Impact as the greatest opportunity of our time
In this open letter written to CEOs, Larry Fink – CEO of Black Rock, describes the importance of including sustainability as an important variable in investment decisions. This statement recognizes impact at the centre of the economic system, transforming it into probably the greatest economic opportunity of our time. Moreover, 95% of millennials are considering impact as an important variable in their investment decisions making processes.
Nevertheless, an impact ecosystem rests on several pillars: impact-driven organizations, impact investments, public policies and infrastructures such as incubators, accelerators or capacity building initiatives. One of the main challenges of such impact-oriented ecosystems is, in fact, the need for capital inflows. On one hand, investors are not sufficiently educated, making decisions based on the usual equation of profit versus risk, while impact-oriented organizations are somewhat lacking the skills to grow efficiently, struggling many times with the paradoxes of their hybrid models.
This is the reason why sustainable investing (as defined by Allianz Global Investors) in its many different forms is paramount to unlock the hidden potential in the impact sector. To foster the impact investing ecosystem it is important to have multiple instruments and approaches from the investors’ side. The need for capital inflows of Impact Driven Organizations changes according to the stage of the life cycle they are at.
3 important phases for impact investors (entrepreneurial, managerial and scale):
There are three stages in this life cycle:
- Entrepreneurial – where the focus is the innovation and the entrepreneur is at the core of everything the startup does, needing to be resourceful and flexible;
- Managerial – where a project is replaced by a structure within an organization. The entrepreneur becomes a manager, allocating resources efficiently;
- Scale – where the organization is planning the scale-up or scale-deep of their internal solutions. This is when the solution becomes widely adopted.
Being aware of these phases is important for impact investors to adapt their decision-making strategies, choosing from a spectrum of instruments and frameworks. This article will focus on three among many others:
- Social Responsible Investment;
- ESG Investing
- Impact Investing.
The difference between Socially Responsible Investing, ESG investing and Impact investing
Socially responsible (SRI) and environmental, social, & governance (ESG) investing and impact investing are three approaches to sustainable investing, although there is still some disagreement over terminology in the investing community. The ones provided here are our perspectives on this topic and a way to help investors and companies to organize and diversify their investment portfolios.
1) Impact investing:
Impact investing is an investment strategy (in organizations, activities or funds) that embeds impact as the main decision variable alongside financial returns and risk mitigation. The impact is usually measured against specific KPIs in alignment with one or multiple SDGs. (Allianz Global Investors).
Most impact investors are looking for lockstep models where profit and impact creation are intertwined and strongly correlated. These investment strategies are important for multiple reasons:
a) It brings cash inflows to a new economic area;
b) Economic externalities become centralities to economic models;
c) Investors can diversify their portfolios, investing in impact-oriented companies with long term profit potential and reduced risk (regarding reputation and societal goodwill challenges).
2) Socially Responsible Investing: A financial first investment strategy
Finally, many instruments can be used according to the nature of the ventures/organizations and the expectations of investors:
- Venture philanthropy – for investors focused on impact and willing to build capacity on less structured organizations;
- Outcome-based investment agreements for organizations creating value for public entities;
- Financial first investments – more mainstream investments where financial return is the key decision-making variable, to mention a few.
From our perspective, socially responsible investing (SRI) is a financial first investment strategy. SRI, also referred to as negative screening, is a form of investment that is considered responsible due to the nature of the companies invested in. In short, the nature of the investment needs to be evaluated. This can be done with ESG rating schemes or certifications such as B-Corp.
Socially responsible investments can be made into individual companies committed to the social or environmental agendas, or through a mutual fund or exchange-traded fund (ETF) as described by Fink. One of the risks associated with socially responsible investments is its sensitivity to a volatile political and social agenda. In general terms, socially responsible investments would exclude investments in addictive substances or pollutive industries (such as tobacco, gambling, oil & gas and pornography), in favour of environmentally-friendly industries.
In this case, investors are looking for long-term investment opportunities with low reputational risk and long-term financial performance. These are more mainstream investment strategies where investors use the traditional investors' equation – profit versus risk – using societal risk assessment tools, ratings or standards. A socially responsible investor aims at getting long-term financial performance, mitigating investment risks related to the most pressing societal issues. These types of investments are important for mature and market-oriented impact ventures and organizations.
3) ESG investment or investment based on ESG ratings
Ultimately, ESG ratings are a measure of a company's long-term commitment to socially responsible investments (SRI) and environmental, social and governance (ESG) standards. ESG ratings are a way to assess the exposure of a company to relevant ESG risks that can affect its long-term financial performance. This risk assessment strategy is an additional layer to risk assessment of investment portfolios that helps investors mitigate financial risks related to relevant Social, Environmental and Governance issues (considered to affect long term economic sustainability).
Nowadays, 33% of total U.S. assets under management (AUM) are scrutinized under ESG criteria. This helps mainstream investors assess different investment risks. Among these criteria the following ones may be found:
a) Governance – Transparency, disclosure, mission and purpose;
b) Community – Suppliers, local engagement, diversity;
c) Environment – Energy use, facilities, Supply chain. The investors' expectations are strongly connected to financial results. Nevertheless, ESG investors are always looking for mainstream investors with no negative impact and/or to reduce long term reputational risk. Hence, ESG investing is more of a method that can be used both for impact investing as well as SRI investing.
Data, ESG and impact integration with the Sustainable Development Goals (SDGs)
Today, the Global Impact Investing Network (GIIN) defines impact investment as a market of $715 billion assets under management. The United Nations estimates that to meet the 17 Sustainable Development Goals (SDGs), a $3.9 trillion investment a year will be needed a year between now and 2030.
The rapidly growing impact investing market has the potential to provide capital to meet these goals. Indeed, impact investments identify and make long-term investments that aim to address the world's most pressing challenges in areas such as renewable energy, microfinance, sustainable agriculture, as well as accessible and affordable basic services, including healthcare, education and housing.
Therefore SDGs serve as yet another instrument to measure impact and provide an ESG rating. An emphasis should be made here on measuring: while measuring financial returns is easily quantifiable, measuring impact often remains a challenge for companies and organisations. There is a need for transparent communication with clearly defined sustainability Key Performance Indicators (KPIs) to properly measure the overall return of impact investment and ensure its efficiency.
Investment decisions should be aligned with personal choices
To conclude, the way you choose to have an impact is largely based on your personal preferences and return basis. While SRI and ESG investing might not be so limiting in terms of returns, impact investment does generate returns that are ultimately just above the market rate. According to GIIN, more than 88% of impact investors reported that their investments met or exceeded their expectations.
Additionally, your investment decisions should be aligned with your personal choices. For example, if you refuse to invest in a company selling alcohol but continue to purchase their product, then chances are they will still perform well on the stock market. Companies play a key role in realizing the Sustainable Development Goals but so do individuals. We all have a small part to play in creating the future we wish to see, beginning with integrating our everyday actions into this shared responsibility.
Finally, SDG Monitor would like to offer the opportunity to answer any questions you may have regarding the topic of the blog. Therefore, if any questions arise you can contact Vilma Catani on the Green Forum.
