Alexandre Sion, ESSEC Business School Runner-up in the 2021 CoBS student CSR article competition, explores the challenges impact investing faces on the world’s capital markets and the success factors that institutions and investors can help craft.
Game-Changer: Making the case for impact investing, by Alexandre Sion, ESSEC Business School.
Every other Sunday, I speak to my neighbours. We catch up on the latest in our daily lives, and from time to time discuss our thoughts on some investment opportunities. Yet we invariably draw the same conclusions: there’s no free lunch and always think ahead.
Looking at the historical data of the S&P 500, you could say that over the past 40 years this was undoubtedly a winning strategy. But the spectrum of international capital markets is shifting irreversibly in a way that leaves more than one dumbfounded. Negative oil prices in 2020. The unexpected surge of bitcoin. Even the surreal demise of certain Hedge Funds in their shorting strategy of GameStop.
This environment has generated much confusion, and a fair deal of anxiety among ordinary investors, wary to fall upon stable and profitable classes of assets. At the same time, one shouldn’t ignore that investors come in all shapes and sizes: some are in for the short-term, while others look at the next decades; some abhor risk while others crave for high returns. At the same time, we observe a lot of good will around us in trying to successfully tackle the issues involving climate change and social inequality.
Yet we also realize that with limited financing capabilities, many initiatives risk being put back on the shelf. We therefore understand that the fundamental question is whether our current financing systems are compatible with ethically, socially and environmentally sustainable trends. In other words, can finance, as we know it, save the world?
An irreversible trend
According to the Global Impact Investing Network (GIIN), impact investments are “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”. What’s quite remarkable is that we aren’t exactly speaking about socially responsible investments.
Impact investing goes way beyond, as not only does it demand that a certain number of environmental and social criteria be met, but also requires a minimal rate of return, as any traditional investment would offer. In 2020, the GIIN reported that over 67% of all impact investments were expected to deliver market-rate returns. In fact, when the GIIN asked investors if they were satisfied with their returns, over 88% said their investments were at least in line or even outperforming their initial expectations. And we are just at the beginning of the trend: according to PwC, assets in sustainable investment products in Europe will triple, reaching a staggering € 7.6 trillion by 2025.
This is a fundamental game changer, as impact investing has the potential to unleash mountains of capital to serve the interests of the sustainable society we crave for. Ultimately, it is the undeniable proof that we are able to successfully and optimally combine capitalism and our aspirations for a global pattern towards sustainability.
Yet in order for this trend to materialise, it can’t be taken lightly. By collectively adhering to impact investing, we will be upping the ante for corporations to reevaluate their degree of exposure to socially and environmentally responsible standards.
We see this in an increasing number of annual reports, especially in CAC40 companies here in France, where the declaration of extra-financial performance report is an increasingly scrutinized document by investors, to the point that they must be audited by certified parties. Whether Air Liquide, Schneider Electric, LVMH or L’Oréal, all have demonstrated a willingness to disclose their involvement in these issues, and ultimately report the impact they have on matters related to socially responsible practices and the environment.
This trend will certainly be bolstered in the coming years not only because of the risk of losing investor capital, but also thanks to the increasing legislative apparatus put into place, especially in Europe. As an example, the 2014/95/UE directive of the European Union imposes large corporations with more than 500 employees to disclose information regarding the way they deal with socially or environmentally related issues.
At a national level, France has created legislation in this respect, especially the PACTE law in 2019, allowing companies to include in their official statutes their purpose (raison d’être in French). The extent of this law stretches beyond conventional responsible publicity, but rather legally binds corporations to the mission they declare for themselves.
If the regulatory environment is becoming increasingly favorable for these types of investments, there are also some risks to factor in the equation. It is common knowledge that greenwashing is all the rage these days, especially when it comes to corporate responsibility. However, a few days before writing this article, the European Union issued on March 10 new rules not only designed to avoid greenwashing, but to also bring, perhaps, a semblance of structure to a very new realm of finance.
Under the new regulatory push, investment products will now have to be classified as “sustainable” or “non-sustainable”, with fund managers having to subsequently be compelled to undergo tough disclosures. In other words, thanks to this milestone, it has never been safer and more credible to invest in ESG funds.
