Our panel of experts discusses simultaneously generating positive impact and attractive returns, their core investment themes and how impact investing can be done across different asset classes.
Maxime Le Floch (investment analyst – Impact Opportunities Strategy, Hermes Investment Management)
Nick Clapp (head of business development, Kempen Fiduciary)
Karen Shackleton (founder, Pensions for Purpose)
David Lanning (partner and head of research – Next Generation Fund, Arisaig Partners)
Amandeep Shihn (director – manager research, Willis Towers Watson)
Funds Europe – Which regions and sectors are attractive in terms of returns and which regions or sectors of impact are the riskiest but also offer the highest returns?
David Lanning, Arisaig Partners – We believe that investors who want to maximise the potential impact of their investments should be looking at countries where populations are much larger and where there is a greater need for investment in essential goods and services and the scope for impact is larger. India is emblematic of this with a huge population, huge scope for growth and for genuinely impactful investment, a great depth of high-quality and high-growth companies. We see similarly promising businesses in other parts of south Asia. Pakistan and Bangladesh, for example, have surprisingly high-quality companies and are great impact stories, but are also harder to access, and much less liquid markets in the public equity space.
Maxime Le Floch, Hermes – We look at the opportunity set through a thematic approach rooted in an analysis of the UN Sustainable Development Goals (SDGs). We believe that companies that generate a positive impact by contributing to the advancement of the SDGs are well positioned to have attractive returns. We have identified themes that drive our research process: energy transition, water, circular economy, health and wellbeing, food security, financial inclusion, education, future mobility and impact enablers. We thus do not organise our work by sector or geography. Currently we are very excited about opportunities in offshore wind, which is gathering a lot of speed. It has traditionally been strong in Europe and continues to see growth, but so does the US and Asia – especially Taiwan. As the Denmark and the UK examples show, it is a good way of decarbonising the grid and in the UK, offshore wind is now a significant part of the generation mix. One factor that gives offshore wind its long-term potential is that there is almost no limit on how big the wind turbines can be, whereas in onshore wind we have reached a natural limit to growth of the equipment size itself. This is important because it drives improvements in levelised cost of energy and thus relative attractiveness compared to other energy sources.
Other areas that we are very interested in include the circular economy, such as recycling equipment. There has been a trend – especially with China’s ‘National Sword’ policy coming into effect at the beginning of 2018 – of effectively banning plastic waste imports. People are realising that what we used to call recycling in countries in Europe and the US was actually sorting and the actual processing was mainly done in Asia, particularly in China. Other countries have also put bans in place and there is an increased need for more recycling capacity in Europe and the US.
A final example is the advance of genomics. We are reaching the inflection point where we do actually have therapies that are being launched. What used to be a really interesting research idea is now coming to fruition, and so there are a lot of interesting companies. We like companies that can help speed up the pace of innovation and drive down costs to make those therapies accessible to a wider population. A good example of this is genome sequencing equipment, which has helped drive down the cost of sequencing – the first step in any research and treatment in this domain – from $100 million in 2000 to $1,000 per genome today.
Nick Clapp, Kempen Fiduciary – We define impact in the same way that the Rockefeller Foundation has set it out – with the intention to make an impact, being able to measure it, in addition to having some financial result. We have identified four key themes that drive both the geography and the asset class that we are invested in. We then map the different territories using the SDG index so that we can find the gaps where there is underdeveloped funding. For us, that doesn’t necessarily mean only emerging markets, we invest as much in developed markets as well.
Karen Shackleton, Pensions for Purpose – As far as my dialogue at pension funds is concerned, returns are actually not what is driving the shift in capital towards impact investment, it is more around the interest in trying to get that capital to work more intentionally to have a positive impact on society or the environment.
I am seeing some themes in terms of interest from the client side. Property as an asset class really lends itself well to impact investment because you can invest in it, deliver a market rate risk-adjusted return and then use it in a number of different ways. These could include addressing homelessness, disability living, educational needs, and you can have a positive impact. Property is an attractive asset class for a pension fund because of the relatively secure income stream that you get from the rental income.
