IMPACT INVESTING

How to make a big impact with investing decisions

Impact investing is the next iteration of responsible investing. Jenni McManus finds out what some managers are doing.

BY JENNI MCMANUS

In New Zealand, most fund managers accept that an impact investment requires three things:

1 Intentionality: investing not just to make money but also with the intention of making a positive social or environmental impact. 2 Additionally: if you did not make the investment, that social good would not happen. For example, buying shares in a listed solar company would not qualify as the shares are already listed so no new capital is being added that could be used to expand the company’s operations. 3 Measurability: Metrics are available to demonstrate how much good an investment is doing. John Berry, chief executive of Pathfinder Asset Management, says impact investing is very different from placing an ESG lens over companies and their operations, and it’s much harder to pull off.

“ESG is essentially data about companies. It helps you choose high quality companies and typically those companies will be lower risk and have higher quality management, but ESG doesn’t actually tell you whether they are necessarily changing or saving the world.

“You need to add an ethical layer on top of your investing. One approach is investing in sustainable themes, so we look at companies on an ESG basis, but we also say we want to be overweight in companies that are promoting energy efficiency or promoting renewable energy or water technology,” he says.

“In that way we’re looking for companies that are actually having a positive impact on the world.”

But impact investing goes a step further, Berry says. For purists, it is a creature of the private markets, not publicly listed companies where most ESG investing takes place.

To determine whether an investment can be properly described as “impact”, Berry suggests looking at its underlying assets. If they’re publicly listed securities, in his view they’re not impact assets.

And lobbying to move directors on and off boards is not true impact investing, Berry says. Shareholders who vote on those sorts of resolutions are simply ESG investors. Impact requires the sort of scenario devised by Engine No 1, a small and activist US hedge fund that attempted to change the board of Exxon Mobil by putting forward directors with renewable energy experience.

Though Exxon Mobil is publicly listed, Berry classifies Engine No 1 as an impact investor because it was trying to get a real-world outcome by changing the Exxon board.

Pathfinder offers investors access to impacting investing in the least risky way possible – via its KiwiSaver funds. For example, it has a stake in Wool+Aid, a business that has developed the world’s first merino-based biodegradable band-aid. “We know that every million band-aids they sell is a million bits of plastic that won’t be in the environment,” Berry says.

Through its KiwiSaver funds, Pathfinder also has an investment in Lodestone Energy which is developing solar farms in New Zealand, and Groov, Sir John Kirwan’s business that provides a mental health phone app. In the debt markets, Pathfinder has done three transactions with the charity Community Finance and offers microfinance, via livelihood bonds, for tens of thousands of women in southeast Asia.

These investments are only a small part of Pathfinder’s KiwiSaver portfolios, Berry says. “Outside of that, it’s hard for retail investors in the same way as it’s hard for retail investors to get access to private equity or a true impact fund. The private equity space is where fantastic investing can be done but it’s really hard.”

Part of the difficulty for retail investors is the illiquidity of most impact investments. That’s why KiwiSaver is so appropriate for impact investing as, like private equity, it has a long-term horizon and matches the trajectory of a growth fund. “But you keep it as a small part, so liquidity doesn’t cause any problems,” Berry says.

The Godfather

Someone who is said to have cracked the impact market is Roy Thompson, the founder of New Ground Capital.

Viewed by many industry players as the Godfather of impact investing in New Zealand, Thompson’s business has set up three impact funds around enterprise and social housing. They’re restricted to wholesale investors though Thompson says “ideally” investors should be able to access impact investing indirectly through their KiwiSaver funds.

He rejects as elitist the notion that impact investing is unsuitable for retail investors, saying the capital markets have become more democratised over

the past 20 years and there is a huge appetite, particularly among the young, for this type of investment.

But it will require a huge amount of commitment and work by fund managers who’re still wrestling with the need to restructure their portfolios in line with modern ESG guidelines. Impact, Thompson says, is “the next evolution” where a positive screen is put over opportunities and fund managers are proactively looking to invest in things that generate a positive impact.

New Zealanders, he says, are exceptional givers but have never learned to build large pools of private capital that can fund much-needed social infrastructure in perpetuity. For example, more than half the $100 billion ploughed into KiwiSaver is going straight offshore.

In part, that’s caused by a design fault in KiwiSaver itself which Thompson views as a “very significant impediment” to impact investing. Because KiwiSaver accounts are easily transferable between providers, fund managers are reluctant to invest in anything long-term. “It’s more of a problem when KiwiSaver schemes are small. But these days most are getting sizeable and some of them are very large so it’s more of an excuse now,” he says.

