The importance of measuring and ‘measured’ impact investment

Impact investment looks set to play a major role in the evolution of responsible investing. But arguably some caution is advised in terms of how far, and how fast, everything starts to become ‘impact’.

There is a growing recognition that the world of Environmental, Social and Governance (ESG) investing is rich and complex – and investors are beginning to determine what the best ways to integrate ESG factors into their investment processes are.

Impact investing is about how we think about a fiduciary duty-led return while ensuring that we succeed in achieving a specific outcome. But as an industry, we need to be quite cautious about how far, and how fast, everything starts to become ‘impact’.

However, we’re still in the early days of impact investing and while we’ll have some winners, there will be losers too.

AXA IM Global Head of Responsible Investment, Matt Christensen and Kyoto University Chair of Finance (Money Design), Professor Yasuyuki Kato, discuss the future of impact investing…

Matt Christensen: When I look at all the work over the past five or six years that I’ve been privy to, in the Japanese market, what strikes me now is that I think this is the first time the discussion has centred on impact investment, instead of remaining focused only on the broader world of ESG. What’s exciting to me about that, is that it’s starting to show the richness of the area and the potential challenges both clients and investors face in this space, in determining the best way to integrate ESG into the investment process – and in assessing information from the notion of impact, in this next phase.

Yasuyuki Kato: Can you explain how impact differs from traditional ESG investment?

MC: Impact investing seeks to capitalise on some of the work that’s been done in the ESG world around the identification of material risk factors. But it aims to stretch beyond that – into identifying a social or environmental outcome. Largely, this started in private markets, because there, an investor has more control in terms of ensuring there is a focus on achieving a tangible impact. And as you start to move across asset classes – from green bonds to public equities – you need to make sure the impact approach is tailored to what that specific asset class can really achieve.

The difference is that an ESG integrated fund can use information from data providers and qualitative assessment to better manage investment risks while impact goes beyond that. Impact is about how do we think about a fiduciary duty-led return while ensuring that we succeed in meeting a specific social or environmental outcome. A good example can be found in the healthcare space.

An impact investment would look not only at the financial return but also for instance, at the number of lives saved or improved. On top of that, it is also attempting to solve a societal problem, which can be connected to the UN Sustainable Development Goals. Fundamentally, impact must be measurable and intentional around outcomes.

YK: Do you think western investors, who are investing in social impact, are clearly aware of the difference?

MC: There is a lot of noise about impact investing presently, and I believe it is only going to get louder in the next two to three years. The noise means that investors still have different views on how they might define social impact. I think that we, as an industry, have to be quite cautious about how far, and how fast, everything starts to become ‘impact’. That’s going to be very important whether it be in the US, Europe, or Japan. The US institutional investor market has not loved the topic of responsible investment until quite recently, while Europe has been keen on it for quite some time.

There are many factors behind this, but to my mind, the key one was the prominence of socially responsible investment (SRI) in the US. In the US, the heritage was very much about exclusions. In Europe, there wasn’t the same luxury to make exclusions a key strategy of focus. So, from the very early days, it was about ESG integration.

What the US market has latched onto quite quickly though, is this idea of impact investing, partly because it is easy to distinguish from the old SRI storylines.

In both Europe and the US, there is now a growing interest to invest in social as well as environmental impact and to have investment stories that showcase this. Successful stories are going to be important because without them, you cannot really come back and say what the difference is between this and normal investing.

YK: When thinking about social impact investment, there is a sense that it’s quite a hit-and-miss process. Not only do you have to find a good fund or a project that produces returns, it also needs to have a positive social impact. You’ll definitely run into bad investments on the way, and these have their own impact, so I feel like high volatility, it is a common trait of the industry.

But when we look at the previous Global Impact Investing Network’s figures on volatility, they seem to be quite low. I get the feeling that there might be a slight survivor bias behind these numbers, how do you see the actual return rates between different bonds?

MC: I think we’re still in the early days of impact investing in alternatives asset classes, such as private equity. You will definitely have some winners and you will definitely have some losers. And you’ll definitely have some of those who have great social impact stories but might not fulfil the fiduciary duty that is required.

As a result, I think we’re going to see over time a number of different type of investors lining up ranging from foundations to pension funds, with slightly different levels of acceptance on volatility. We are reaching a point where I believe institutional investors are going to start putting money to work in this field, and it’s going to become even more professional as a result.

YK: Within social impact investment, I believe that private asset investments are at the heart of the business. But stocks and investments that focus on both listed assets and listed shares have been growing as well. Could you explain what these social impact investments, carried out through listed shares are like?

MC: I think that public equity, especially active equity, has a chance to think about impact investing in a way that can take over, or at least add onto, an ESG approach. We mentioned the SDGs earlier and I think there’s an opportunity for investors of all types to think through which SDG might be relevant to a specific strategy. Let’s use a public equity fund, for example. If as the managers of that fund, we decide that access to healthcare is one of our areas of interest, then SDG 3 would be appropriate.

You might say, okay, we are going to meet companies that are touching health and ask them what solutions their R&D department is working on, or how it’s trying to reach new markets, as part of its business strategy. Then, we are going to take an activist approach on that, through our engagement. In my mind that starts to give some legitimacy as to how an impact approach can cross over to other areas such as listed shares.

TK: Do you think there is a risk of conflict within a company if, for example, it worked towards a specific sustainable development goal but in return saw a drop in its profit? Do you think this is a valid concern for listed companies?

MC: I think that when you start to think about where ESG integration and the impact SDG world come together, there will be areas where it does come together – and work. But there will be other areas in which they might work against each other, and I think that will come back to product design, client demand and the business outlook. Part of what we’re talking about are long-term challenges. The SDGs were designed by the UN for governments, for companies a bit, but not really for investors.

They’ve been adopted now as an architecture for everyone to use. I think it’s early days to talk about how much they can be employed across the board. But in terms of making them work across asset classes, I think some of the SDGs will be more investable than others.

But I think you’re right, in some areas, and we’ve seen this, you will find that you can make more money shorter term by not following the SDG path right away. There’s no doubt that this will be a question that businesses and investors need to think about.

YK: One last important theme that you already slightly touched on – evaluation. It has often been said that it is hard to evaluate the performance of social impact investment. What do you keep in mind when evaluating possible social impact investments?

MC: When you’re looking at private investments, I think you have the ability to decide what is the outcome you’re trying to achieve and how to best evaluate its success. What we’ve done is put together some specific criteria such as lives improved and lives saved on the health side.

On the environmental front, we have looked at emissions avoided. But if we go to a larger scale, one of the discussions we had with AXA IM’s management and board, is how we as asset managers, can think about impact investing and targets that might work for the entire company.

One of the areas we have looked at would be within SDG 13 – climate change.  We are working to develop a portfolio temperature gauge so that a portfolio manager can evaluate how his/her portfolio is doing as benchmarked against the Paris Accord of 2015, which talks about a 2°C world.

We could eventually extrapolate the temperature of all of the portfolios managed by AXA IM over time. Now that’s a big impact goal. But I think you’re going to see a move from small scale, very bespoke metrics, to large but simple impact targets effecting significant asset pools – whether it be pension funds or asset managers deciding that this will help drive their allocation goals over a five, 10 or 20-year horizon.