There is definitely interest in the low carbon transition, no doubt about it, and it is a very common theme that we are seeing now from pension funds. As David said, there are opportunities in emerging markets because of the huge need there. That of course will be a more volatile journey for the investor, but pension funds should be happy to be quite patient with their capital.
Amandeep Shihn, Willis Towers Watson – Impact investing is about creating a social and/or environmental benefit alongside a financial return. Another key concept outlined by the Global Impact Investing Network is additionality – what effect or difference have I or my investment made?
When you break down impact investing to first principles, it is about the allocation of capital – what is my dollar actually invested in? Am I invested directly in a company to provide it with capital to grow, expand or change? Or am I investing in the shares of a company which I think will have a positive social/environmental impact. If it is the latter, then what can I do to try and either improve that business, or at least have a say on how that business is run via the execution of stewardship rights? Can I vote, can I engage, if I am investing in the debt can I impose warrants, can I apply restrictions on how capital is used, how do I execute my views in terms of creating an impact on the investment?
There is no single solution because everyone comes at it from very different perspectives. The values and beliefs which underpin how everyone shapes their view on impact will therefore impact how they allocate capital and the frameworks they use to assess the outcomes. The UN SDGs are a great framework for identifying different areas where capital can be deployed in terms of creating an impact. This creates themes where investors can now effectively pick and choose which areas of impact they want to focus on from their investments.
We believe that you don’t need to sacrifice returns to make an impact, and we believe a number of our investments have made an impact in the private market space. We have invested in social housing, education and renewable energy. Our secure income fund has invested around two-thirds of its portfolio in businesses which we think have had great financial returns, but also have a wider social impact attributable to them.
Funds Europe – What are some of your main impact investing themes? How do you decide what you will focus on from an impact and investment point of view, and potentially which SDGs you may address in doing so?
Clapp – The themes for us are around good health and wellbeing, climate action, the circular economy and good working conditions. We want to be focused and not all things to everyone. We have selected five SDGs that specifically relate to those four themes, and each one of our investments needs to deliver against at least one of those themes at its very core. Then we have to make sure that we are able to measure against that, which is ultimately critical for the end investor.
As a fiduciary manager, we were able to work alongside some of our clients to help create an impact pool. Last year we were able to deploy capital, contribute to positive environmental and social outcomes and set the impact management framework for the years to come. Our investments include a broad range of financial instruments, in different sectors, ranging from credit, to be used as working capital, brown and greenfield projects in renewable infrastructure, and to private equity.
During the first year of its operations, we invested into five funds, diversified through a range of asset classes and in aggregate targeting the five SDGs. Our clients’ capital is reaching over 45 countries around the world from the US to Kenya, and to India and Togo. Despite still being early in their life, the underlying funds have achieved impressive results. For example, reaching over 20 million emerging consumers, saving over 360 thousand tonnes of CO₂ and helping to finance over 12,000 farmers.
We expect that in the following years, this impact will grow as our impact pool grows and our fund investments continue to deploy their committed capital towards businesses that strive to make a difference on the ground.
Le Floch – We have nine investment themes: energy transition, water, circular economy, health & wellbeing, food security, financial inclusion, education, future mobility and impact enablers. They drive our research: we spend time looking at thematic research and companies in these areas.
In terms of prioritising, we are not going to decide that we will focus on one theme or the other – it is not our role to say energy transition is more important than healthcare. Ultimately, we invest in companies and we need to find attractive ones from both an impact and financial perspective. Even though this drives our research process, what matters most are the specifics of each company, so where we spend most of our time in terms of impact is really company by company. We have developed a methodology around impact assessment that is focused on the specifics of each company as opposed to just taking a top-down thematic approach that can drive allocation.
Shackleton – I usually start a conversation with a pension fund by talking them through the spectrum of capital so that they understand where they sit today, which is usually around the responsible investor part of the spectrum. We then discuss beliefs, so if they are looking to shift from a value-based investment strategy to a values-based strategy, what are the things that they care about? What do they think they want to have reflected in their investment portfolio? That is a fairly strategic set of investor beliefs, so it will be things like climate concern, focusing on the low carbon transition or on health in their portfolio and so on. Whatever the investor beliefs are will to some extent dictate what the investment strategy looks like, because there are some themes that are best having a separate allocation to.
