According to the UN, getting there will require an estimated annual investment of USD 5–7 trillion. We believe that companies which help to solve societal and environmental challenges will be uniquely exposed to a clear growth path over the coming decades.These businesses will benefit from innovation, regulatory changes and a shift in consumer demand, enabling them to grow faster. As stock prices tend to follow EPS growth, these companies will tend to outperform the market and this potential will be captured by those asset managers who are able to fulfil the dual mandate of impact investing.
There is still much confusion about what separates impact investing from other sustainable investment strategies. ESG (environmental, social, and governance) investing typically focuses on a company’s operations, whereas impact investing focuses on its output, whether products or services. ESG criteria are used to assess how well a company is run, but they say nothing about the effects of its business on the world. With impact investing, it is critical that making a positive and purposeful impact should be part of a company’s business model.
Focus on solutions
Companies that contribute to solving the most pressing environmental and social problems in emerging markets are likely to be best positioned, should experience faster growth, face fewer regulatory issues and have higher profitability. This is because achieving the UN Sustainable Development Goals will require a great deal of innovation and high capital expenditure, especially in emerging markets. The prospects of these companies are characterised by three secular drivers: first, changing legislation, e.g. net-zero emissions; second, innovations can achieve sustainability goals faster or more efficiently; third, the consumer behaviour of large sections of the population is changing.
Thematic approach
Those who base their investments on the UN Sustainable Development Goals can try to harmonise their portfolio with the 169 sub-goals. A thematic approach, as developed by UBP in collaboration with the Investment Leaders Group, facilitated by the Cambridge Institute for Sustainability Leadership, appears to be more pragmatic and target-orientated for impact-oriented equity investments. This allows a portfolio to be diversified across the various SDGs. With three environmental themes and three social themes, 15 of the 17 SDGs can be allocated in a meaningful and investable way: the environmental themes focus on healthy ecosystems (e.g. sustainable agriculture and forestry), climate stability (e.g. renewables), and sustainable communities (e.g. mobility, waste management and recycling). The social topics cover basic needs (e.g. water, food, housing, education and financial inclusion), health and well-being (e.g. medical care and prevention, and medicines) and an inclusive and fair economy (e.g. testing and measurement methods, and products and services for women and minorities).
Stringent categorisation
In the debate about impact investing, it is often said that a genuine focus on impact only exists in private market investments, because only there is an investment providing additional capital with an earmarked purpose; the logic is sound, but the claim of exclusivity is not. According to this interpretation, an impact company would lose its essence on the day it is listed on the stock exchange, preventing the (socially desirable) scaling of the business and thus the solution. In view of the immense investment required to fulfil the objectives associated with the SDGs, we believe that a complete capital structure is required. In particular, shareholders have an important lever at their disposal in the exercising of shareholder rights and the opportunity to enter into a constructive and critical dialogue through engagement. However, a stringent allocation and review is of course necessary, in particular for shares. Key criteria for the question of whether an investment in a public limited company can be categorised as impact-oriented are intentionality (how strongly is the solution anchored in the company’s strategy?), materiality (how high is the share of revenue and profit?), additionality (how unique is the solution?) and potential (will it be a game changer?). Only if companies can clearly score points here can we really speak of an impact investment.
The time (and timing) is now
Impact investing is most effective when it is accompanied by commitment and long-term capital investment. At the moment, the signs are good for establishing and expanding an impact-oriented emerging market portfolio. The arguments in favour of investing in emerging markets are well known: demographic growth, economic growth and productivity growth; in the long term, investors will find greater leverage for achieving ecological and social goals. Already today, more than every second electric car worldwide is sold in China, which is now also home to the highest-volume manufacturers. In addition, the valuations of emerging market equities, including those that make a positive contribution with their services and products and therefore have above-average growth potential, are at a very low level compared with previous years and the global equity market. The end of the tightening cycle should offer additional upside potential. Long-term investors should ask themselves if this is not a good time to join in: the recent challenges might have set the stage for a rebound.
Yvan Delaplace