Intent on Impact

Asset owners are overcoming internal and external barriers in their pursuit of positive impact.

How do we invest for impact? What are the risks, opportunities, and barriers? As investors, how do we ensure we’re investing in firms, projects and assets that are having, on balance, a positive impact on society and the environment? How do we measure their performance, and demonstrate our own to stakeholders?

Investors need to decide the impacts they wish to target and the strategies with which to achieve then. To reduce carbon emissions, for example, does engaging with high-emitting incumbents like Shell, with the aim of accelerating their transition to renewables, count as positive impact? Or do we focus on the disruptors, backing firms that are revolutionising tired, slow-moving and carbon-intensive sectors, like Tesla, or its equivalent in other industries in dire need of change?

In mid-September, ESG Investor and Artemis Investment Management gathered asset owners and other experts to consider the current and future state of impact investments. Appetite for impact was strong, guided by emerging frameworks, but the forces of inertia were present too, both internal and external.

For many asset owners, the motivation for seeking positive impact comes from an appreciation that limiting negative impacts, through management of ESG risks, is in insufficient to address profound and urgent systemic risks. Just as importantly, from the perspective of serving the interests of beneficiaries, positive impact offers alpha opportunities.

“Investor motivation for seeking impact is coming from an extension of an established philosophy, i.e. looking beyond ESG risks and taking a longer term view that considers a better future state of the world. As awareness grows, so is the availability of product,” said Sarita Gosrani, Director of ESG and Responsible Investment, at investment consultancy bfinance.

Vast opportunities

In theory, the opportunity set is vast, meaning asset owners are often in need of definitions and frameworks to guide them from the reducing negative to accentuating the positive.

As Gosrani noted, existing priorities can mark the entry point to impact. Driven by its mission to create a better future for its members, UK pension scheme Railpen’s active ownership approach embraces climate transition, biodiversity, worth of the workforce, modern slavery, sustainable financial markets and responsible technology.

“Taking climate specifically, work to date has been skewed towards risk management versus opportunities,” said Chandra Gopinathan, Senior Investment Manager, Sustainable Ownership, at Railpen. “There is a better understanding today around decarbonising businesses and portfolios, but to increase exposure to climate opportunities we need to better define and classify these solutions.”

London CIV, which invests £48 billion on behalf of the capital’s local authorities, also takes stewardship priorities as the basis of its approach to impact.

The scheme’s methodology for identifying stewardship themes considers global drivers, client priorities, social impact, financial materiality, and regulatory risk factors. The responsible investment team calculates where investments might be having a negative impact, for example on climate or water risk, human rights, diversity and inclusion, or biodiversity, before looking to identify opportunities for positive impact.

“Our approach is geared towards reducing the negative footprint of investments, whilst maximising the environmental and socioeconomic returns,” said Jacqueline Jackson, London CIV’s Head of Responsible Investment, acknowledging also the greater opportunity to “clean up existing funds” at present.

London CIV has recently signed up to the Impact Investing Institute’s (III) Impact Investing Principles for Pensions, co-created with Pensions for Purpose.

“The Impact Investing Principles have been really helpful, especially given the increased scrutiny of funds and concerns over greenwashing. It has been useful in shaping our own framework as it enables us to align our activities to credible principles, providing focus and direction in what can be a somewhat murky area,” said Jackson.

“Given that all investments have some negative impacts, there should be more focus on positive impact maximisation. Impact investing does not have to deliver below-market returns; it can provide good opportunities to diversify and generate better real world outcomes,” she added.

Setting objectives

Georgina Chiu, Senior ESG Analyst at Nest, saw regulation as one of the forces behind the momentum pushing asset owners to think more about how they manage the impact of their investments, citing compliance with the recommendations of the Task Force on Climate-related Disclosures, which requires them to factor in Scope 1-3 emissions.

The UK government-established workplace pension scheme has also recently adopted Impact Investing Principles to help shape its priorities. “The III framework has been very helpful because it asks you to set your impact objectives first. What, for example, does investing in the circular economy mean to us? Does it mean we want to increase use or recycled materials in production; and if so, by how much?” she posits.

Having identified priority themes, Nest’s approach is highly geared toward maximising measurable positive outcomes.