Shihn – As Karen says, a lot of it is being led by clients and investors in terms of their beliefs and how they view impact, the areas they wish to focus on and how that affects their capital allocation decisions. Not all clients will have a strong belief around how to allocate capital from an impact perspective and they sit on varying points of the impact-versus-return spectrum. Some want impact but also do not want to give up financial returns, whilst others are more willing to give up financial returns for the benefit of the impact generated by their investments. Generally, those investments tend to sit more in the private markets camp compared to public markets.
When we consider which investment strategies and managers we want to partner with and areas where we think the investments can have positive impact, we tend to be more at the returns-neutral end of the spectrum. We understand that most of our clients do not want to give up financial returns for an impact benefit, and so we will look for strategies and opportunities which still generate positive financial returns comparable with other investments they might receive. That has led us to renewable energy, social housing and education. In the fixed income space, we have invested with a manager that’s involved in African development financing. So, impact investing can be done across different asset classes, and impact can be measured in slightly different ways.
Funds Europe – How do you ensure your impact investments are delivering market-beating returns, and what constitutes a good return on impact for your clients?
Lanning – Our impact themes were selected based on areas where we are confident we can find high-quality, high-growth businesses, rather than purely on the basis of maximum impact generation.
The themes that we have selected are health, human capital development, financial inclusion, gender equality, education and environment. They are six themes in which we think we can find intrinsically positive impact businesses, and where we can make a difference through engagement, thus improving both the returns profile and the impact generation profile of those businesses. Under these themes we believe we can find truly long-term buy-and-hold growth stories where as earnings growth compounds, impact generation also compounds.
Le Floch – Our focus is on investment management and we see our portfolio as a collection of attractive individual companies.
We need to have very strict impact/financial analysis and valuation. The companies we invest in typically have some emerging growth characteristics because they are usually leaders in a specific niche, such as genome sequencing. They have very good market share, and they may have even created the market and this market is going to grow fast. There is a specific skillset to be able to assess valuation of those companies that are typically misunderstood by the market. ESG analysis is a very important part of the process, which we carry directly within the team, together with the impact and financial analysis.
The final step is portfolio management. We aligned our portfolio construction approach with research from Cambridge Institute of Sustainable Leadership around what constitutes a portfolio that aligns with long-term value creation. One of the things is to be very selective – we are currently very concentrated with 30 positions. Our time horizon is focused on the long-term.
Clapp – We focus more on market rate returns, so we let the asset class allocation shape what those market rate returns are. So, something like investing in greenfield in Europe is going to be very different from investing in agriculture in Togo, and we take that into account.
We also do not use a benchmark. We don’t see this is a relative issue, this is an absolute concept and therefore for possible investors trying to understand that there isn’t a benchmark to compare it to is an important part of the process in understanding how to become an impact investor.
Shackleton – I look at it more in terms of assessing managers rather than assessing investments. I refer to the Global Impact Investing Network (GIIN) survey, which is published each year, and over the last three years they have consistently asked investors how their investments performed relative to expectations, financially and impactfully. Fairly consistently year on year, 91% have performed in line with expectations financially. Two-thirds of those investments are market rates risk-adjusted returns. That is a staggering statistic, because I know as an investment adviser who monitors managers in the traditional space, there is no way it is 91%.
Why is it that impact investments are actually delivering with a higher degree of certainty financially than the traditional alternatives? My personal view is it’s because the impact manager has something else to sell and it’s around the impact story, and so they feel less inclined to push up the financial expectations to win the business.
Shihn – We have been assessing from the outset whether these investment opportunities could deliver from a financial perspective, and that’s been part of the reason for making them in the first place. We have had some great results, selling assets at 40% above holding value and generating multiples on invested capital and 10%-15% IRRs [internal rates of return] on cashflow-generating assets. From an individual absolute return perspective, yes, they have been meeting the financial returns criteria they were set out to.
