Sophisticated investors and impact investments

A new report by UBS Wealth Management UK - Return on Values - makes interesting reading.

For the report, it surveyed more than 5,300 investors in 10 markets on sustainable investing. It found that 39% hold sustainable investments in their portfolios, defined as at least 1% of their investable assets.

Not only that, the adoption of sustainable investing is expected to grow significantly to 48% over the next five years. Additionally, many investors expect to increase the allocation of sustainable investments in their portfolios. In fact, 58% of investors expect sustainable investing to become the standard approach to investing in 10 years.

These are sophisticated investors. What’s driving their turn to sustainable investments?

In one way, the reason is obvious. Today’s investors care and want to make a real positive difference to the world in which they live and they want to do this through the way in which they deploy their money.

Return on Values found that creating a better planet is extremely important to just under two thirds of some of those surveyed. In pursuit of this goal, many investors deliberately base their spending decisions, lifestyle habits and even career choices on their moral values and beliefs. For example, 69% of wealthy investors willingly pay more for products and services from companies whose practices they support.

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This is supported by research by Triodos Bank, which found that a majority of investors in the UK favour a fairer and more sustainable society and 64% of investors would like to support companies that make a positive contribution to society and the environment.

This is likely to accelerate with the new generation of investors. In a white paper Mobilizing Private Wealth for Public Good, UBS points out that globally, over the next 20 years, some 460 billionaires will be leaving US$2.1trn to their heirs and impact investing is especially popular with millennials.

In a report - Investor Motivations for Impact: a behavioural examination - Barclays Bank found that millennials are the most active age group when it comes to impact investing. It took data collected for research from 2015 with approximately 2,000 investors and data collected in 2017 by the Advisory Group to the UK Government from 1,000 UK investors.

This revealed that, in 2017, 43% of respondents under 40 had made an impact investment, compared to 9% of those aged 50-59, and only 3% for those aged over 60. In 2015, 30% of respondents under 40 had made an impact investment, rising to 43% in 2017. This 43% compares to 9% of those aged 50-59, and 3% for those aged over 60.

As the Barclays report puts it:

“At the same time, they’re set to benefit from a significant intergenerational wealth transfer from Baby Boomers (those currently aged approximately 55-78), and so it’s no wonder they’re receiving so much attention: they have the potential to completely re-shape the wealth and investment management industry.’’

But, even for the millennials, idealism on its own would probably not be enough to drive the new interest in impact investing among sophisticated investors. People may want their money to make a difference, but, at the same time, they also want their money to make more money. That’s the whole point of making an investment.

At one time the assumption was that making an investment for the sake of the social benefit it might have was bound to come at the expense of return on capital. Surely, a business that was more concerned about making a positive social difference, or a beneficial global impact, than it was about making a profit would probably make smaller profits and therefore give a poorer return to its investors.

This, however, has not been borne out by the evidence, which increasingly shows that impact investments can give returns which equal, or even exceed, those which are available from non-impact investments.

For example, a survey by the Global Impact Investing Network (GIIN) and JPMorgan has found that 55% of impact investment opportunities result in competitive, market rate returns.

No wonder that last summer, insurance giant Swiss Re announced it was moving its entire US$130bn investment portfolio to new, ethically-based benchmark indices.

Chief investment officer Guido Fuerer told Reuters:

“This is not only about doing good, we have done it because it makes economic sense. Equities and fixed income products from companies and sectors with a high ESG [environmental, social and governance] ratings have better risk-return ratios.”

This shouldn’t be surprising. There are a number of good reasons why impact investments perform well:

• Businesses which seek to make a positive social impact are not out to make a fast buck. These are organisations which are in it for the long term and so tend to lay firm foundations for sustainable, long term future growth.
• If they’re truly making a social impact then they must be addressing a proven market need, which is not being addressed, or not adequately addressed, by other providers.
• Their purpose is to improve lives and increase social good and, in doing so, they are going to create satisfied customers.
• Satisfied customers help them build a strong and positive brand image, with investors, employees and customers being enthusiastic brand ambassadors.
• They’re able to attract talented employees, the kind of people who have no interest in working for employers whose only concern is the bottom line. These are often creative and passionate individuals – natural disruptors and entrepreneurs.

Another reason is that the definition of what constitutes an impact investment has broadened in recent years.

In an article in the FT, Mark Haefele, chief investment officer of UBS global wealth management, lays to rest the myth that investors sacrifice returns for sustainable and impact (SII) investing.

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He argues that the old critics of SII were attacking a “straw man’’ argument, contrasting regular or traditional investing with “exclusion” investing or the exclusion of ethically questionable investments. However, exclusion investing is an outdated approach to SII and now that impact investing has been added to the mix, it’s no longer just a question of not supporting bad things, but of backing good things. Impact investments are made in businesses or projects that have a positive social impact, which could, for example, be developing new drugs or building houses.

When impact investments are included, the returns available to the investor begin to look far more attractive. In fact, increasingly the evidence is that sustainable and impact investors can at least match, if not beat, the returns of ordinary investors.

Haefele points to more than 2,200 academic studies over the past 40 years which have analysed the relationship between ESG factors and corporate financial performance. According to a meta-study by Friede & Busch, more than 90% of them have found that ESG factors have a positive or neutral impact on financial returns. It says:

“The results show that the business case for ESG investing is empirically very well founded.’’

And since 1990, the MSCI KLD 400 Social index, of companies with strong sustainability profiles has outperformed the S&P 500, with annualised returns of 11.2% against 10.7%.

Also, the fact that there is now a much broader understanding of what an impact investment can be means that there is a much wider choice available to the impact investor. So, the sophisticated investor can not only fund businesses and projects which have the potential to give high returns, they also have a much greater chance of achieving diversification in their investment portfolio with impact investments.

The World Bank says:

“ESG investing is increasingly becoming part of the mainstream investment process for fixed income investors, as opposed to a specialist, segregated activity, often confined to green bonds.’’

In an article for Forbes magazine, Georg Kell, chairman of Arabesque and founding director of the United Nations Global Compact, wrote that ESG factors:

“…might include how corporations respond to climate change, how good they are with water management, how effective their health and safety policies are in the protection against accidents, how they manage their supply chains, how they treat their workers and whether they have a corporate culture that builds trust and fosters innovation.’’

It’s no wonder then that sophisticated investors are enhancing their portfolios with impact investments. By doing so they can help fulfil their ideals of making the world a better place, they can target a good return on their investments, and they now have enough choice to be able to build a truly diversified portfolio.