Delivering a social dividend

Environmental, social and governance (ESG) has democratised investing by giving socially-conscious investors a way to have their money impact change in society, not just to generate a return.

However, new investors are quick to learn the downfall of many ESG funds – that they often use negative screening. This isn’t necessarily a bad thing; having the option to screen out sectors like fossil fuels, weapon manufacturing, gambling and pornography has been a huge win for socially-conscious investors.

But it doesn’t drive change – and that’s where impact investing comes in. Impact funds differ from traditional ESG funds as rather than negatively-screen undesirable companies, impact funds will invest in companies actively driving expressed outcomes.

Alex Vynokur, BetaShares chief executive, said the historical conventional wisdom around investing ethically coming at the expense of returns had been well and truly debunked and disproven, and this applied to impact investing too.

“Over the last decade there’s been quite a significant shift in the mindset of investors to recognise the fact that investing can be not just about obtaining significant returns on your investment, but also an opportunity to influence society in a positive and meaningful and constructive way,” Vynokur said.

“The value of impacting investing is in addition to achieving strong returns, you can also deliver a social dividend.”

With a spectrum of ESG funds on the market and products increasing, advisers are left with the challenge to establish the difference between each product and how it fits in with the needs of a particular client.

Evergreen Consultants launched the Evergreen Responsible Investment Grading (ERIG) index which classified funds (from least to most contribution to ESG solutions) in either ‘ESG integration’, ‘negative screen’, ‘norms-based screening’, ‘active ownership’, ‘positive screening’, ‘sustainability-themed investments’, and ‘impact investing’.

Meanwhile, Zenith had classified 878 funds on its approved product list (APL), classed by ‘traditional’, ‘aware’, ‘integrated’, ‘thematic’, and ‘impact’, with each category designating the extent of each fund’s incorporation of RI factors. 

Dugald Higgins, Zenith Investment Partners head of responsible investment and real assets, said fund managers are increasingly realising they must show how they are delivering impact.

“The game has changed – everybody is moving to the viewpoint from ‘what are you looking at doing’ towards ‘well, tell us how you’re going to achieve it’ and now it’s about ‘show us how you’re going to measure the impact on the world that you have’,” Higgins said.

“Now we see a lot of managers producing various forms of stewardship reports, engagement reports and impact reports.

“There’s clearly a burning need to move businesses of all sizes to be more sustainable because what’s the alternative, that you’re an unsustainable business?

“While we are seeing more impact funds come to market, the rate of growth in that sector has been enormous.”
However, Higgins warned that as with greenwashing, ‘impact-washing’ was starting to “rear its head”.

“For all that, some of the managers are very keen to try and make certain they’re having a positive impact on the world and wanting to ensure they help industries transition,” Higgins said.

“In the transition to be seen embracing responsible investment, sometimes it’s really a case of the manager reach exceeding their grasp.

“They’re keen to say the impact they’re going to have but they are sometimes further behind in actually being able to do it.”
Patrick Noble, Zurich senior investment strategist, said impact objectives may be more bespoke than widely-distributed ESG funds and may include areas such as those identified in the United Nations Sustainable Development Goals (SDGs).

“There are 17 SDGs in total which could all realistically include impact investing with objectives focused on eliminating poverty, climate, clean energy, education, and good health and well-being to name but a few,” Noble said.
Noble said, unsurprisingly, areas like the environment, such as a reduction in carbon emissions, would immediately spring to mind.

“Early impact funds in Australia are environmentally focused, but the pandemic has moved the spotlight to now also cover social impact opportunities such as those found within the healthcare sector,” Noble said.

CLIMATE CHANGE

When it comes to sectors investors are interested in having an impact in, climate change takes centre stage.

According to a report from the World Economic Forum (WEF), failure to address climate change was the number one global risk in terms of impact for 2020, and four of the top five risks were all related to climate change.

Amber Fairbanks, Mirova US Global Sustainable Equity fund co-portfolio manager, said climate change was a long-term trend that could not be ignored.

“Sea levels will continue to rise, natural sources of fresh water will continue to become scarcer, people will continue to live longer, and innovations in technology will continue to change the way the world interacts and conducts business,” Fairbanks said.

“We believe companies that are positively exposed to these long-term secular trends will experience economic tailwinds, whereas companies that are unable or unwilling to address them will experience business model risks over time.”

Equities could still be used for climate impact – and BetaShares and VanEck had both launched competing funds in this space – but if investors are open to fixed income, green bonds present a strong option for impact.

“The early days of ESG investing focused on the equity side of things, but as ethical and sustainable investing is continuing to move into the mainstream, we’re seeing the fixed income part of investors’ asset allocation is also in need of genuine true to label investment alternatives,” Vynokur said.

“There will be more and more opportunities for green bonds and investors are demanding that more and more and Australian banks are starting to issue more green bonds.

“Some of them could be used to fund green buildings or high energy efficiency buildings, some of the proceeds might go into climate change related projects, and some of them might go into technologies to combat carbon emissions.

“There is a variety to impact directly, green bonds actually have a number of direct impact touchpoints.”

HEALTHCARE

The COVID-19 pandemic has pushed healthcare outcomes from market forces into the spotlight with contributions from listed companies including Pfizer, Johnson & Johnson and CSL, but that has only been a reminder of value they can provide in other healthcare outcomes.

Henry He, American Century HealthCare Impact fund portfolio manager, said there is now a “special” demand for healthcare. 

“There’s a crop of companies that can supply new revolutionary products that can meet demand,” He said.

“There’s a tailwind of demand which creates a lot of pressure on society, what’s great is at this moment in time we are seeing tremendous innovation across all facets of healthcare.

“We’re looking for companies that have internal research and development capabilities, to replenish their pipeline, to generate multiple solutions over time.

“These are the companies that really add value; they’re not financial projects, they’re real scientific investments.”

He said it was important to focus on companies in the sector that prioritised long-term growth, not short-term gains.

“The companies that can generate long-term sustainable financial returns are also the companies that can create impact,” He said.

“In the short and medium-term you have companies that can generate earnings growth by exploiting certain aspects of the healthcare system through high prices, price increases or slashing research and development.

“That’s not how you grow earnings over the long-term and that’s not how you generate impact so we believe those two are absolutely entwined.”

PUTTING IT ALL TOGETHER

With all this information, Jessie Pettigrew, BT head of ESG and sustainability, said it was important for advisers to dig into the specifics of what the client is interested in.

“What we tend to see – and I know making broad demographic generalisations can upset different groups – but what we see is that younger investors tend to be really interested in that impact piece,” Pettigrew.

“They might have a portfolio of investments and they’re interested in how sustainability is considered in that, but it might be suitable for them to have a small satellite allocation to an impact investment that shows what they’re doing.

“Whereas if you have a strong values-driven investor, they’re going to want to make sure that’s considered across every single asset in their portfolio.”

Pettigrew said advisers get a bit “nervous” when she says this to them as the information and options can be overwhelming.

“They think it’s a different strategy for each client, but I don’t think that’s necessarily the case,” Pettigrew said.

“You have those foundational building blocks, so you have that conversation with the client, understand what they think sustainability means to them and match that to the right investment strategy, there’s definitely going to be commonalities.

“It’s having a couple of different options available and as with every other type of financial advice then pulling the different levers that are appropriate for clients.”