Funds Europe – While the climate crisis is not a new issue, it is a race against time – particularly as global carbon emissions reached a record high of 37.1 billion tonnes in 2018, according to the Global Carbon Project report. How do you approach the need to curb carbon greenhouse emissions (SDG 13) and does it go hand-in-hand with other SDGs?
Le Floch – We think offshore wind is going to be one of the most attractive ways to achieve decarbonisation at scale. Onshore and solar photovoltaics (PV) have been very good and are still growing, but from an investing perspective it is more challenging because the barriers to entry are lower. In solar it can be quite ruthless, the product cycles are extremely short, typically 12-18 months.
In terms of electric vehicles, we are mainly invested in the auto parts segment. It has been challenging with the trade tensions and the issues with original equipment manufacturers (OEMs) having to comply with new regulation. There are timing issues that became quite challenging over the short-term, and longer-term questions on the economics of electric vehicles for the auto OEMs. But we believe that there are companies with leading technologies and the ability to manufacture at scale, like Hella in Germany, that should benefit from this secular transition.
The interconnection is where it gets a lot more interesting. Deep decarbonisation – the world needs to go carbon-neutral by around 2050 – requires a massive mobilisation across the economy, so it should be weaved into everything we look at.
We have shares in a bank called ProCredit who do SME financing in Eastern Europe and about 15% of their long book is green loans, so it’s for energy efficiency and renewable energy. They find that attractive because the clients who do these types of investments are higher quality and so it attracts clients to the bank. There is also climate change and greenhouse gas emission reduction from things like water treatment. In the US, 4% of electricity is used for water treatment, which is a lot, considering it’s moving mass volumes of water through pipes and using a lot of electricity. We are seeing a lot of those interactions, which are very interesting.
Shackleton – The London Borough of Islington are looking at this and are very public about it. A campaign group would come to their public meetings and every quarter ask: ‘Would you consider divestment?’ They then took some time out to think about their investor beliefs and have set themselves carbon goals on reducing their carbon footprint and their carbon emissions. They have shifted their passive to low-carbon strategies, and they have agreed to allocate 15% to impact investments – of which some will be in renewable energy. So, they considered divestment, but decided that they still wanted to engage with the fossil fuel companies. They decided that it was more than just about the fossil fuels in the portfolio, and so they are taking a more sophisticated approach of trying to de-emphasise the carbon footprint. They measure their carbon emissions and carbon footprint in the portfolio annually so that they can measure the improvement that they achieve in the portfolio over time.
Funds Europe – In an open comment section on a Funds Europe survey on women’s views on workplace diversity and equality, 20% of respondents explicitly cited a greater need for equal parental leave policies. How do you address or approach this with the companies and clients that you engage with, and are you seeing improvements?
Shackleton – I decided to go to the companies that I work with, so I started with MJ Hudson, who I put my investment advice through. They informed me that they have an equal pay maternity/paternity leave policy, and that was introduced recently, and they are unusual in the legal community in offering that, so I was pleasantly surprised.
I think that there is a changing emphasis, and many firms now are offering similar leave arrangements, paternity and maternity, and we are starting to see a change in equal maternity/paternity pay, so the paid leave being similar.
Clapp – It’s not a specific area of focus for our impact pool. That said, equal parental leave policy is probably quite a developed market issue. If we think of it from an emerging market perspective, there is an even more fundamental problem, which is sometimes just being able to have childcare so that people can actually get to work and do a job. For example, we invested in a cashew processing plant in Togo. As farmers, the value was not actually being held within the country as it was being processed overseas. We invested in building that processing plantation, which has created around 700 jobs that offer slightly enhanced wages, more of a living wage to the individuals and childcare facilities so that parents can go to work too.
Le Floch – It is an issue that is very important for engagement. The first thing to acknowledge is that the fund management industry itself has been quite bad with diversity, including gender. Seven percent of portfolio managers in the UK are women, and recent disclosures by fund managers show that there are wide disparities in terms of compensation between genders. The fund management industry needs to be better at this. Hermes Investment Management has been very active in those debates, driving an open discussion internally and pushing this issue in engagements with companies.
Shackleton – I agree that this has to be an issue that we start looking at ourselves before looking outside.