“Investing in sustainability themes, such as biodiversity and water, means the impact is clearer. However, thematic funds are impact-aligned rather than strictly speaking an impact investment. You have to go back to the true definition based on intentionality, additionality and measurability. If we sway away from that, we really dilute impact,” said Chiu.

“As an investor, we’re worried about impact-washing, which is why we’ve spending a lot of time exploring what impact investing means to us, as an asset owner.”

To this end, Nest is trying to explore options that are complementary to its broad market-wide investment strategies, with the aim of uncovering opportunities to capture future growth. “This is where impact investing has a part to play. It is possible to use the UN Sustainable Development Goals (SDGs) to consider areas of opportunity,” Chua added.

A holistic view

Increased appetite from investors has spurred the development of a number of frameworks and tools to support identification and measurement of impact opportunities. The Global Impact Investing Network has evolved its capabilities and guidance over more than a decade, while the Impact Measurement Platform offers a range of resources, recognising one size does not fit all needs.

Like Nest, many asset owners have found the SDGs useful in directing investment toward projects and firms that contribute materially and positively to people and planet.

Four like-minded asset owners founded the Sustainable Development Investments Asset Owner Platform (SDI AOP) to help them develop a broad, strategic and top-down approach to impact investing, to complement what was available from the niche fund providers that offered a bottom-up approach.

“The benefit of an SDG-based approach to impact is that it offers a holistic view; it helps asset owners to assess and consider the opportunity side, and go beyond a climate focus,” said James Leaton, Research Director at SDI AOP.

Leaton asserted that transparency is particularly important to impact investing, with asset owners typically needing even more granular data on the relationship between investment and outcome than when assessing the broader ESG risks of a large company, for example.

But they also need impact investments to satisfy traditional investment analysis and criteria. “Potential users of our data will ask us for 10 years’ history, but the SDGs were only created in 2015,” he observed.

“To deliver on this kind of strategy, you have to deviate from the benchmark, so a higher tolerance for tracking error is required. But these are the hoops that people have had to go through traditionally to get approval.”

Mohammed Khalil, Equity Strategist, ESG at Phoenix Group, the retirements and long-term savings provider, acknowledged that the expectations of both regulators and internal stakeholders impose steep requirements on asset owners when proposing adjustments or additions to existing investment strategies.

“We try to balance traditional investment analyses with other metrics, for example looking at scenarios in which carbon intensity increases relative to expectations and potential P&L. But we don’t have the historical time series data with which to do the backtesting. And if we’re struggling on climate, where we have a lot of data, it’s even more challenging for SDGs,” he explained.

Potential restraints

Railpen’s Gopinathan said there were a number of potential restraints that explain why asset owners have so far struggled to increase their allocations to impact investments. When it comes to larger portfolios, he suggested that the risk taken on to achieve positive impact could potentially compromise fiduciary duty.

“There’s a question of scale and credibility in terms of the many impact investing opportunities available today. The investment process has to be clean and credible and the output has to be clear and measurable. I’ve not yet seen an investor portfolio with a list of companies or assets that can populate a £1billion+ impact portfolio which also stands up to scrutiny from a risk, governance, control and stewardship and clear impact measurement perspective,” he said.

Gopinathan noted that liquidity could also be an issue for the impact investments offered in the private markets and real assets space. “Additional allocations to illiquid assets including alternatives for impact pose a risk budget and illiquidity issue for asset owners and managers. A defined benefit scheme may potentially handle the additional illiquidity [implicit in most impact investments], but there are liability-related factors to consider as well, including inflation linkage, matching cash flows and employer contributions,” he added.

Some of these issues apply less to impact investment opportunities in the public markets. Here, there are increasingly fund vehicles offering exposure to innovators and disruptors, as well as openings to drive change among existing components of the portfolio. But where does the biggest impact lie?

The latter approach may appeal to asset owners constrained in their ability to make significant changes to their investment strategies, suggested Khalil. “In this circumstance, your engagement and stewardship agenda needs to be extremely strong,” he said.

