Investors expect to scale up allocations, following increasing returns.
The UK impact investment market was worth an estimated £58 billion in 2020, according to research by the UK Impact Investing Institute (III) and EY, representing 3.3-8% of the total global market.
But the widespread intention of survey respondents to increase asset allocations to impact investments over the next five years suggests an almost doubling of the market to more than £100 billion.
The estimated size of the UK impact market is “significant both in the scale of capital that is being deployed and in the impacts that it is delivering”, said the Institute, which used the Global Impact Investing Network’s definition of impact investing: investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.
An additional £53 billion of investments are categorised as impact-aligned – investments that are generating positive social or environmental benefit but that are not made intentionally and are not measured.
Penney Frohling, Partner, Financial Services Strategy, EY, said more investment professionals were dedicating themselves to the impact sector. “This will unblock significantly more capital flows for impact investing,” she said,
Impact allocations and returns increasing
Almost all (97%) of research respondents said their asset allocation to impact had been increasing over the past two years. Ninety per cent of respondents reported that 2020 financial returns from impact investing were either in line with or exceeded their investment targets.
According to Simon Bond, Executive Director Responsible Investment Portfolio Management, Columbia Threadneedle, investing in impact funds ten years ago meant investors would be “making a sacrifice in terms of financial returns”.
The research had shown that this has “fundamentally changed” over the past decade. “It seems you can have your cake and eat it – you can get financial returns and do good for society and the environment,” he said.
While the market is now sizeable, relative to mainstream investing, it is still growing from a comparatively small base. Frohling said there was considerable room for growth as the capital flowing to impact investments is estimated to be less than 1% of total UK assets under management.
Ninety per cent of respondents said they plan to increase their asset allocation to impact investments within the next five years, with around 75% planning to increase their allocation by more than 10% while 36% forecast an increase of above 20% per annum.
“Applying a weighted average to the estimated future market growth rates from our survey suggests a 15% market growth which, in practise, could double the funds allocated to impact to over £100 billion in five years,” said Frohling.
Drivers of growth
According to the report, key drivers of growth in impact investments include policy initiatives such as the Financial Conduct Authority’s (FCA) consultation on sustainability disclosure requirements and investment labels; the role of blended finance in catalysing more institutional investment into the market; encouraging impact-aligned sectors to shift into more intentional and accountable investment approaches; more impact investment vehicles that can take on institutional investment.
Three of the UN Sustainable Development Goals – healthcare, affordable and clean energy, and sustainable cities and communities – were reported as the top three focus areas for impact investors.
Social investors (67%), private equity and venture capital firms (49%) and foundations (49%) were cited as the leading impact investors. However, institutional investors, including asset managers, insurance firms, pension funds, banks, and family offices, were identified as the primary drivers of future growth.
Overcoming challenges and perceptions
Measurement and data remain challenges for impact investors in the UK. More than 75% of respondents said that “sophistication of measurement processes”, “appropriate returns across the risk/capital spectrum”, and “data on impact investing” were moderate or significant challenges.
Whilst “research on market activity and trends” and “suitable exit options” were regarded as the least problematic, only a small proportion of respondents (16% and 11% respectively) saw “no challenge” in these areas.
The adoption of a consistent definition of impact investing would address such concerns, as would measurement frameworks that allow for greater effectiveness in impact outcomes, the report added. These measures would promote accountability and transparency in reporting of impact investments.
Refining existing regulations or introducing new regulations were cited as potential avenues for unlocking assets to support impact investment and strengthening the integrity of the market. The report cited perceived incompatibility with fiduciary duty as a significant obstacle to impact investing by pension funds, arguing that government “interventions” could address this issue, thereby unlocking major capital flows into impact by institutional investors.
“This could include, for example, the Department of Work and Pensions issuing guidance on the compatibility of fiduciary duties and impact investing; or go further to introduce additional regulation or legislation to spur change.”
Additionally, the introduction of impact investment labelling by the FCA would “make a significant contribution to improving the integrity of the market and countering asset managers over-claiming”.