Delivering impact in listed assets: A guide for institutional investors
- Impact used to be confined to private markets. This is no longer the case. Investment and business dynamics have combined to give institutional investors the scope to deliver impact in public equity and bond markets
- There are challenges in measuring and verifying data for credible impact investment. We think it is important to use strict processes and frameworks to help overcome those challenges and seek to identify leaders within the impact universe
- We think institutional investors now have the potential to confidently build highly focused portfolios that target specific SDGs, while maintaining financial performance.
The rise of responsible investing has given pension funds new opportunities to put their money to work in ways that can seek positive effects alongside financial returns. At the sharp end of that trend has been impact investing – originally a way to direct capital to small-scale, privately-held businesses, but now an investment strategy that we think can be successfully deployed at scale across listed asset classes.
There are push and pull factors at play here. Over time, the rise of responsible investment has helped to create an environment where companies know they may attract capital from long-term, active investors if they seek to embed environmental and social sustainability.1 Alongside that evolution, political and consumer momentum around those themes has created demand for goods and services that can offer clear positive benefits.
This virtuous circle has helped expand the universe and make impact a realistic goal in listed assets, in our view. The Global Impact Investing Network last month estimated the financial value of asset management portfolios that meet its impact investing definitions had crossed the $1trn threshold.2 More broadly, overall issuance in the sustainable bond market passed that same milestone in 2021.3
This popularity and momentum may signal a vibrant market, but they have not swept away the challenges around measurement and verification, or the need for careful, detailed analysis of potential investments when building impact strategies or designing impact mandates.
The goal of impact investing is to seek out financial returns while tackling the world’s biggest social and environmental challenges. This broad objective requires focus, and we think the United Nations’ Sustainable Development Goals (SDGs) offer a powerful lens through which to view assets and construct portfolios.4 By targeting specific sets of SDGs, setting out a clear process, identifying leaders and pursuing focused engagement with management, impact becomes a reality. It is possible to focus on a few select SDGs, for example when looking at biodiversity as a theme, or to consider a suite of SDGs when looking at a broad set of social themes that may fit a client’s objectives.
With the SDGs helping to guide the approach, how does the portfolio construction process work? First, we tailor approaches to the asset class. In equities, we focus on companies seeking to deliver impact through their products and services and in the case of green, social and sustainability bonds (GSSBs), we can target the financing of relevant projects.
When investing in equities we look to five pillars designed to evaluate and refine the investment universe. We think investors should seek out intentionality – both from the portfolio manager and from the constituent companies. We want to see materiality that ensures significant effects, and additionality that reflects the serving of unmet or under-met needs. We then seek to avoid negative externality, where a company’s other operations outweigh their positive activities and, crucially, we demand measurability, where transparency and clarity allow for verification of positive impact.
In debt markets, GSSBs have emerged as discrete asset classes and offer different scope for analysis. The five pillars above, therefore, help form the starting point to guide our assessment of the environmental, social and governance (ESG) strategy of an issuer. We then examine how the proceeds from bond issuance are planned to be used, before verifying the proceeds are used as expected once issuance takes place. Again, reporting is a key part of the equation; we demand key performance indicators (KPIs) that reach into the heart of what the issuance is designed to achieve – for example emissions avoided in the case of a renewable energy company. We use proprietary frameworks designed to embed and enforce that process.
It is important to note that while listed and private impact are complementary, they are clearly different. We are not attempting to replicate the sometimes very direct, hands-on nature of impact in private markets here, but we believe we can deploy client capital to companies and projects delivering genuine positive outcomes for society and the environment. And, crucially, we can do this at a scale unimaginable in private – putting to work the power of responsible asset management in highly focused active portfolios.
Seeking leaders, understanding challenges
Impact leaders will form a key part of our pooled equity strategies and client mandates. They may be generating positive outcomes through their goods and services, but also through the example they set as corporate citizens, helping to establish new models of sustainable business. They may be front-line businesses, producing renewable energy for example, or embedded in a supply chain, delivering important technology or services. Leaders will not be perfect – and our engagement with them is designed to maintain and improve that leadership position.
Impact contributors, meanwhile, are companies that verifiably generate significant positive social or environmental impact but may be held back from leader status by a variety of factors – perhaps only a limited portion of revenue contributes to the SDGs while the rest of the business is largely neutral. Our assessment may also be affected by the relative severity of the issue being addressed, a lack of corroborating disclosures, or negative externalities.
In green bonds, expansion of the sector has brought a lot of new issuance to market. This is good news on many levels – as the pool of investible assets increases so does the possibility of regional and sectoral diversification. When AXA IM launched its own green bond strategy in 2015, the market was dominated by quasi-sovereign issuance, but the split of sovereign-related to credit issuers has since moved to about 50/50 and the number of issuers rests at around 600. Banks remain key, but we have also seen a substantial contribution from sectors such as real estate, telecoms, autos, chemicals and consumer goods.
This is now a dynamic market, and one that we think rewards active management – not all green bonds are created equal, whether from a valuation or ESG-credentials perspective. And this leads us to a crucial question in any form of impact investment: How can you prove a company is having the effect that it claims?
This is the fundamental issue behind fears of ‘greenwashing’ (and ‘social washing’) and there is no shortcut solution. We think the best approach is to rigorously apply our standards to every investment call and seek out credible, consistent and verifiable impact KPIs. Measurability and transparency are perhaps the two most crucial considerations wherever we are invested.
There is another potential challenge for investors in piecemeal harmonisation of the techniques used to collect and report impact data across asset classes. They may necessarily be very different for companies operating in different sectors, but while we focus on actively assessing each investment on its merits, we think it is also important for asset managers like AXA IM to work towards establishing a working consensus in markets. It is clear too that this would help address the greenwashing issue.
True harmonisation will require a wide acceptance of KPIs that are able to reach into the heart of impact delivery. We always look for granularity in data: If we can identify hard numbers like renewable power generation or the number of under-served consumers accessing socially beneficial services, then we can invest with confidence – particularly when this is repeatable over time and across sectors or issuance.
A structural opportunity?
Our investment case on impact, whether in private-equity-style portfolios or in the liquid listed markets discussed here, is that we are tapping into some of the most important macro and corporate trends at play. We expect financial returns in impact portfolios to reflect this as companies and issuers deliver potential solutions to some of the world’s most pressing problems.
In equity markets, we see the potential for financial returns from companies that support the transition to a new era in energy or that address social issues attracting attention from policymakers. The same considerations underpin our assessment of the viability of green bonds, where we have also seen that the so-called ‘greenium’ pricing effect is an uneven and evolving trend – and a possible opportunity for active and engaged investors.
In truth, finance is only part of the solution here. As long-term investors we clearly have an important role to play, and a business interest, in helping to build sustainable economies that will provide powerful investment opportunities over the years and decades to come. But impact is a collaboration and real-world positive effects will only occur when governments, regulators, consumers and investors are all pushing in the same direction. And as governments define the new policy environment, as regulators enforce new rules and as consumers drive demand for new products and services, so investors continue to allocate capital to the companies best placed to respond to a changing world. It is a dynamic that has taken genuine impact beyond the world of private markets and created a potentially powerful opportunity set for responsible institutional investors.