A force for good

Investing in mission-led businesses with environmental or social objectives is poised to become mainstream. But how do you measure a company’s true impact? Moira O’Neill investigates

Investing themes

Illustration by Borja Bonaque

Many investors want to put their money to use to help solve the world’s numerous challenges, from climate change and pollution, to poverty and rising inequality. Twenty years ago, your main option would have been ‘ethical investing’, whereby managers of ethical investment funds screened out companies that made negative contributions to the world. More recently, there have been niche investments available in this space too. These include ‘green’ funds that focus on specific issues, particularly climate change, by investing in companies that aim to help the environment.

Today, many of these problem-solving funds come under the broader banner of ‘Socially Responsible Investment’. These SRI strategies incorporate environmental, social and corporate governance (ESG) factors in their investment processes, and may or may not exclude companies because of their products or sectors.

Profits with principles

As few investors want to sacrifice profits for their principles, reassuringly many of the funds in this area are focused equally on making good financial returns. This brings us to the relatively new concept of ‘impact investing’. The term describes investment in companies that have environmental or social objectives at the heart of their commercial strategies – mission-led businesses that also aim for financial returns.

Crucially, investing for impact allows investors to build portfolios in keeping with their own societal and environmental values without sacrificing the potential for financial return.

Impact investments can be made in both emerging and developed markets, addressing the world’s most pressing challenges in sectors such as sustainable agriculture, renewable energy, conservation and microfinance. Impact investors will also target companies providing affordable and accessible basic services including housing, healthcare and education.

However, impact investors need to be prepared to invest for the long term. While some aim for below-market-rate returns, in line with their strategic objectives, the majority pursue market-competitive and market-beating returns. It’s not about philanthropy.

However, impact investing requires active management by a fund manager, rather than a passive investment strategy. This is because a fund manager needs to talk to a company’s management to understand its impact strategy alongside traditional financial metrics. This engagement with management encourages better company behaviours and disclosures.

United Nations goals

Practitioners of impact investing believe that it is set to become mainstream. According to J.P. Morgan research, demand for impact investing strategies could reach $1 trillion by 2020. Institutional investors – including pension funds and charities – can often see the benefits of impact investing but lack the framework for applying it.

However, this changed in 2016 when the United Nations set an agenda for sustainable development, which aims to eradicate poverty, address climate change and rising inequality, plus cut unsustainable production and consumption. The UN set 17 Sustainable Development Goals (SDGs) and a number of specific targets to be achieved by 2030.

According to J.P. Morgan research, demand for impact investing strategies could reach $1 trillion by 2020

The SDGs are ambitious and estimates of the cost of achieving them range from $2 trillion to $7 trillion a year. This can only be done through partnership between governments, regulators, philanthropists and the corporate world. Global asset managers, with over $80 trillion of assets under management, believe they have an important role to play in meeting the SDGs.

Robust measurement

The term ‘impact investing’ is often used loosely and funds will differ in their approaches. There needs to be intentionality for an investment to be defined as ‘impact’, i.e. an intention by a company to contribute toward solving a problem or meeting a need that is external to their business strategy.

So how do fund managers measure impact? A company’s products and services may deliver a measureable positive impact, but that does not necessarily mean that the company is a responsible business. The fund manager will need to understand the negative impact of a company’s operations too, to ensure that they don’t offset the positive environmental and social impacts.

Take the case of LafargeHolcim, a giant manufacturer of building materials, cement and concrete, which has a presence in 80 countries around the world. A cement producer may not seem an obvious candidate for an impact portfolio, but the industry’s environmental impact means there is significant scope to make a difference. LafargeHolcim had established itself as a significant innovator in the way that cement was produced in order to minimise the impact on the environment.

However, there were problems in the governance of the company. The former CEO, Eric Olsen, stepped down in April 2017 due to controversy surrounding a Syrian cement plant that kept running as the country descended into civil war. Human rights groups alleged that the plant was helping to finance terrorism.

Impact reporting

One fund in the impact space is the Standard Life Investments Global Equity Impact Fund. This fund actively engages with the companies in which it invests to better understand their businesses and to encourage best practice when it comes to impact reporting. It uses the UN’s 17 SDGs as a foundation for its proprietary approach to ensuring companies’ business, products and services are having a genuinely positive, measurable impact. To make the goals more applicable to companies, it uses eight ‘pillars’ of impact as a framework for company analysis, covering everything from sustainable energy to financial inclusion. While the Fund positively selects companies, its impact criteria means that it also excludes them on the basis of products or services, for example, tobacco and oil.

The Standard Life Investments Global Equity Impact Fund has identified three key stages of impact maturity, as illustrated below by three companies in the Fund’s universe*.

A three-stage proprietary process

The Standard Life Investments Global Equity Impact Fund wants to be able to invest at the start of a company’s impact investment journey. So the first stage is to establish intention – the company board must have a clear strategy to pursue an impact agenda. For example, Japanese real estate company Takara Leben aims to be “a pioneer of solar-powered condominiums”. It has met its targets to increase the ratio of solar-powered condominiums it builds to 50% annually, and has set ambitious goals for 2019, while stating that it wants to be an affordable provider.

The second stage is implementation: putting this strategy into practice. German plastics maker Covestro aligns its product portfolio with 13 of the 17 SDGs and considers the sustainability of its products in supply chains right through to product disposal. Plus, it has a goal to address underserved markets by 2025, focusing on affordable housing, sanitation and food security, areas in which its materials can offer significant benefits.

The third stage, impact quantification, is when the outcomes of an impact strategy can start to be measured. Yes Bank is the first Indian bank to launch a green bond, and partners with non-governmental organisations and governments to fund ‘green’ initiatives. It also offers assistance to ‘sustainable entrepreneurship’ designed to ingrain sustainable business practices at an early stage and harness the savings. Plus, its investment focuses specifically on the strategy of financial inclusion. Its annual report and presentation discloses a lot of detail, including the number of people and households reached.

First and foremost, though, before a company can be considered for an impact portfolio, it must be a compelling investment opportunity.

* Note: these companies may not be held in the Standard Life Investments Global Equity Impact Fund at the time of publication.

Expert Viewpoint

Julie-Ann Ashcroft, Head of Investments, Standard Life Wealth

Julie-Ann Ashcroft

Increasingly, our clients are asking how we can more effectively align their investments with their values. This is not just millennials, the vast majority of whom indicate in surveys that they would only invest on an ethical basis. It’s also the ‘more experienced’ clients, who feel empowered to stand up for what they believe in. Our starting point is that consideration of environmental, social and governance (ESG) factors is integrated into our investment process for all portfolios. We strongly believe this gives u an advantage in understanding the key risks and assessing the quality of any investment. Taking this a step further, we offer the traditional negative screen approach through client-tailored, ethical strategies, utilising MSCI ESG Manager – an independent ESG scoring resource.

More recently, the launch of the Standard Life Investments Global Equity Impact Fund has provided an opportunity for us to take a huge leap forward in what we can offer clients. This fund uses the UN’s Sustainable Development Goals (SDGs) as an investment framework – an all-encompassing agenda to tackle the most significant problems the world faces. We are delighted to be able to offer the opportunity for our clients to not only support this ambitious programme, but also to seek an attractive financial return. Most importantly, we can show clients the significance of their investments through reporting that maps outputs of the companies held to the UN’s key performance indicators for the SDGs. For convenience, we offer this solution as a fund or a portfolio of direct holdings. We think that investing responsibly goes to the heart of seeking sustainable returns and maintaining client trust; we truly are looking to invest in a better future.

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