Whilst the number of investors who would like to make a positive impact to society and the environment continues to grow. A number of misconceptions prevent some savers from taking the plunge.
Misconception 1: All sustainable investment approaches are the same
There are a variety of ways in which sustainability considerations can influence investment mandates and portfolio management. To summarise the three most common approaches:
- Traditional ethical investing focuses on excluding a set of industries or companies based on controversial behaviour, often called the “sin stocks”. To do this, investment strategies will apply a values-based negative screen on industries like tobacco, alcohol, or pornography. The rest of the strategy is then managed with traditional investments.
- ESG investing [1] introduces information on how well companies manage relevant operational Environmental Social and Governance (ESG) factors into the investment decision-making. Investment strategies can integrate this information differently. Common approaches may overweight or set inclusion thresholds based on company ESG performance, relative to peers. But this approach usually overlooks the analysis of companies’ products and services.
- Impact investing focuses on creating material, measurable positive impacts on people & planet. Instead of being a relative assessment, such as ESG, the focus here is on maximising the absolute positive impact associated with investments. Investment strategies can do this by positively targeting sustainable themes like clean water, renewable energy or accessible healthcare. This approach puts a very strong emphasis on companies’ products and services and the solutions they bring to the many challenges we face.
Misconception 2: Sustainable investing will sacrifice investment returns
There is mounting evidence that sustainable investing does not sacrifice performance, in fact, incorporating ESG factors into investments can help boost financial performance. Overall, businesses that demonstrate greater operational sustainability (ESG) and sustainable products & services, can perform better.
Evidence indicates that the positive correlation between sustainability and performance holds both at the corporate accounting, and investment performance level. The reasoning is that businesses managing E, S and G better than peers demonstrate better risk control and compliance, suffer fewer severe incidents (for example, fraud, environmental spill litigation) and ultimately carry lower tail risk. Additionally, ESG leaders invest more in Research and Development, foresee future risks and plan ahead to remain competitive.
Impact investing also offers the opportunity to capture the potential upside from competitive advantage, sustainability trends and legislative support. Impactful companies are those that have turned the largest societal challenges into profitable business opportunities. These companies benefit from the growing global demands for their products and services, greater regulatory support and from avoiding reputational and stranded asset risks. A recent example is the EU pandemic recovery package that demarcates special financial support for green economic activities.
Market evidence is also accumulating – showing superior returns of many sustainable strategies over their traditional equivalents. At EQ Investors, the Positive Impact Portfolios [2] have been our best performing portfolio range, beating their benchmark for each of the nine years since their inception.
Misconception 3: Sustainable investing is too risky
It is true that many high-impact investments can be in more volatile markets (such as emerging markets), but real opportunities exist across all asset classes, from small to large companies located in the US, in the UK and all regions of the world – and risks vary between these. For example, social housing investments can provide reliable government backed income streams while providing significant societal benefits. Water utilities prevent industrial wastewater from polluting natural ecosystems and provide defensive investment characteristics.
Therefore, portfolio managers like EQ Investors can adhere to normal risk categories and create portfolios for different ‘risk appetites’ of private clients, as well as tailor these to sustainability preferences.
While long track-record data is not yet available across all risk categories for the aggregated impact investment sector, we have evidence that EQ’s Positive Impact Portfolios have shown better risk-adjusted returns than their conventional benchmarks since their inception. To us this supports the opinion that by investing in well-managed businesses that target long-term needs, some potential higher short-term volatility is worth the sustainable returns. However, investors should be aware past performance is not a guide to future performance and that the value of investments and any income derived from them may go down as well as up and they may get back less than was invested.
Misconception 4: It is a narrow investment universe
There is no single defined investment universe for impact investors. Investor preference defines the opportunity set by deciding on risk, return and impact theme targets. The amount of companies eligible for investment can depend on the impact or ESG standards set by investors.
While this means that we can’t give a reliable impact universe estimate, opportunities are larger than some might assume. For example, the EQ Positive Impact Balanced Portfolio has exposure to about 1,000 unique companies and organisations globally.
This universe is also expanding. As much as investor interests are turning to sustainability, companies’ business models are too. For example, in 1999 Impax Asset Management had an investment universe of 250 companies which generated more than 50% of their revenues from environmental solutions. This universe has now grown to about 1,400 companies. The same would apply to the healthcare universe, the financial inclusion or education universe.
Misconception 5: Sustainable investing cannot actually make a positive impact
When investing through traditionally managed portfolios, disregarding the impact of investments on people & planet can contribute to business activity that actively works against the client’s values. On the other hand, investing a client account through a positive impact mandate, the output of companies and that associated with an investment can align with the client’s values.
Even in listed markets, allocating equity capital or investing in bond issues of businesses that create positive sustainable impact, will support their share price and provide easier access to capital thereby producing a license to operate. Using capital to invest for positive impact will signal to the market that such non-financial impacts are valued and nudge laggards in the right direction.
Additionally, sustainable investors will use their company relationships to engage boards on any sustainability weaknesses and thus create change. They are also able to use voting rights to back or block strategic decisions that concern the company’s ESG performance.
The dual objective to create financial and sustainability outcomes means that the investment reporting that private clients receive should not solely cover the financials. At EQ Investors we invest significant resources to bring the impact that our portfolios have “to life” and demonstrate that we are delivering on our clients’ positive impact objectives. For example, we have created an interactive impact calculator that shows the investments’ associated positive impacts, like renewable energy generated or hours of education provided. We also transparently disclose alignment with the UN Sustainable Development goals, [3] and how portfolios are aligned to climate change scenarios.