Shihn – Over the last year or two, we have been placing greater emphasis on diversity within fund managers and placing more emphasis on the cultural aspect of the teams with which we are entrusting client capital. So, we have been very focused on understanding the gender splits within the investment teams, the ethnic breakdown of teams, the number of languages spoken and the diversity of background of individuals.
There are different ways to cut and slice diversity, we are asking fund managers for data on their diversity. It’s harder to get that data in some places, and in some organisations compared to others, but assessing the data is an important part of what needs to happen to drive change in the industry. We are trying to find more high-quality female fund managers.
On the question of parental leave, it is good to have both parents having equal leave, but we need to see both parents taking it. We need to get into a situation where people are willing to take the leave, not just merely having it provided.
Funds Europe – The Global Impact Investing Network estimates the current size of the global impact investing market to be $502 billion. What are your expectations for impact investing over the next five years and which themes are you most excited about?
Shackleton – When I set up Pensions for Purpose, I set a personal goal of wanting to see pension funds allocating at least 5% of their assets to impact investment before I retire. At our conference last year, we asked pension funds where they saw themselves now and in three years’ time in terms of moving along the spectrum of capital. In three years, 58% said that they would like to be allocating to impact investments, compared with 16% who were already doing that in 2018. That is a 42% shift in the number of funds who said that they expected to be allocating to impact in three years’ time. That is a big swing in capital that will require scalable opportunities if the demand comes through, and some of those will need to come with liquidity. That plays to the listed markets quite well, but equally as pension funds become increasingly cashflow-negative, there is a desire for secure income. The impact space is where some of the private market opportunities could really come to the fore in terms of stable income but still getting a positive impact.
Clapp – As the asset managers and the investment consultants, we also need to take a leap and express this as well, not just wait for the client. It falls into two areas. From a UK defined benefit institutional investor’s perspective, they are facing up to regulations really for the first time, and so that is very much in their crosshairs at the moment. There is a distinct possibility it could be a box-ticking exercise for many trustees this time around, but that will then be a catalyst for change and impact investing might be an area that they end up heading towards.
From the supply side, there is work that we can do. Clearer taxonomy is needed and there needs to be greater collaboration between the asset management community and how we help the end buyer, the asset owner, understand what this market is about because it is very new to them at the moment.
Lanning – From the changing profile of some of the clients we deal with, we sense that there is a growing motivation to understand more about impact investment and to find promising impact investing opportunities. What encourages me is that some early setbacks do not seem to have derailed impact investing as a movement; there is more and more interest and most impact investors are doing a really credible job.
Le Floch – It will obviously first depend on global macro conditions, and how those funds will perform if the economic conditions become more challenging. I think that the secular drivers around the need for decarbonisation, for instance, are powerful enough to endure beyond economic cycles.
One trend I would expect is that, as the question of whether impact investing offers attractive investment opportunities gets clearly answered in the positive, the focus shifts to more scrutiny on how different players go about implementing strategies. There are players we regard highly who are very high quality and try to do things with a high level of integrity, but then there is also an awful lot of very simplistic approaches to impact investing – and to ESG more widely. I would hope that as the sector matures, the market would gravitate towards the higher quality. I would also hope that we would see the momentum continuing to accelerate and drive real-world impacts, with companies seeing that providing solutions to global social and environment challenges can benefit their financial performance and attract long-term capital.
Shihn – In the broader sense of the word, every investment should follow an impact framework and depending on how you define it, stewardship is a big part of that – i.e. what do you do with your voting rights and your ability to engage with corporates? For that, we need the larger investment houses to up their game, be more proactive with their voting rights and their engagements with company management. That has a big impact on society in terms of how capital is currently allocated within public markets. But if we focus on pure impact, it will be a growing trend over the next five years and we will see more themed and focused strategies dedicated to delivering an impact.
In five years, I hope everyone agrees on general principles around taxonomy and measurement. However, we will also get to a place where it may be harder to disentangle what is a thematic beta versus what is investment skill in choosing the right investments within that theme as thematic investing gets more popular. That might make it harder for investors to allocate capital to those who are actually creating the impact.
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