The need today for real solutions to worldwide threats like climate change and pollution is everyone’s concern. Impact investing offers equity investors the opportunity to contribute to preserving the planet while also generating financial returns.
There is still much confusion about what defines “impact” and what separates it from other responsible investment strategies such as the integration of environmental, social and governance (ESG) criteria into the investment process in order to generate higher risk-adjusted returns.
Although ESG factors are important in impact investing too – in the same way as fundamentals are – it is not the companies’ ESG profiles that drive investment decisions, but rather their revenue streams. . For example, an oil exploration company with strong employee welfare, sound governance, and responsible supply-chain management may have a “best-in-class” ranking from an ESG perspective. However, regardless of the strength of its operations, it would not qualify as an impact investment, because its revenues are not generated with the intention of fighting global warming or pollution.
The stock market offers several high-impact gems with attractive return potential, especially in innovation-oriented sectors. The food industry is an example: requirements for ‘clean’ labelling and healthier ingredients in foods are now widespread and present a challenge for traditional producers. Under pressure from both regulators and consumers, food manufacturers must rethink their processes and revise their recipes, and not all of the costs can be passed on to their customers. But when a sector transforms, constraints for some can create opportunities for others. Several pioneering companies, such as Chr. Hansen in Denmark, Kerry Group in Ireland, and BRAIN in Germany, have come up with natural alternatives to salt, sugar and fat maintaining the taste of their original models. Such firms are consequently in high demand and have strong growth potential.
Another priority theme for impact investors is climate change, an area that extends well beyond companies producing renewable energy. There are promising profiles among companies developing new materials that contribute to reducing the ecological footprint of the construction industry, such as Ireland’s Kingspan and Switzerland’s Sika.
A cornerstone of impact investing is that non-financial performance is measured alongside financial returns. For example, in addition to traditionally reported metrics, an impact fund should disclose certain key performance indicators that show how the company addresses the United Nations Sustainable Development Goals (or comparable targets). These metrics can be top-down (carbon footprint) or stock-specific e.g. tonnage of reclaimed fishing nets used for an industrial process. There is still progress to be made, but the more indicators become available, the more points of comparison there will be, and the more investors will be won over by impact investing.
Victoria Leggett is head of Responsible Investment for Asset Management, Union Bancaire Privée (UBP)