Big pension funds have already set pretty steep targets, and asset managers are developing products relating to the goals. This is moving impact investing to the next level. It is going from niche to mainstream, from illiquid to liquid investments, and from direct impact projects and investments to understanding the impact of all companies and countries. So it’s time to elaborate on the basics of impact investing.
The definition of impact investing is: “Investments made in companies, organizations and funds, with the intention of generating a social and environmental impact, alongside a financial return.” There are three key elements to it:
Intentionality: the investment should intend to create a positive social and/or environmental impact
Financial return: the investment is expected to generate a financial return
Impact measurement: the intended and non-intended impacts need to be measured and reported on.
So before investing, it needs to be clearly defined what is the fund’s intended impact, and what is the expected return (and risk). Based on this intent, measures for impact can be defined and monitored.
SDGs provide a good framework
The SDGs provide a good framework with which to determine the intended social and environmental impact of an investment or project. They were launched in September 2015 as a successor to the Millennium Development Goals, which consisted of eight targets. A lot of progress was made, but many global issues still need to be resolved.
With the launch of the SDGs, the UN specifically invited corporates and financial institutions to contribute towards achieving the goals. Some of the largest pension funds and asset managers have taken up this challenge. The 17 goals are shown in the chart below. Not all of them are equally investable, and not all of them are relevant to all organizations. So, some investors have decided to focus on a few of them, while others have grouped them into higher level goals to be targeted. These goals have though proven to be a convenient framework with which to define the impact that an investor aims to have.
For each goal, the UN gave guidance as to what the intended impact of each goal was. For example, SDG 3 aims to promote good health and well-being, including long-term targets for the elimination of serious diseases such as malaria. On a more functional day-to-day level, it promotes the attainment of affordable and universal health coverage for all, but also aims for a halving of the number of global deaths and injuries from road traffic accidents.
This is where corporates can become directly involved. Taking a closer look at these specific aims, it is clear that assessing the impact of a company on this SDG is less straightforward than you might think. For example, not all healthcare companies automatically contribute to achieving SDG 3: there should be a greater focus on activity that combats certain diseases, and regionally more on targeting developing countries.
And it is not only healthcare companies that can contribute to this goal; those involved in transport and finance, for example, can also help. Meanwhile, companies can also contribute negatively to the goal such as through pollution or unhealthy products. This negative formulation is needed, because in measuring the overall contribution, the difficulty often lies in balancing the positive product contributions with the sometimes negative process contribution.
Financial returns still needed
Most institutional investors require a competitive financial return for their impact investments. However, as the field is moving from traditional impact investing initiatives to a more mainstream approach, and the field is fairly new, investors might also consider making investments with unproven returns. In my opinion, investing in companies that provide solutions to global problems just sounds like a solid investment strategy!
And as the goal of impact investing is making a clear difference in a social or environmental context, we also need to measure this impact of our investments. Currently, what is measured is generally outcomes (CO2 emissions, employee engagement results etc.). Impact measurements is about outcomes like the increase of biodiversity, a reduced impact on climate change, and the economic growth created. Traditional impact funds have already developed methodologies to measure their results: in microfinance, for example, outreach to women and rural areas, and the jobs created are measured.
In the corporate space, another interesting example is how the food ingredients maker Christian Hanssen targets SDGs. It makes food cultures & enzymes, health and nutrition products, and natural coloring ingredients. It has determined that 81% of its products actually directly positively contribute to the SDG goals 2, 3 and 12 by promoting sustainable agriculture, improving global health and reducing food waste.
And in academia, many scientific frameworks have been established to measure impact. Scientists and the financial industry need to work together to come up with practical solutions to this measurement challenge.
So, even though the challenges and hurdles are plenty, taking impact investing from niche to mainstream will be the way forward. The financial industry needs to take on these challenges in order to really show that impact investing can be implemented on a large scale to bring change, where change is needed.