17 March 2022
Safeguards against false claims of positive impact are necessary to protect the market, writes Alberto Monzonis
According to the most common definition, impact investing is the process of intentionally making investments with the aim of creating a measurable beneficial impact on the environment or society, as well as earning a positive financial return.
Impact investing would therefore fall within the spectrum of different 'responsible investment' strategies – in other words, investment that integrates sustainable or environmental, social and governance (ESG) aspects into the decision-making process in one way or another. If we order the different investment approaches, from the lowest to the highest "weight of responsibility" in the asset selection process, impact investing would be on top, just before philanthropy, differing in the fact that in the case of impact investing a competitive financial return is also pursued.
Getting a financial return while your money creates a positive impact on the world is an appealing concept, especially to capture the interest of the millennial generation, or 'the purpose generation' as some experts call them.
Knowing this trend, institutional investors are striving to incorporate impact-generating messages in financial products that in one way or another include ESG aspects, sometimes with a desire to generate impact and sometimes assessing the impact generated as part of the asset management process.
At the same time, it is easy to see how this investment approach is permeating from the institutional investor to the retail investor.
Good news? A priori, yes. More practitioners of this approach mean more resources for those initiatives that seek to create a better world.
However, like any concept that becomes trendy, impact investing suffers from the risk that some of its practitioners, through ignorance or malicious interests, use the name to promote something that is not based on the fundamental values of this investment technique. This is common when a movement reaches a mature stage of expansion, as has been seen across several aspects of society - including the environment, with 'greenwashing'.
Impact investing is a minority investment approach. According to the Global Sustainable Investment Alliance, in 2020, of the $35 trillion in assets broadly defined as 'sustainable' globally, $352 billion were managed based on an impact approach, a sum which represents 1% of the total.
There is good reason for this. Impact investing is a very complex investment approach for the asset manager, given that:
- It is highly selective. It is not enough to discard options that are not adequately managing their ESG risks. The final net result for the company must be positive and significant. In fact, it is desirable to obtain the maximum 'Social Return of Investment' per unit invested and is often an element of comparison between investment options. As a result, asset managers have an added difficulty in finding options that allow them to achieve the expected financial return.
- It requires a high level of measurement and management effort throughout the process. It is necessary to establish a prior framework in which the impact objectives that the asset manager wants to pursue are established, usually through an evaluation framework known as 'Theory of Change'. In addition, a very detailed process of quantitative assessment of the potential impact must be established, which will be used in the selection, management and exit stages of the investment.
For all these reasons, real impact investing is not an easy product to mass-market. If we want to ensure that the concept does not become an empty marketing tool, we must require a number of safeguards before selecting financial instruments based on these techniques.
The following are some green flags to consider when evaluating this option:
- The financial product is clearly impact-oriented, in other words, the search for impact is not a side-effect of the process.
- The asset manager uses recognised frameworks such as the COMPASS for Comparing and Assessing Impact methodology published by the Global Impact Investing Network or its analysis and decision-making process is shared transparently, either publicly or on demand.
- The impact assessment is carried out by an independent external party that does not benefit from the approval or non-approval of the evaluated asset.
- The process is audited by an independent external party.
- The organisation has a track record of credibility and transparency in offering past financial products.
The promotion of impact investing is desirable for society, and we would all benefit from this form of capital allocation being used not only by institutional investors, but also by retail investors. We all have a responsibility to demand the necessary guarantees to ensure that the supposed positive impacts we are financing are permanent, significant and verifiable.
Alberto Monzonis is an independent advisor expert in the inclusion and development of ESG aspects in corporate strategy.