21 October 2019
One of the big debates among impact investors is about whether listed equities investments can really help meet the SDGs. Peter Cripps reports
Impact investing is most often pursued via private, illiquid investments. These see investors take a direct stake in companies or projects and where they can most easily claim that their investments are 'intentional', and perhaps also 'additional'.
But an increasing number of investors are attempting to implement impact strategies via listed equities.
This approach, however, divides opinion. This feature will explore some of the arguments for and against impact investing in listed equities.
Zurich Insurance Company has a target of making $5 billion of impact investments, which will help avoid five million tonnes of carbon dioxide-equivalent and benefit five million people per year. But it has shied away from classifying its listed equities investments as impact investments, concentrating instead on real estate, private equity, infrastructure debt and 'use-of-proceed bonds', such as green bonds.
"We are of the opinion that declaring listed equities as impact investments is quite tricky," explains Johanna Köb, head of responsible investment at Zurich. "We are still open to being convinced, but we currently see listed equities as an environmental, social and governance (ESG) integration and active ownership topic. Not as an impact investing asset class."
She draws a distinction between impact investing and what Zurich refers to as "footprinting". Impact investing, according to the Global Impact Investing Network (GIIN), requires the 'intention' to generate a positive impact, points out Köb. Footprinting, on the other hand, involves assessing a company's overall positive and negative impact on people and the planet.
She is in favour of footprinting, arguing that it is an important exercise: "You should look into footprinting as much of an investment's underlying activities as you can. It complements the ESG risk and opportunity view and helps identify engagement opportunities.
"In footprinting, we look at the positive and negative aspects of what we finance – this fits listed equities very well. But the methodologies of doing so are just being developed."
But she argues that reaching the conclusion that an investment has a positive impact does not necessarily make it an 'impact investment' because this 'intentionality' can be lacking.
Some impact investors also look for 'additionality'. They want to know that their investment is helping to finance a project that would not otherwise have been financed. According to Zurich's thinking, this is when an investment can qualify as 'deep impact'.
Making an impact investment is hard in listed equities because "you buy something that someone else has bought before and [the capital] goes towards general corporate purposes anyway," points out Köb.
Tim Macready, chief investment officer at Australian pension fund Christian Super, agrees that making the case for impact in listed equities markets is tough.
"We are consistently seeking sustainability in our listed equities, but they don't meet our definition of impact," he says. "There's a few parts of the portfolio that would almost get there, for example our funds managed by Generation Investment Management, where the ESG is so strong we would almost see it as impact.
"But we have not persuaded ourselves that it's got sufficient additionality. Most of these companies would receive the capital whether we invested or not."
James Purcell, head of sustainable and impact investments at UBS Wealth Management, is also of the opinion that making the case for impact in listed equities markets is tricky.
"As an investor, if you are putting your money into companies in liquid markets then your impact, regardless of the companies' impact, is next to nothing," he asserts. "If you sell your stocks, that means someone else has bought them. You have not changed management behaviour or restricted the company from accessing capital. Your impact is extremely small."
Similarly, if you buy shares in a firm, unless it's via an initial public offering, you have not helped the company raise capital, he says.
"Buying shares in a low-carbon portfolio does not help create a low-carbon world," he argues.
According to Purcell, the only way to have significant positive impact in listed equities is for investors to use their influence to steer companies to make their impact more positive.
"Engagement is the most powerful way to have impact," he says. "Engagement can be the driver of returns, not just an ancillary activity.
"If you believe private equity can deliver outsized returns by improving operational performance, as a public market investor you should also be able to drive operational improvement, though to a lesser extent.
"We consider ourselves to be on a mission to improve transparency"
Ivo Luiten, NNIP
"Rather than buying a company because of what they do today, you can help shape what they do in the future."
He uses the example of a mining company in South Africa, which has problems around worker absenteeism and poor relations with the community in which it operates.
He says the absenteeism is partly due to health problems, which the company can help address. And the problems with community relations are caused by waste water extraction. Again, this can be solved, through adopting more water-efficient technology including water recycling, and better cleaning of waste water.
"A mining stock would often be on an ESG exclusion list. But it has potential to be one of the most impactful things in your portfolio," he says. "It's a good thing from a sustainability perspective and it's profit-positive too."
In line with this philosophy, UBS has invested in three impact funds with engagement at their heart. These are the Hermes Sustainable Development Goals (SDG) Engagement Equity Fund (see Figure 1 for top 10 holdings), the UBS Engage For Impact strategy, and the BMO SDG Engagement Global Equity Fund. These funds actively seek listed companies whose impact they believe can be improved with the help of investor engagement.
Purcell says this engagement is, whenever possible, collaborative and conducted with companies that are amenable to change.
"We strongly refer to this as collaborative engagement," he explains. "It's not activism or trying to throw your weight around. It's pushing on open doors, or else the engagement is more than likely not to work."
He says the concept of these funds is "grounded in academia".
"There's a reasonable amount of academic research that shows engagement is associated with excess returns," he continues.
Yet he acknowledges that it is too early in the lives of these funds to prove that the approach has been successful.
He adds: "I would love to say that we have a dozen killer case studies detailing the full journey from first contact to operational improvement and eventual successful exit that prove this thesis. What we do have is dozens of engagements at various stages of being successful, and very strong financial returns.
"To link one to the other in a perfect causation would be a step too far, but it is building a body of evidence that you can use your voice to engage collaboratively to trigger a virtuous process of co-linear sustainability and profitability improvements."
