For investors, this has sorely tested both their patience and their convictions. Some are questioning whether these kinds of investments – aside from their sustainability benefits – are capable of living up to their promise as regards returns.
Although consumers currently seem more concerned about their spending power than the planet, global warming and environmental protection are topics that will not be going away any time soon. The extreme weather events seen in recent months are a reminder that urgent action is needed, and without an effective response these problems will only worsen.
Number-one risk
Whether we like it or not, environmental issues have become unavoidable, to the extent that global leaders now regard them as the number-one risk, according to the World Economic Forum’s Global Risks Report 2020.
As well as its importance for the future, the impact theme also represents a major opportunity for companies that can address it. After the industrial revolution of the 19th century and the technology revolution of the 1990s, we are likely to see a genuine “environmental revolution” in the coming years.
The shift to a more sustainable economy will transform our societies and, in the future, global economic growth will be driven by sectors linked to energy transition, climate change, biodiversity protection and the management of natural resources. These sectors are expected to attract huge investment, and their leaders should see rapid growth.
Two subdued years
Clearly, investors who have adopted impact strategies in the last 24 months may be disappointed with the results. It would have been more profitable to invest in luxury goods, big tech, oil and gas. As regards commodities specifically, while the conflict in Ukraine led to a focus on fossil fuels to ensure power supply, it was also a reminder of how important energy independence is. That independence inevitably requires growth in renewable energies, which will benefit companies operating in the impact space.
Returns from impact strategies should also be put into context. Over the last two years, those returns appear to have trailed the performance of major stock market indices. However, those indices are heavily weighted towards major US oil and tech companies, which skews the analysis. For example, from the start of this year to 24 October, the S&P 500 index was up 11.7% whereas its equally weighted version (the S&P 500 Equal Weight) was down 2.0%. The same is true of the MSCI Global index, which showed a gain of 7.9% while its equally weighted version was down 3.4%.
Firstly, as with any equity investment, it is essential to adopt a long-term view with impact strategies. Over a timeframe of at least 3–5 years, the sector’s superior outlook should erase memories of the relative disappointment experienced in the last two years.
It is worth remembering that the Nasdaq nosedived after the dot-com bubble burst in 2000, but is now almost six times higher than the level it reached back then. Clearly, the Nasdaq has more than recovered from that mishap. It does not always pay to be right before everyone else, but investing ahead of the curve is generally a good way to achieve significant returns.
It is worth bearing in mind that when investing in the impact space – where things are changing very rapidly – it is crucial to do so via active managers capable of identifying tomorrow’s winners, or in other words, companies that can adjust to technical progress and market developments, but also improve their profitability. Some of today’s leaders may lose their edge, as has happened to many former tech giants such as Nokia and Yahoo.
In addition, given that an impact-focused stock market index still does not exist, it is hard to compare returns achieved through this theme with other equity indices. Instead, impact managers and investors should focus on beating the historical average return from equities, i.e. 7–8% per year, or on outperforming a benchmark index, provided that they only consider the equally weighted version.
In any case, when it comes to asset allocation, diversification remains vital. Just as it would be unwise to put all your eggs in the tech basket, a maximum weighting of 20% seems sensible for impact strategies.
Although impact investments are currently struggling to take off at a time of two pivotal wars and the craze for big tech stocks, the strength of this global secular trend will win out in the end. And the good news is that as impact stocks are currently trading at a significant discount, this looks like an ideal time to invest in the theme.
Nicolas Faller