The upcoming UN Climate Change Conference (COP26) stands to be the most important meeting yet of major nations on the topic, at a time of rising frequency of major environmental events – from floods to wildfires. The latest Intergovernmental Panel on Climate Change report sounded a code red for the climate, and added together with the effects of the Covid-19 pandemic – which has revealed profound social inequalities – and many investors are increasingly focused on how their capital can help address these global issues.
Until recently, the challenge had been to combine the twin goals of doing good and earning a return in a single investment. Fortunately, this is a challenge that the investment industry has met head-on. The growing field of impact investing helps investors balance a measurable environmental or social impact on the one hand, with a financial return on the other.
Impact investing was once largely the preserve of direct private-market investments, but it is moving from a niche approach into a significant market segment. According to a Global Impact Investing Network survey focused on private markets, impact investing accounted for just 0.5% of global assets and US$715 billion of assets under management at the end of 2019. However, it is growing at pace: the volume of impact-oriented investments rose by 77% annually between 2017 and 2019, according to technology advisory and investment firm GP Bullhound.
The growth in impact investing has in part been driven by an increase in investment options across the various impact asset classes. Yet all this rapid growth has highlighted the question of what constitutes an acceptable rate of return for these investments. Given that the underlying premise of investing for many is a risk-adjusted financial return, how can returns be adjusted to account for non-financial risks?
The investment industry is working on this issue, having already introduced metrics such as social return on investment and impact multiple of money. We expect to see more research in this area. At the same time, assuming one can accurately calculate and attribute financial and non-financial returns, where is the balance between the two? We disagree that there must be a trade-off between impact and financial returns. In fact, as non-financial returns become an increasingly important factor, they could provide a strong technical tailwind.
As the debate continues, the investment industry is looking to see where impact investments are being directed and why – and how the impact can be measured and reported. Fortunately, asset managers and others are beginning to coalesce around some newly proposed standards. These include high hurdles for transparency and reporting to help the industry deliver on its promise and insulate itself from accusations of impact washing, where funds make claims that are not substantiated by any relevant and demonstrable positive impact.
So where is the impact being seen? Consensus has emerged that impact investments should contribute to at least one, and preferably several, of the 17 UN Sustainable Development Goals. The notion of co-investing with sovereign and corporate entities to support climate transition strategies is also proving to be integral to impact investing. This field can extend to blended finance, where investment from both institutions and philanthropic funds can be combined to create opportunities for commercial investors.
Sovereign nations are also getting in on the act, where impact investing can complement initiatives such as the World Bank’s International Development Association lending to low-income economies. Earlier this year, Benin issued Africa’s first social bond in the international markets, raising money to broaden access to drinking water for its population of 12 million. Many impact opportunities revolve around new technologies and services that are often in an early stage of development – an area that has typically been the preserve of venture capital and private equity. Today, these solutions are being developed and scaled for wider application.
Impact investing’s reach into both public and private domains means it can cover the full breadth of the opportunity set – and it comes not a moment too soon. This has helped change the nature of the conversation between asset managers and their clients. Where investors previously thought only in terms of risk and reward, they are now adding a third dimension of oversight to their portfolios: impact.
Matt Christensen, global head of sustainable and impact investing, Allianz Global Investors.