now using ESG and SRI criteria to evaluate investment performance. Further, certain lenders are offering preferential rates to borrowers with high ESG scores.  

Generational Divide

This rise of SRI primarily results from the growing number of profit-with-purpose businesses, often established by Millennials and Generation Z-ers who eschew the traditional mind-set of "profit for profit's sake". These younger generations are socially and environmentally conscious and expect businesses to make positive societal contributions. Also, CEOs of businesses who have made their money the "traditional" way, now have to justify themselves to their children and grandchildren; the Millennials, Gen-Z-ers and Generation Alpha.

Who, What, Why?

Impact investors range from individuals to institutions and they are increasingly investing through private equity impact funds.

Typical sectors for impact investment include healthcare, renewable energy and education. However, the sectors for impact investment have long since outgrown such "worthy" recipients and now include mainstream, multinational businesses. Unilever is a prime example.

Financial Return vs Impact

The misconception that impact investments necessitate a sacrifice in financial return is far from the reality. Investors with strategic objectives requiring them to intentionally invest for below-market rate returns account for a small proportion of investments. Most of the investors surveyed in GIIN's 2019 Annual Impact Investor Survey achieve competitive returns. Many of these investors have reported that:

"portfolio performance overwhelmingly meets or exceeds investor expectations for both social and environmental impact and financial return."

SRIs growing popularity and the increase in the creation of profit with purpose businesses suggests that impact investments will begin to outperform "traditional" investments in the not too distant future.

Further, impact funds and wealth managers are striving to make financially and socially lucrative investments. The Future Business Partnership (FBP) invests in sustainable consumer brands, and suppliers of sustainable inputs for those brands to encourage these businesses' values whilst facilitating their growth. Vish Srivastava, FBP's founder, believes that:

"Impact investing is growing but we believe it will grow fastest in the profit-with-purpose sector, that is, in businesses with combined environmental, social and financial goals. More and more consumers are identifying with, and buying into, consumer brands which demonstrate a focus on impact and ESG as well as providing great products at the right price. A social or environmental mission gives a brand direction and durability. It is definitely an advantage in today's marketplace to be authentic in your ethics."

Market Advantages

Aside from offering financial returns whilst aiding global challenges, impact investments have other benefits for investors.

Studies show that impact investments are less volatile than their non-impact counterparts so can help stabilise investment portfolios.

With the increase in certified B Corporations (B Corps) impact investors now have verifiable data to inform their investment decisions. Certified B Corps maintain high standards of social and environmental impact requiring higher levels of accountability and internal reporting. Underlying businesses in which impact funds invest will likely outperform their non-impactful peers as they tend to:

Adopt better systems to manage risk (e.g. as required by B Corps);

Be better managed as the management team's personal values are closely aligned with those of the company; and

Be able to attract and retain the best employees or stakeholders, as Millennials and Gen-Zers become increasingly influential.

Finally, studies show that the rise in impact investments correlates with a surge in client demand. It is becoming crucial for investors to offer such services to satisfy their own clients.

The Future

Whilst the COVID-19 pandemic has created vast uncertainty around the future of business, it seems likely that investors' focus on SRI and impact investments will continue to grow. 

It has been widely reported that sustainability focussed businesses have shown greater resilience during the COVID-19 crisis, with their stocks outperforming competitors. For example, an analysis by HSBC found climate-focused stocks "outperformed others by 7.6 per cent from December and by 3 per cent since February and that ESG shares beat others by about 7 per cent for both periods".

The crisis has highlighted the world's social and economic interdependence. To recover from the social and economic consequences of COVID-19, governments, institutions and individuals need to work collaboratively. There is no single solution but business will have its part to play. Recently, the CEOs of L'Oreal, Unilever, Lego, Ikea, Danone, Suez and many others joined calls for Europe to rebuild post COVID-19 in a green and sustainable way.  

Alexander Rhodes, Head of Mishcon Purpose believes that:

"The most important outcome of this crisis is likely to be an urgent reappraisal of our values: as a global community, as nations, as businesses, as individuals. It is this, more than anything else, which will determine in whom, for what and how we choose to invest for our futures."

Impact investing, preserving the planet, benefiting people and driving economies forward can (and should) be a key component of the world's recovery.

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