Can impact investing work in listed equities?
The expansion of impact investing into public equities, largely prompted by the United Nation's Sustainable Development Goals (SDGs) initiative, has raised much debate. The reason for this is that there are a number of grey areas to consider when it comes to applying impact investing to listed markets. Simply applying a catch-all ‘impact’ label to all environmental, social and governance (ESG) investments does both approaches a disservice.
Perhaps the best way to highlight the challenges of public market impact investing is to show how it could be applied in practice.
The developing world is where capital is needed most
The liquidity, transparency and scalability of public markets means they have the capacity to ‘move the needle’ in terms of impact.
Research shows that in 2011 some 71% of the world’s population lived on less than US$10 a day1, and as such, firms have a massive opportunity to grow into a market simply by servicing people’s basic needs.
Companies that can supply goods or services, like essential medicines, clean water and sanitation or basic financial services are in a position to make a positive impact.
We are most interested in corporations that look to tackle such problems by broadening access to their products and services, especially to underserved populations, through lower prices, wider distribution or education. This is usually made possible by leveraging their scale, tapping public sector support and/or simply being innovative and focused.
How do we do it? Impact investing must go further than ESG integration
When creating a public equity impact strategy, a number of objectives must be fulfilled concurrently. As always we look for companies that we believe can generate significant, sustainable shareholder value over the long term.
In terms of 'impact' we are looking for companies offering products and services which provide useful societal benefits for either their customers (e.g. healthcare, education and agricultural solutions) and/or for society at large (e.g. renewable energy and water conservation strategies). We may also include firms generating impact via their operational strategies, such as unique corporate social responsibility programmes, or through their targets to significantly cut CO2 emissions and/or landfill waste, for example. Our feeling is that only the stand-out groups should be considered as operational impact companies.
To work this into an equity strategy, we have developed a framework of 14 impact themes covering three broad territories of impact – these include; social impact (e.g. healthcare or education), environmental impact (e.g. climate change or sustainable living) and economic impact (e.g. livelihoods or productive infrastructure). Some impact funds may focus on a single theme or a narrow list of themes, such as climate change or water scarcity. Others may target multiple themes, and therefore, may be grouped together under umbrella themes that help clients to better understand the fund’s focus, such as 'inclusion', 'enabling', 'well-being' or 'planet action'.
Based on the impact themes selected, each strategy explicitly addresses a number of UN SDGs through our core investment themes. In the case of emerging markets, umbrella themes might include providing for basic needs, enabling the population to participate and contribute to commerce, and/or increasing social mobility. From here we categorise potential investments under each theme and develop an active engagement strategy to deliver positive social impact.
Investment themes and UN SDGs
In any impact investment - through public or private markets - the specific objectives around the explicit impact themes will form the basis of the strategy.
Typically, the investor should have some sort of theory of change. For instance, what types of micro finance or infrastructure solutions and outcomes actually help to resolve targeted SDGs, and what types don’t? These theories can then guide fund managers in terms of their investment decisions as well as in establishing which impact key performance indicators (KPIs) to monitor. A lot of work should go into which KPIs to use, to ensure that firms can viably disclose the necessary data, and that they really do provide valuable insight into whether positive change is occurring.
Promoting greater economic participation in under-served populations is a particularly good example of how we frame our 'enabling' umbrella impact theme within emerging markets. This area incorporates financial inclusion, enabling technology, and productive infrastructure. The investment opportunity in this space is very exciting, where technology adoption is providing opportunities for companies to disrupt incumbents and to cater for potentially huge addressable markets that were previously inaccessible. Rapidly rising smartphone adoption, the proliferation of electronic wallets and more widespread use of biometric identification are opening up a wave of new markets in many broad areas such as ecommerce, payment solutions, micro insurance and online learning. We believe the winners will be those bringing the underserved into the formal economy quickly and responsibly, and the potential rewards for these companies could be huge.
Below we outline how we frame our investment case in terms of delivering positive societal impact as outlined by the UN SDGs .
Impact umbrella theme: Enabling
Creating opportunities and making lives easier through finance, productive infrastructure and technology
Lack of financial penetration is an impediment and a problem but it also represents a huge opportunity for innovative financial companies and the economy at large.
Investment and growth opportunities are easier to facilitate through the development of a stable domestic savings base and the use of technology, such as smart phones, to bring people into the formal economic system
Applying an impact investing philosophy to public markets requires a cohesive framework, firstly to identify themes to be addressed, and then to carefully assess the relevant underlying investments. Equally the investment manager will need to tenaciously encourage better company disclosures on societal impacts and try to track and report on appropriate KPIs. However, it is this reporting discipline - giving a clear indication of the positive societal benefits that have come about as a result of the investment - that is key in helping to establish impact investing’s credibility in public markets.
1Source: Pew Research Centre. “A global middle class is more promise than reality’ (updated August 2015). 15% were classed as ‘poor’ (under $2 a day), and 56% were class as low income ($2-10 a day).