“There will be companies you need to engage with because you have issues with how they operate. But there are others, perhaps in the small to mid-cap sector, that you want to engage with because they have innovative solutions and you want to support them on their journey. That approach can make a positive impact from an engagement standpoint, while also generating positive outcomes,” added Khalil.

Impact through stewardship

Asset owners are increasingly aware that decarbonsing their portfolios through divestment does not necessarily reduce CO2 emissions in the real world, meaning that many are open to extending or escalating engagement even when progress is frustratingly slow. Bfinance’s Gosrani noted that at least some investors accept having a less than clean portfolio today to help achieve a positive outcome tomorrow.

“How many investors today are willing to own a stock that’s on a trajectory to change, but which currently has a high carbon footprint, for example, or are not as clean as their disruptors?” she posited.

Phoenix’s Khalil acknowledged the fine judgements facing asset owners in driving impact through stewardship. “Many of the leaders in the energy transition are among the biggest polluters today. We believe there is an opportunity cost in negative screening or exclusionary approaches, because you may miss out on the benefits from the [transition] opportunity. They are also cash-rich companies with power to invest,” he said.

Chiu said Nest would continue to seek impact by driving operational change in investee companies. “This might include investing in mining firms with a view to influencing how they are using water. That is still positive impact. We should not ignore how transformational that can be,“ she said.

But would the bigger impact be achieved through exposure to disruptors, both in terms of alpha and driving the transformative change needed to address systemic risk at the pace and scale required? Craig Bonthron, Fund Manager at Artemis Investment Management, noted the challenges inherent in trying to turn round the supertankers that dominated 20th century economy.

“Incumbents tend to have access to capital, but instinctively want to reinvest in unsustainable status quo systems, such as those built on fossil fuels. Incumbents become optimised around the status quo, so when there is technology which shifts the basis of competition, it disrupts them and they instinctively resist it rather than embrace it,” he said.

“For example, large oil and gas firms are generating large amounts of free cash flow from fossil fuels, but investing a fraction of it in renewable power generation and infrastructure, which will ultimately displace them.”

Catalytic impact

While noting that electric vehicles could be regarded as a non-optimal low-carbon mobility solution and that Tesla’s overall ESG performance remains open to question, Bonthron pointed to the firm’s catalytic impact on an industry that was doubting the technical validity of electric vehicles before Elon Musk’s vision took shape.

Further, he argued, the revolution Tesla had set in motion was only just starting, its impact likely to improve, in terms of its benefits over existing manufacture, partly due to expected improvements in production efficiency and circularity across the supply chain, but also through the inevitable increase in the proportion of renewable energy to be used in those production processes.

But Bonthron acknowledged also the challenges facing asset owners required to manage risks and opportunities across a balanced and diversified portfolio.

“Transformative positive impact tends to come from younger, more innovative companies, whilst negative impact tends to be more common with companies toward the end of their lifecycle. As the products become obsolete, addressable markets shrink and it is common for companies to become short-term and negative sum in their outlook,” he said.

“Many mature companies do still achieve positive impact, but if they are operating on business-as-usual basis – not thinking about the long-term impacts of their products – this tends to be incremental.  We think growing markets and businesses are therefore more likely to create transformative positive impact. Positive sum outcomes tend to be created by technology and innovation, which therefore leads us – as managers – towards a clear growth style of investing.”

London CIV’s Jackson felt that there was scope for asset owners to accommodate both approaches to achieving investment impact.

“It’s important to recognise both the dual ability to reduce the negative impacts of traditional industry and generate positive impact through investing in disruptors. You’re much better placed to think about diversified risk, both from an ESG and a traditional investment perspective, if you consider both sides of the coin.”

A good starting point, she suggested, is to recognise that every investment has positive and negative impacts. “Understanding these nuances is important. Scores and screening tools can oversimplify when, in reality, every company, supply chain, asset class and industry is complicated. Unless you really delve into the detail, you won’t even be able to have a meaningful engagement. Looking at individual companies on a case-by-case basis takes a lot of time, resource and understanding but it can be an effective approach to take.”


The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

Copyright © 2024 ESG Investor Ltd. Company No. 12893343. ESG Investor Ltd, Fox Court, 14 Grays Inn Road, London, WC1X 8HN

To Top
Share via
Copy link
Powered by Social Snap