2020 May - The Netherlands

Investment managers are slowly recognising the need to react to climate change together with social and economic inequality in order to perpetuate investment results in the long term. Climate change threatens the basic elements of life for people around the world — access to water, food, health and use of land and the environment. As a consequence, people worldwide will experience declining crop yields, rising sea levels and sudden shifts in regional weather patterns. Investors now understand they can no longer ignore these developments and must adjust their investment strategies with sustainable and impactful philosophies.

Indicators suggest the financial world is finally getting back on track after a decade of global crisis. While global markets still haven’t fully recovered, for example many issued bonds still trade with negative yields as a result of central banks’ purchase programs, and investment results are still not sufficient to fill the wide gaps in the liabilities of both institutional and retail investors.

These two developments together have made many investment managers realise there must be a change of direction in order to overcome these challenges. These investment managers understand that there are not only risks for the investment sector but also opportunities. The investment sector is inevitably going to change, big time!

Correlation between impact and financial return

Impact investing can be best be defined as “impact investments are investments made into companies, organisations and funds with the intention to generate measurable social and environmental impact alongside a financial return. They can be made in both emerging and developed markets and target a range of returns from below market to market rate, depending upon the circumstances” (Saltuk, 2013).

This market is being considered to have a positive result in the possible system risks (Lydenberg, 2017). The anticipated costs related to not taking appropriate action on global warming, growing income inequality, and political dysfunction are expected to be enormous. Given this situation, companies’ investments will face increased costs from the effects of extreme weather events, climate-related migration, social unrest and growing incapacity of governments alone to address problems.

Investors actions can improve the resiliency and sustainability of the environmental, social and governmental systems in which investments occur. Doing so helps mobilise capital to address systematic problems and directs investment towards companies and funds that are better positioned to thrive in a sustainable global economy. This will encourage companies to think long-term, develop a sense of purpose, and figure out their role in making the world a better place.

How to move forward?

Following research of Grabenwarter (2012) it is strongly advisable to integrate newly defined impact investing perspectives not as an add-on to existing investment models but to apply the conceptual approach as a fundamental investment policy, realising a clear strategy and focus.

This will force the investor to focus on the specific investment goals and gaining knowledge and experience with an organised investment channel. The research made it clear that the least successful impact investors were the ones who had the largest shortcomings in the setup of their investment strategy. These investors approached investments on personal preferences and emotional ties instead of actual information.

In the investment managers’ product offering impact philosophies capitalise on new opportunities by creating new investment solutions that are best equipped to close these liability-gaps generating financial returns and the address the issues of climate change together with social and economic inequality. This requires an active management of assets driven by an impact investment strategy. The time of the benchmark-hugging approach is over; precision investing enables the manager to achieve strategic results.

Define the impact investment philosophy

The investors’ time perspective plays a big role into defining an impact investment philosophy. For example, long term investors are more exposed to physical risks like floods while short term investors are relatively more vulnerable to here-and-now regulatory risks and short-term valuation volatility.

But both types of investors can implement an impact investment philosophy around the following topics:

• Incorporate sustainability considerations in the investment process as a necessity : There are two main methodologies in order to incorporate sustainability as key considerations. The first one is based on exclusion, which can be done based on ESG information or sector related decisions. The second method is based on inclusion, which can be done by research if a company defines targets based on the United Nations’ Sustainable Development Goals (UN SDGs).

• Institutional activism : There is an increasing focus on translating shareholder engagement into concrete action. Organisations are expected to provide a detailed analysis of the risks and opportunities pertaining to its business policies and aims to improve the social and environmental impact of its operations. Companies will include Impact investors in these decisions in order to develop a long-term lasting positive impact.

• Research the supply chain : The supply chain is increasingly important for impact investors as companies are not the only factor. Company targets have to be aligned with the investors’ impact objectives, sustainability, productivity and efficiency but these must also include the vendors of the company in order to ensure a stable supply chain for optimal positive impact.

Acquiring market and sector knowledge supporting the impact philosophy

The measurement and disclosure of impact information is currently far from perfect. Data is often incomplete, based on self-assessment and using different indicators which makes it hard to compare. Even though common standards are being developed (SASB), it will nevertheless remain hard to make cross-sector comparisons. Initiatives are currently focused on the improvement of the ESG side of companies and not so much on the impact caused by their products.

This information is also important in the process of determination of the “stranded assets”. Based on the previous example where the impact investment is intended to prioritise sustainable energy is it of enormous importance that reliance on nuclear or coal-fired power plants is known. It’s anticipated these sub-sectors within the energy sector will be under pressure from tougher regulations and renewable competition.

But investors have to be selective: not all traditional market participants will be losers, and not all renewables will be winners. There is no golden investment rule that can be followed and detailed insight regarding the objective and the measurement of these objectives are very important in order to achieve positive financial and social investment returns.

New fundamentally changed technological services required

Despite these information-challenges data is expected to become more granular and consistent over time. It will not be the core objective of the investment manager to gather, clean and store the information in an efficient and consumable manner.

Market drivers ensure that technology service providers, like Impactalytics, will provide sustainable and impact integrated services with the support of state-of-the-art technology solutions. These solutions are designed on scalable and optimised platforms in order to support investment managers around the world.

Impactalytics services support impact investment strategies around a set of SDGs. For example, for an investment objective to have a positive impact on sustainable energy the portfolio must track companies supporting the UNSDGs’ goal “SDG 7 — Sustainable Energy”. Impactalytics gathers, structures and ranks company information around topics like used materials, waste and energy efficiency for the production of wind turbines. Based on this example, information concerning the delivery of an offshore wind turbine and its local impact on sea-life is of crucial importance in order to determine the net impact in social and environmental terms.

It is possible to measure impact progress in combination with several other perspectives; comparable with a rubrics while financial performance is analysed and reported according to conventional methodology. This rubrics approach is based on constant validation of exclusions of sub-industries, companies carbon reduction results and metrics based on Impact, Environmental, Sustainable and Governance information.

Impactalytics’ service solution translate, integrate and visualize any sustainable, impact and responsible investment philosophy into one investment strategy. These services ensure that information is embedded in the investment manager’s core investment process.

Moreover, Impactalytics offers real-time analyses of the portfolio invested position, based on flexible portfolio metrics combined with robust data modelling, creating a consistent way to look at investment (impact) results.

‍2018, as first published in the Financial Investigator 2018–04