Measuring impact

Chris Di Leva, a director at Harbour Asset Management, defines impact investing as investment that makes a real and measurable contribution towards the UN’s sustainable development goals.

“We measure it that way because the UN has set these goals to drive better environment and social outcomes in the world. That, in our view, has set up a really good framework for when you’re investing, assessing companies through the lens of how they are benefitting the world and helping to fulfil some of those goals.”

Harbour offers a sustainable impact fund and earlier this year issued its first-ever sustainability report to inform investors about its progress and approach to investing sustainably (Pathfinder has produced a similar report).

Di Leva says measuring impact is the key. In his view, board scrutiny is “definitely” part of impact investing as it’s helping to make positive change. But Harbour also has investments in early-stage unlisted companies where it’s easier to prove the impact of the additional capital.

One such investment is UbCo, an electric utility bike manufacturer which is aiming to decarbonise the farm bike sector. Another is Calix, an Australian business that is trying to decarbonise the cement and lime industry by developing kilns that not only run on renewal energy but are also capable of carbon capture.

Most of Harbour’s funds meet the criteria of strong ESG practices, Di Leva says, and about 20% are also making a measurable impact. “We believe impact investing can be done across multiple asset classes - public and private equities, public debt and also private debt.”

He acknowledges the wide range of industry views about what constitutes impact investing. “But it would be beneficial if the industry could come to a landing point about the definition.”

Harbour subscribes to the more expansion GIIN definition, and Di Leva says it would be “a shame” to view impact investing narrowly, particularly if it excluded retail investors.

“First, if it’s purely in unlisted markets that are accessible only to investors with very large amounts of money, you’re shutting out a really large portion of the population that wants to do meaningful and impactful things with their money.

“Investment markets have come so far in democratising and giving access to investors…. I’d hate to see it take a backward step and for impact investing to be viewed so narrowly that it excludes most investors.

“Second, for meaningful change to occur in the world and for us to meet the UN’s sustainable development goals, we need tens of billions of dollars of capital. So, excluding the deepest capital markets in the world from impact investing isn’t going to be great for helping [reach] those goals.”

‘For meaningful change to occur in the world and for us to meet the UN’s sustainable development goals, we need tens of billions of dollars of capital’

Chris Di Leva

Defining impact investing

In the financial media, one of the first to attempt a definition of impact investing was The Economist, which noted in its edition of January 1, 2017 that the sector was “inching from niche to mainstream”.

“The concept of investing in assets that offer measurable social or environment benefits as well as financial returns has come a long way from its modest roots in the early 2000s,” it said.

The Economist also noted that BlackRock – the world’s largest asset manager – had in the previous two years launched a fund called “impact” and investment bank Goldman Sachs had acquired an impact-investment firm.

It pointed out, despite definitional squabbles plaguing the impact sector, investor demand was driving the activity while the United Nations and a global taskforce under the aegis of the G8 was also promoting impact investing.

For sticklers, The Economist said, investments should be described as “impact” only if they delivered both near-market levels of return and strict measurement of the non-financial impact – for example, of the carbon emissions saved by a renewable energy project.

But no matter how it’s defined, virtuous investing attracts big money. An industry group, the Global Sustainable Investment Alliance, says sustainable investment funds in 2020 managed US$35 trillion of assets, up from US$23 trillion in 2016.

Another group, the Global Impact Investing Network (GIIN), regularly surveys its members, most recently in 2020 with responses from 294 of the world’s leading impact investors. Collectively, these investors manage US$404 billion of impact investing assets.

In the foreword to the survey, GIIN founder and chief executive Amit Bouri notes that global crises are not scaring impact investors away. And in answer to its critics, he says the industry is showing signs of “slowly coalescing” around a consistent set of measurements and management frameworks.

The survey also reveals that 88% of respondents reported meeting or exceeding their financial expectations, which Bouri says might mean a shift from the “increasingly outdated perception of the inherent trade-off between impact and financial performance”.

In terms of definition, GIIN likes the phrase coined by the Rockefellers in 2007: “doing good by doing well”. A

Making impact investing accessible

BY CHRIS DI LEVA (DIRECTOR, PORTFOLIO MANAGER)

In a former life, before I was a fund manager, I used to research other fund managers. When the research meetings came down to talking about Environmental, Social and Governance (ESG) considerations, the conversations would vary. Some absolutely believed in it and actively integrated it into portfolio decisions, some believed in it but were scared that integrating it too widely would be a breach of their fiduciary duty and some believed generating outperformance was hard enough without adding further restrictions to portfolios. Few had internal ESG resources, subscribed to external research or had exclusions lists that exceeded what was required by law.

