Critics have long questioned the ability of responsible investment (RI) practices to modify company behaviour, and as capital markets have grown and become ever more global, the tipping point for divestment campaigns to achieve real impact on cost of capital has arguably become ever harder to reach.
As some investors divest, others are willing to take the risk, thereby negating any real financial impact on the issuers targeted.
For example, so-called sin funds are set up to profit directly from the under-pricing of tobacco and other ‘sin’ stocks due to their systematic exclusion from institutional investor portfolios.
Nevertheless, in the case of tobacco specifically, more investors are excluding than actively investing in those stocks, and this has resulted in a persistent and measurable impact on their share prices. Still, tobacco firms continue to exist, be profitable and finance themselves successfully.
Unfortunately, in the absence of global regulation to materialise the ESG issues at stake – such as global restrictions on tobacco products or a global carbon tax – divestment campaigns like this may not achieve their intended outcomes. Targeted engagement to accompany such strategies may also help boost their impact.
Real world impact remains a big issue for ESG investing at large. Measuring the real impact of investments made into green companies is challenging, and some investments are, frankly, better at evidencing this than others.
At one end of the spectrum, we can place direct private equity and debt investments. These provide close to full confidence on the use of proceeds; impact metrics and reporting can be agreed upfront as part of investment agreements, and impact reports from development finance institutions can demonstrate what good impact measurement and reporting should look like. Good examples are the Development Effectiveness Rating from DEG, and closer to the private sector, Actis.
A step down from this, investors might consider green and social bonds that provide clear use of proceeds and reporting requirements. Good examples are the International Finance Corporation’s impact reports for its green and social bonds, and the European Investment Bank’s disclosure of granular project-level impact data for its Climate Awareness Bonds. These reports provide investors with plenty of detail about where proceeds are being spent, and what impact the underlying projects are having to address sustainability challenges.
At the other end of the spectrum, approaches seeking impact through public markets currently rely largely on negative and/or positive screening.
Defining and tracing the positive impact of these strategies remains challenging. Their contribution towards a real world impact is more marginal, less certain, and harder to measure and attribute. Impact reporting for these strategies is still experimental, but nevertheless interesting for certain investors.
The key going forward is to develop realistic expectations within the context of available data and industry standards.
We are encouraged to see the industry refocus on quantifying and demonstrating its contribution to a more sustainable future and expect investment conversations to continue rebalancing from “returns” to “impact” as investors increasingly aspire to use their capital to effect measurable positive change. We see this trend mirrored in the corporate world as companies place greater focus on long-term resilience and results, and better balance the needs of multiple stakeholders— customers, employees, shareholders, suppliers, and local communities—as they strive to go beyond just delivering short-term financial returns to shareholders.
However, we still need new benchmarks for ‘impact’, especially when it comes to public markets. We need to agree on standards urgently so that public companies can start disclosing the right metrics for us to compile more meaningful impact reports. As investors, we need to encourage and demand consistent reporting of impact performance metrics while giving companies confidence to show both positive and negative trends. This kind of data is fundamental to meet reporting best practice standards set by development finance institutions, and could also be used to set incentives aligned with client objectives.
Despite the problems, it is an exciting time to be in impact investment. Well-devised, impact-focused investment strategies in public markets could mobilise an unprecedented scale of private capital towards business practices and activities that contribute to solving the world’s most pressing sustainability issues. Active ownership of both sides of the balance sheet will be critical in helping public companies achieve such impacts, as well as to demonstrate investor additionality.
It will be a stimulating experience for engagement specialists, moving from dialogues usually focused on poor practices and controversies to conversations on business strategy and positive impact. We are certainly looking forward to tackling the challenges.