Among other investors seeking ways to integrate impact considerations into listed equities strategies is Dutch asset manager NN Investment Partners (NNIP), which launched the NN Global Equity Impact Opportunities fund in October 2016. It aims to invest in listed equities that offer attractive financial returns alongside a positive social and environmental impact.
The fund's literature says: "We believe that investing in impact themes enables us to capture tomorrow's financial growth drivers, while also adding value to the world in which we live."
The fund's methodology sees it take a starting universe of more than 15,000 stocks from a Credit Suisse database called Holt.
Using a proprietary system of measuring a company's potential impact on the SDGs, this list is whittled down to 3,000 potentially eligible companies. This list is then reduced to 1,300 companies by applying a financial 'quality' filter.
These companies are then tested on three criteria to determine the degree of positive impact:
Material: Do the company's impactful activities affect the company's licence to operate in its markets and with its stakeholders?
Intentional: Is the impact part of the company's strategy and purpose?
Transformational: Does the company offer a solution that contributes to a social or environmental impact?
A shortlist of some 300 potentially eligible stocks is devised, from which about 45 are selected using traditional financial analysis including ESG integration. (See Figure 2 for list of top 10 holdings.)
The resulting portfolio is biased towards the healthcare sector, where the managers "see a lot of opportunities to create positive impact", says Ivo Luiten, senior portfolio manager at the fund. The fund invests in eight solutions that help to meet the SDGs and one of them, "Access to health", accounts for 25% of the value of the portfolio, which is the maximum allowed for any one solution.
Luiten says the fund invests, wherever possible, in 'pure-plays' and is disproportionately exposed to smaller companies and those in emerging markets.
And the fund engages with all its holdings at least once a year on issues related to the SDGs. It pushes companies to invest in sustainable activities and to report more on them.
"We consider ourselves to be on a mission to improve transparency," he explains. "The criticism about additionality is fair but we use engagement to try to push companies in terms of their capital allocation. We also help grow awareness of the SDGs, where intentionality among companies can be low."
"It's quite clear that we are helping them expand a lot, although it's not new capital," he claims.
Based on its assets of €297 million ($330 million) at the end of June, the fund claims to have saved 144,401 tonnes of carbon dioxide equivalent and avoided 26,739 tonnes of waste, when compared with the MSCI All Countries World Index.
Zurich-based RobecoSAM also has a listed equities strategy that looks to invest in companies that have a positive impact on the SDGs.
RobecoSAM Global SDG Equities starts with a universe of 5,500 stocks, and whittles these down to about 850, by selecting only those that have high or medium impact. It assesses this by looking at a company's products and services, its operations and any controversies in which it has been involved.
This list is reduced to 600 by stripping out poor ESG performers (using RobecoSAM's proprietary Smart ESG methodology) and smaller, less tradable stocks. A final portfolio of 50 to 80 stocks is arrived upon following financial screening and then a portfolio construction process that gives exposure to impact in all areas.
Certain sectors such as fast food and fossil fuels are not represented. (See Figure 3 for top 10 holdings.)
Jacob Messina, head of sustainable investment research at RobecoSAM, says: "If you are an impact investor, you want to end up owning a company that delivers products and services that are useful to society. The SDGs are a clear way of describing a sustainable economy.
"We have tried to develop a methodology that covers the entire economy, that makes us owners of companies delivering products and services that contribute to the SDGs in a responsible way.
"We are hoping to provide investors with an option on a much more sustainable future."
The same approach can be applied to listed credit too, he suggests.
He points out that intentionality, but not additionality, is mentioned in the Core characteristics of impact investing document, issued by the GIIN.
"If you want to say impact is only about starting new businesses to address problems in certain underserved communities, that is a very specific definition," he argues. "And it is probably only applicable to private markets.
"With private market investments, what you do in the first year or so is additional in terms of providing capital, but after that you become the owner of, or investor in, that company – it becomes about the fact that you own a business that's doing something useful for society.
"This is not so different from owning a listed firm that is substantially contributing to the SDGs!"
But he continues that asset managers should be "very careful" about what they promise to the market: "Our promise is that we allocate our client's money to a portfolio, and the holdings have a real world impact. But we don't say that if you buy the fund something will change immediately.
"That said, if impact investors can lower the cost of capital for these firms, the companies can lower their internal hurdle rates for new projects, and this will allow companies to undertake new projects that would not otherwise have happened."
UBS's Purcell says listed equity strategies that invest in companies that make a positive contribution to the SDGs have some merit because being selected to be held by an impact equities strategy sends a message to companies.
"The mapping in itself is a form of engagement, if you publicly say: 'Here are companies doing good or bad'," he argues. "It's not the most collaborative or direct way to engage but it could be able to bring about some form of change.
"We are hoping to provide investors an option on a much more sustainable future"
Jacob Messina, RobecoSAM
"Impact is not binary – it's a spectrum," he adds.
But for Christian Super's Macready the term 'impact investing' needs to be used with care.
"When consumers say they want positive impact, they mean they want something more than saying: 'We invested in BHP Billiton and it created thousands of jobs around the world'," he argues. "They are really after a change in the way capital is being used. Otherwise, they will become disillusioned."
Proving the case for impact may be harder for listed equities than for private markets, but RobecoSAM's Messina maintains that it is an important asset class for impact investors.
He adds: "Listed assets can help allocate huge amounts of capital. If you are selecting companies that are contributing to achieving the SDGs, I don't know if you can ask for much more of listed equities, than to know what a company is doing and what it contributes to the SDGs."
"I think it is clear that impact investing in listed assets is different from traditional impact investing in private markets, and for very good reasons. Perhaps it should have a different name, but there are already a lot of names in this space, and 'impact in listed assets' is specific enough for me!"