Systemic change is needed in order to tackle the social and planetary problems we face. Business is driving increasingly towards greater corporate purpose and stakeholder capitalism, and its fuel must be investments that seek returns through creating a green and inclusive economy. There’s evidence for the benefits of integrating social and environmental impacts alongside financial returns. But, while the sustainable and impact investment markets have been growing in a solid trend in recent years, to provide a sustainable and peaceful world as the basis for our future economy, this approach must enter the mainstream. Fortunately, there is a lot of existing learning that can be adopted.
Re-defining value for a new chapter
The world is in a state of flux, fuelled by multiple crises. The urgency of the climate emergency and biodiversity loss crisis is increasing. And the pandemic shone light on the ‘S’ in ESG, exposing insecure work, insufficient wages and socioeconomic inequality. Moreover, these crises highlight our interconnectivity, at local and global scales. It’s clearer than ever that the economy is founded in our societies and environment; it’s not a science above the realities of being human. It therefore makes eminent sense to move towards business models that put people and planet at the core of commercial strategy. We’ve written before about the value of ‘building back better’ through purpose-driven business.
Businesses create value in the world and investment drives that productivity but, in some circumstances, that investment can support negative impacts that are also created. As well as the risk of incurring liabilities or reputational damage as a direct result of harmful externalities, cumulatively these feed the macro crises we now face, which in turn can undermine the bottom line for all businesses. Unless we factor risk, reward and impact into investment decisions, how can we fully assess potential performance, particularly in the long-term? How can unpriced, natural and human capital costs be reconciled in the investment approach? Fortunately, growing numbers of impact investors have been developing and refining this approach, creating a thriving global market.
The promise of impact
For some years now, people have been making the case for positive investment performance in sustainable or purposeful business. Commentary on this subject notes that businesses with high ESG performance tend to be well-run and have lower levels of controversies. Recent research by Morningstar and HSBC indicates that businesses that actively manage ESG risks could be more robust in a crisis and generally perform better in the long term. And there is a growing body of more granular evidence of the potential for positive financial performance from impactful investment. In relation to B Corporations, an exemplar of hardwired purpose-beyond-profit business, a 2018 report by Yale, Patagonia and Caprock describes research findings that B Corps had a 50.48% revenue growth rate during the 2008 financial crisis. It also claims that, as of May 2017, nearly every major Silicon Valley venture capital firm had invested in at least one B Corp, totalling over US$1.4 billion in deal flow.
Whilst many factors influence performance, for some investment managers a strategy founded in social and environmental impact is proving successful. B Corp investment manager, Tribe Impact Capital, has published its three year performance results to 2019. Tribe’s Medium Risk Portfolio returned 20.6% (net of fees) over the period, compared to the “ARC PCI Balanced Benchmark”, which returned 13.9%. LeapFrog Investments, an impact investment manager with US$1.5 billion in assets under management in 24 companies across 35 countries, has released its ten year performance results to 2019. On average LeapFrog companies grew 32.8%, with several growing by more than 50%.
In building back from the pandemic, there are significant impactful opportunities to pursue. Achieving the UN Sustainable Development Goals is thought to represent a US$12 trillion opportunity for the private sector. And a 2018 report from the Global Commission on the Economy and Climate stated that transitioning to a low-carbon economy could deliver a direct economic gain of US$26 trillion through to 2030, compared to business as usual. Significant public and private investment will be required to achieve these goals[1], and this presents the opportunity to invest for systemic change.
A growing market
There is a growing market for impact investing, which is maturing in a number of aspects. The Global Impact Investing Network’s 2020 Annual Impact Investor Survey updates its estimation of the size of the impact investment market to US$715 billion, up from US$502 billion in 2019[2]. Interestingly, 88% of survey respondents reported meeting or exceeding their financial expectations in their investments, and 67% were investors that had sought risk-adjusted, market-rate returns. This may suggest that we’re leaving behind the idea of an inevitable trade-off between impact and financial return. In addition, in the broader market, the Global Sustainable Investment Alliance found that the global sustainable investment market in 2018 had grown to a value of US$30.7 trillion, up 34% since 2016.
However, whilst investment activity that does not at least support long-term environmental and social sustainability continues, parts of the economy that contribute to our current problems can carry on with a ready pool of capital. There is a risk that ‘business as usual’ could detract from the efforts of sustainable and positively impactful investments. What would the world look like if all investors invested with a view to reducing the likelihood of systemic disasters, such as climate change, social unrest, and inadequate healthcare and education provision?
Leading global investment firms are taking increasing interest in impact and sustainability markets. For example, this year KKR made headlines when it closed its US$1.3 billion debut impact fund. And BlackRock declared that sustainability should be its new standard for investing, which triggered much discussion including with regard to the role of the fiduciary in taking into account the climate emergency. Whilst the spectrum of capital remains very broad, the wider market is waking up to what impact-conscious investing has to offer. Right now, there appears to be a need for greater education to help financial advisors, particularly in light of upcoming changes to the EU MiFID Directive that will require investment firms to assess clients’ sustainability preferences.
Investing for a greener, inclusive economy
Bates Wells works across a full spectrum of impact investment and social investment transactions. Our clients come to impact investing and social investing from different perspectives, with varying financial and impact goals. In this difficult period, much of our focus has been on supporting them to restructure their investments, to preserve their impact and returns, and make as productive and innovative a response as possible in the circumstances. The need for emergency funding has been great, and we were pleased to support Social Investment Business with setting up the Resilience and Recovery Loan Fund, to help charities and social enterprises get through the pandemic. However, we’re thinking deeply about what comes next.
Many of our clients provide great examples of what impact investing can achieve. We’ve supported impact driven banks to invest in social housing, and advised development focused funders creating water and hygiene solutions. Currently, we’re working with a coalition of charitable foundations, NGOs and faith groups, seeking a ruling from the charity tribunal in order to gain clarity on how charities’ investments should be aligned with the interests of wider society. And, as part of a panel of law firms, we’re working with the Impact Investing Institute on a paper and set of principles to help pension fund trustees better understand how their fiduciary duties allow – and may even compel – them to invest with impact. We hope such work will move the conversation forward and reassure fiduciaries about the existing scope for bringing impact into investment decision-making.
Sarah Gordon, Chief Executive of the Impact Investing Institute, recently pointed out that it was in the post-war period, at a time of great national debt and loss, that the UK’s National Health Service was formed. Similarly, Gordon notes that in the period following the 2008 financial crash, banks were required to increase their capital buffers. Both our healthcare and financial services systems have been crucial to resilience in the face of the pandemic. However, for all our progress, a recent United Nations report on the pandemic notes that “we could have been better prepared for this crisis. The [Millennium Development Goals] and the SDGs could have put us on track towards a world with access to universal health coverage and quality health care and more inclusive and sustainable economies. Instead, most countries have underinvested…”
The pandemic has provided us with an opportunity to hit the reset button on our economy, and there is a growing impact investment market, with a track record of delivering impact along with returns, that we can learn from. In particular, many of Bates Wells’ clients have shown us just how innovative and effective impact investing can be. But investors of all kinds have a huge role to play in the transition ahead of us and, for the sake of people and the planet, this is an opportunity for impactful change that must not be missed.
[1] Citing $2.5 Trillion Annual Financing Gap during SDG Business Forum Event, Deputy Secretary-General Says Poverty Falling Too Slowly, United Nations press release, 25 September 2019.
[2] Abhilash Mudaliar and Hannah Dithrich, Sizing the Impact Investing Market, Global Impact Investing Network, April 2019.