By Jim Neumann, CIO, Sussex Partners – The news that Blackrock is to advise the European Commission on how the EU could boost the growth of green finance and build the market for sustainable financial products is a welcome announcement. It is also a long overdue step forward.
By Jim Neumann, CIO, Sussex Partners – The news that Blackrock is to advise the European Commission on how the EU could boost the growth of green finance and build the market for sustainable financial products is a welcome announcement. It is also a long overdue step forward.
For many years, institutional asset managers and allocators have been calling for the development of consistent ESG standards that can be universally adopted and applied to investment decision making. These alternatives allocators, to both hedge fund and private equity style vehicles, now seem to have assets ready to deploy as standardisation occurs.
Five years ago, in September 2015, when the United Nations published its 2030 Agenda for Sustainable Development, it established 17 Sustainable Development Goals (or SDGs), each one covering a different area from hunger eradication to clean energy and climate action.
While it was no doubt an accomplishment to get all the SDGs laid out and at least somewhat described, it is the implementation of these which is of paramount importance to those seeking to make an impact with their investment dollars, and while ESG criteria are defined, the objective measurement of these is still unresolved. Until common measurement criteria are equally defined and widely accepted, investors will struggle with this aspect of their portfolios.
As responsible investing transitions from theory to action, it is increasingly important for investors to know that their allocations are having the desired effect. The amount of investment dollars that is targeted or will be targeted by investors towards ESG, SRI and Impact Investing are staggering. In the US alone, SRI and Impact are estimated to account for USD1 of each USD4 currently invested, or USD12 trillion in AUM. The Global Impact Investing Network (GIIN) estimates impact investment assets at USD502 billion.
While ESG, SRI and Impact Investing are too frequently used interchangeably as terms, each has a different meaning and distinction is important here.
ESG and SRI in the public markets typically involves screening methodologies to include or exclude investments, and it is Impact investing that most notably seeks to achieve a measurable change from the investment. ESG and SRI might be found in long-only funds, but are increasingly housed in long/short hedge funds. The impact objective may be best expressed by targeted thematic, generally private, investment around the UN’s SDGs.
Impact investment generally comes with PE-style structures and liquidity so eliminates those investors that require greater liquidity, pushing them towards ESG or SRI.
The “holy grail” is synthesising the need for return on invested dollars and the positive impact whether environmental or social. The ability to make investments that meet the financial return objectives without discount for positive intention, and which deliver these previously believed conflicting rewards in harmony is the goal of a new breed of investment managers.
Impact funds operate around different SDGs and some arguably have too broad a mandate. Impact investors however are increasingly focused on targeting specific goals, thus having more control over asset and impact allocation. Having decided on the impact(s) desired, the investor can look to the SDG (or across SDGs as there is overlap) and then select the manager targeting that impact, directly and tangentially, most effective.
So if, for example, concern centres around deforestation or desertification, SDG 15 “Life on Land” should be targeted; for Oceans/Seas, SDG 14 “Life Below Water” will be most appropriate. The problem of overly broad goals or unmeasurable ones need careful consideration.
There is generally no shortage of fund professionals that possess the deal expertise to source investments, assess the financial details, execute, shepherd, and finally to exit investments. Asset managers have embraced Impact investing, aware of the tide of capital that is coming into the space.
However, managers have generally failed to staffed up sufficiently to deal with the non-investment issues, particularly the science understanding and measurement of impact. This is changing and both the key elements of execution against an SDG (including all the needed science behing that) and the measurement of that execution are being addressed.
If one peruses the “Moves” sections of financial publications, the theme of establishment of dedicated ESG personnel resources within asset managers of all types including alternatives like hedge funds is quite apparent.
It seems imperative, at least, for climate, land, and ocean impact investing which are often seeking new technological solutions to have deep scientific knowledge around the problem resolution, and impact of the solution.
Brad Harrison, co-head of USD3 billion Impact/ESG investment strategies at Tiedemann Advisors, which has a total AUM of USD22 billion, recently commented: “Impact funds designed around specific ecological SDGs need to ensure that their capabilities span both financial and scientific realms.” It is, after all, the marriage of thoughtful science and protective deal terms which improve the odds for anticipated performance including measurable impact.
This is particularly applicable to the early and growth stage investment periods in which many of the hopeful technologies lie. The informed scientific evaluation of relative technologies providing some solution trumps or at least is of equal importance to the financial details.
The second common problem is the way to measure impact versus the investment goal. While most will have an IRR target associated with an investment, quantifying the impact by non-financial measures is challenging. Perhaps unsurprisingly so as this concept is a relatively recent one. Fortunately, as managers increasingly understand the importance of being able to quantify non-financial impact to their investors and other communities, methodologies are being developed at both the manager and industry levels.
Obviously, some goals lend themselves to impact measurement with greater precision than others and thus there will likely be a range of measurement outcomes. However, the difficulty of measurement should not sway managers or investors from seeking to get this into the most standardised format possible with a goal of being able to confidently refer to both the IRR and the impact IRR of an investment/portfolio/fund. And market regulators, not just in the EU but in all investment geographies, have a role to play here too.
After years of discussion, deliberation and consideration by all communities in the investment chain, it feels as if investing around principles and objectives that reap social or environmental benefit is finally taking hold in an industry-wide global way. Despite the meaningful disruption to all markets from Covid-19, ESG if anything is more front and centre for allocators of all stripes. Amongst the popular options of ESG, SRI, and Impact is a profile that suits almost any investor’s return, liquidity, and objectives profile.
Impact investing is the purest expression which allows the investor to target a goal and measure the goal impact in addition to reaping financial return. It is this approach augmented with science and quantitative evaluation that has attracted a significant flow of funds and which can change the way institutions invest.
While the investment may be in public or private markets, in long-only, hedge fund, or PE format the trend has been established. Once investment committees are able to operate under some new normal realm, SDGs will all be examined through the lens of the crisis and the outcome is likely to be a stronger case for Impact investing than ever before.