Our collective effort starts individually
In order to exploit the full potential impact investing has to offer, we should start by aggregating individual efforts. One way is to target employee pension choices towards ESG funds. According to David Macdonald, founder of The Path, an advisory firm specialising in impact investing “moving a £100,000 pension pot with a traditional portfolio (…) to a positive impact portfolio is the equivalent of taking five or six cars off the road a year.”
This has the advantage of taking a highly personalised approach. As you’re the one who ultimately decides what you put in your pension, you choose what are your ‘red lines’ (not investing in tobacco, alcohol or fashion for example) and what your appetite for risk is. Therefore, it appears to be much easier to invest in financial products generating impact if you are already convinced of the environmental and social fights you pick. In other words, impact investing can turn out to be a long-lasting success if individual investors work out their priorities while building diversified portfolios.
And if one can be concerned about the availability of such funds, in particular for pensions, these are proliferating at an impressive rate. Whether Aviva, or BNP Paribas, all are increasingly incorporating ESG principles while developing such responsible funds.
Accelerating the trend: Breaking into public equity markets
As said earlier in this article, impact investments not only do good to society, they also do good to your portfolio. Last February, a Moody’s report forecast that ESG investments will be the main driver of assets under management in 2021. However, even though the forces behind impact investing are gaining pace, it risks bypassing a key solution to open up this opportunity for a vast array of investors. We know that, from a historical standpoint, public equity markets have been overlooked by the impact ecosystem, the former favoring more traditional instruments like fixed income or private market financing. The problem with these tools, especially private market financing, is that they don’t offer the same scalability and access as public equity markets do.
The idea is the following: if you buy stocks on capital markets from a company, the probability that you are going to generate impact is remote. In order to create impact in ESG fields it could, therefore, be more accurate to concentrate on private markets. The main advantage of public equity markets compared to the traditional stock market is the possibility to operate additionality. This concept, born in microfinance, shows that if it weren’t for this specific capital, a particular sustainable project could not have seen the light of day and created impact. In other words, the capital you invest is directly linked to the specific business generating impact. Hence, the capital generated impact.
This is quite an attractive idea in theory. Yet, as mentioned earlier, the issue with these private financing platforms is their limited scalability, while we know that the issues with which impact investing grapple require much higher amounts of capital. The alternative is therefore combining the agility and proximity of public equity markets with the concept of additionality, by binding together additionality through the investor’s contribution, through the investee’s business model and through the asset class. This is what the fund manager BlackRock has initiated, by offering its clients the possibility to invest in funds dedicated to companies respecting the United Nation’s Sustainable Development Goals (SDGs), notably through its fund BLK Impact Universe.
Additionality through the investor’s contribution can be achieved in various ways. The investment should first be undertaken with a long-term ownership mindset, enabling the target company to achieve its long-term goals and build meaningful impact. These investors can also bring in capital directly, without having to go through an IPO, when the company needs funds (even though its stock is temporarily unattractive). Investors can, finally, keep a close eye on key KPIs relating to specific environmental and social standards, to keep the corporation in check.
On top of what’s been said regarding the investor’s contribution, the success of impact financing through public equity markets may only be achieved if the company is willing to operate with innovative business models and place at the center of their operations the impact it seeks. This last condition could be called the “materiality” criteria, and it could require, for example, that a certain percentage of revenue ensures that a major environmental or social issue is solved.
Ultimately, we understand the crucial role finance will have to play in deploying sustainable solutions for the future. Yet the forms in which this will materialise still remain unclear. Our chance is to be able to be a part of the crafting of these new paradigms, practices and patterns. Impact investing should undoubtedly be integrated within them, perhaps even at the center of global financing schemes. Time will tell.
- 2017 Annual Impact Investor Survey, The Global Impact Investing Network, 2017
- European Directive 2014/95/UE of the European Parliament modifying European Directive 2013/34/UE relative to the publishing of non-financial information and information relative to diversity in some large corporations, Eur-lex.europa.eu, 2014
- How Green is your pension? Josephine Cumbo, The Financial Times, February 26 2021
- Greenwashing in finance: Europe’s push to police ESG investing, The Financial Times, March 10 2021
- Invest with Impact, the case for impact investing in public equities, BlackRock, 2020
- Link up with Alexandre Sion on LinkedIn
- Read a related article: The What and Why of Sustainable Finance
- Download this article and others in the book Responsible Finance & Accounting
- Discover ESSEC Business School, France-Singapore-Morocco
- Enquire about the ESSEC Master in Management degree.
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