Today paints a different picture and largely for the better, as ESG integration in portfolios has become more mainstream and a key part of the investment process. However, at times it has felt like the discussion around ESG has been more about what isn’t in portfolios as opposed to what is. The rise of impact investing threatens to flip that on its head.

What is Impact investing?

The roots of impact investing started in private markets where investors provided capital to companies, aiming to generate strong incremental environmental or social outcomes alongside a financial return. The test of whether the investment was an impact investment or not hinged on whether the impact made was a result of that investment (and therefore would not have been made had it not been for the investment). This gives rise to some issues though:

1 Private markets are a very small part of the capital structure. 2 Listed companies account for around 30% of total emissions and often hold dominant market positions, meaning that if investors can influence their behaviour through voting and engagement, often large changes can be made.

Further, company disclosure has markedly improved in recent years making it easier to track and hold companies accountable for their impact goals and carbon intensity. 3 There is a wider range of debt instruments available now such as Sustainability-Linked Bonds (SLBs) that link the quantum of their coupon payment to the borrower’s achievement of an explicit sustainability target. These bonds therefore clearly incentivise sustainability outcomes. The wider range of instruments available has led to broader definitions of impact investing, such as Global Impact Investing Network’s (GIIN) definition: “Investments made with the intention to generate positive, measurable social and/or environmental impact alongside a financial return”. It has also led to organisations such as the Responsible Investing Association Australasia (RIAA), certifying several listed equity funds as impact investing funds including the T. Rowe Price Global Impact Fund (which features in the Harbour Sustainable Impact Fund).

What do we mean when we say “Impact”

Given definitions of impact can be wide and varied, Impact Funds themselves are not homogenous.

The Harbour Sustainable Impact Fund has an asset allocation which, at the surface, might not look to dissimilar to a traditional balanced fund. The key difference, however, is that each investment is evaluated and only viewed as making impact if it strongly contributes to at least one of the 17 UN Sustainable Development Goals (SDGs). The SDGs have been designed as a prioritisation of goals to achieve peace and prosperity for people and the planet, now and into the future. A key to qualifying as ‘impact’ means being able to establish a clear link to contributing to at least one SDG.

Many private market-focussed impact funds can narrow a fund’s focus on a set of impact objectives, targeting specific areas such as climate or social housing outcomes. Accessing listed equity and debt markets means we do not face resource constraints and are explicit in aiming to deliver a positive contribution across a broad range of SDGs, as opposed to limiting the Fund’s scope to a specific number of targeted SDGs.

One of the aspects of impact investing that most practitioners agree on is avoiding harm while creating impact. One of the greatest challenges we face as humans and investors is to reduce our carbon footprint in order to help reduce global warming. Today the technology exists to measure the carbon footprint of investment portfolios. In our view, a great way to avoid harm is to ensure the Harbour Sustainable Impact Fund has no carbon footprint at all, offsetting the carbon generated by the Fund’s investments by helping fund projects which prevent carbon entering the atmosphere.

Measuring Impact

Measurement of whether a company applies “good” or “bad” ESG is highly subjective, evidenced by the lack of consistency of ESG scores across providers. While measuring the impact a company can come with challenges such as data availability, the assessment of whether a company is making an impact needs to be supported by a metric demonstrating impact – the output- which importantly provides a proof-point to combat greenwashing.

The output measure will vary by company speciality. For example, Sunrun is a leading US residential rooftop solar and storage provider. It provides households a renewable energy alternative and its battery solution offers customers back-up power during power outages. The way we measure Sunrun’s impact is by measuring the emissions mitigated through use of its products.

Finding solutions

The oil & gas industry is a good example of where we have seen a huge amount of change. Investors have shied away from the industry, resulting in a much higher cost of capital for these companies. Data from Goldman Sachs suggests traditional and deep-water oil CAPEX peaked in 2006. Overall, upstream oil and gas capital expenditure peaked in 2014, according to the International Energy Agency.

This widespread avoidance of fossil fuels will be to no avail, if capital is not channelled towards replacing these sources of energy with cleaner options. In that regard, divestment has not contributed to the solutions required. That is one of the gaps that impact investing aims to fill.

History teaches us that the greatest financial rewards accrue to companies that deliver highly valued solutions to challenges. The SDGs outline some of the greatest challenges facing humanity and we believe the companies that aim to address these issues will not just deliver environmental or social value, but also generate significant financial value. A

This content is not intended as financial advice. Harbour Asset Management Ltd is the issuer or Harbour Investment Funds. The Product Disclosure Statement is available at www.harbourasset.co.nz/