Demystifying impact investing

It's time to bust some myths: here are five common misconceptions about impact investing, and what's really going on.

Facebooktwittergoogle_pluslinkedinmailFacebooktwittergoogle_pluslinkedinmail   by Louisiana Salge, 19th December 2018

At EQ, we are passionate about impact investing and engage with a fast-growing number of investors who would like to make a positive impact on society and the environment. However, a few misconceptions are still preventing some investors and advisers from joining in with our impact enthusiasm. In this blog we will be busting five common myths around impact investing.

1) Impact investing is just like ESG investing

We believe the simplest factor distinguishing the logic of ESG (environmental, social and governance) investing and impact investing is that ESG focuses on the quality of a company’s operations, while impact investing primarily focuses on the purpose of a company’s main products and services.

ESG investing aims to invest in companies that show efforts to reduce their negative effect on some of their stakeholders, for example their employees, whereas impact investing aims to allocate capital to companies that provide solutions solving the largest societal needs, while doing so in a responsible manner.

For more info on what impact investing is, see this FT Adviser article written by EQ’s Damien Lardoux.

2) Impact investing will sacrifice my investment returns

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 report found that bold climate action could deliver at least US $26 trillion in economic benefits through to 2030, compared with business-as-usual.

Albeit a shorter track record versus traditional investing, market evidence demonstrates that impact investment can produce market rate returns or above. The EQ Positive Impact Portfolios have outperformed their conventional benchmarks since their launch six years ago.

By targeting sustainability themes that by definition are long-term societal needs, impact investments also have much greater long-term return growth potential. And the sustainability of investment returns should matter for long term investors.

For more info on the relationship between sustainability and returns, see our article here.

3) Impact investing will mostly target small-cap, early-stage and non-profitable companies

Impactful investment opportunities exist across a range of asset types and company sizes. EQ’s Positive Impact Balanced Portfolio shows a healthy split between 14% small-, 39% medium- and 47% large-cap companies.

While impact investors do seek out innovative companies, it does not mean that these are early-stage. We see many mature corporates switching up their core offerings to reflect the changing needs of society, and to adjust to new risk constraints. The median founding year of the companies within our Positive Impact Portfolios is 1996, compared to 1998 for the current FTSE100 index.

While a number of those impactful companies may have been small in size 10 years ago, thanks to above-average growth, they have now become mid- and large- cap companies. A good example being DS Smith which recently joined the FTSE100 index.

There is ample evidence that sustainable businesses are well-managed, are more innovative and that sustainability themes provide great market potentials – thus pulling and pushing profits.

Our latest Impact Report highlights this in more detail.

4) It is a narrow investment universe and you cannot get real impact opportunities at attractive valuations

There is no single defined investment universe for impact investors. Investor preference defines their opportunity set by deciding on risk, return and impact theme targets. The amount of companies eligible for investment can further 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. The portion of the equity universe invested into by the EQ Positive Impact Balanced Portfolio spans to over 630 unique companies, globally.

This universe is also expanding. As much as investor interests are turning to sustainability, companies’ business models are too, increasing the amount of ‘impactful’ candidates. For example, Impax Asset Management, in 1999, had an investment universe of 250 companies generating more than 50% of their revenues from environmental solutions. This universe has now grown to 1,100 companies.

Our own research shows that while the weighted average valuation (P/E or Price to Earnings) of the companies we invest in is higher than the FTSE 100 companies, the average earnings growth is two times higher. As a result, the valuation adjusted for growth (PEG or Price to Earnings to Growth ratio) is cheaper than the FTSE 100 companies.

5) Impact investing is too volatile and risky for private investors

Many high-impact investments are located in more volatile markets (e.g. emerging markets), but it is also true that sustainable businesses show reduced residual volatility.

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 (i.e. factoring in volatility). 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.

Impact investment is an investment strategy, not an asset class in itself. As discussed, opportunities exist from small to large companies, equity, debt and real assets – and risks vary between these. Therefore, portfolio managers are able to adhere to normal risk categories and create options for different ‘risk appetites’. This way, any private investor can make their pension or ISA contribute to positive societal change.

 

About the author: Louisiana Salge

Louisiana joined EQ in October 2018 as an Impact Specialist after completing a masters in sustainable business at Imperial College London. Her MSc thesis was on impact reporting and this research led to the publication of EQ’s 2018 Impact Report for the Positive Impact Portfolios. She is now responsible for impact fund research and further evolving EQ’s impact strategy.

Louisiana graduated from UCL with a BSc in Geography and spent a year working for a Cleantech innovation research company before starting her masters.

Outside of her career, Louisiana loves travelling and discovering new places, cooking with friends and spending time outdoors.

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