Impact investing – Debunking common myths

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Since the United Nations launched the Sustainable Development Goals (SDGs) in 2015 as a global call for positive change, investors have directed private capital in the form of impact investing to address these societal issues. The challenges range from reducing poverty, increasing gender equality, providing access to clean and affordable energy, and creating more sustainable cities and communities.

As of 1 April 2019, the Global Impact Investing Network estimates that over US$500 billion has been channelled into companies intended to make a positive change. The practice uses capital to contribute to improvements in people’s lives and the environment while generating financial returns.

Why impact investing makes a difference

At the core, impact investing directs dollars to companies that are socially responsible with their business practices, products, and profitability — and avoid companies that do not. While much of impact investing has gained mainstream popularity, it is still surrounded by myths and misconceptions.

Here we clarify the top myths surrounding impact investing.

Myth 1: No different from philanthropy

Impact investing has been confused with philanthropy. While both aim to create a positive impact on the world, philanthropy does not feature a financial return component. Specifically, philanthropy focuses on specific social causes while impact investing has the broader task of improving causes that can include supporting sustainable agriculture, making healthcare or housing affordable, and developing clean technology.

Myth 2: Returns may be compromised in exchange for doing good

On the contrary, when the intention of positive impact is genuine and incorporated into a firm’s offerings and practices, we believe this promotes better corporate health. It can also potentially lead to improved long-term returns for investors.

Impact investing is often evaluated using environmental, social and corporate (ESG) criteria that socially conscious investors use to screen potential investments. A 2019 Harvard study provides empirical evidence that good performance on ESG issues contributes to higher financial returns. Most tellingly, the researchers found that whereas firms with good ratings on material ESG issues significantly outperform firms with poor ratings on those issues, firms with good ratings on immaterial issues do no better than firms with poor ratings on those issues.

Myth 3: Nothing but a marketing ploy

While impact investing began as an ethical investing concept, it has since become an integral part of fundamental securities analysis. The idea stems from good ESG decisions that tend to be less risky than those with bad ones because the latter are more likely to get face financial losses related to ESG issues. For instance, companies making vehicles with poor emission standards would score lowly within the environmental framework and are more likely than not to incur regulatory fines or issues.

Companies that have good ESG decisions are also setting positive precedents for themselves in longer term against their competitors. By addressing unmet societal needs, companies are more likely to be first movers into potentially large addressable markets. Additionally, acting responsibly can have the effect of building trust and loyalties among key stakeholders and can better prepare their business for a resource-constrained future.

Myth 4: ESG analysis merely puts ticks in boxes without real impact

ESG is a useful methodology to assess if the metrics merit a stock inclusion or exclusion into their selection criteria even if a high score may not necessarily confer immediate beneficial outcomes.

For instance, ESG analysis could exclude a social media company if it failed to protect users' privacy and poor governance to deal with the problem. This is not too different from credit ratings where a downgrade to junk status mandates all investment grade bond fund managers to dump the name.

Myth 5: Impact investing is a niche asset class

The reality is that impact investments are not a separate asset class. ESG analysis can be applied to existing investment vehicles where financial professionals need not create a separate bucket for ESG strategies. ESG strategies may be considered a core part of a portfolio, or a satellite component, depending on what makes sense given the particular client and the particular ESG product option.

Conclusion

Impact investing is heavily dependent on ESG analysis which requires sophisticated, ongoing monitoring and reporting of real-world outcomes across thousands of businesses and products is even more dependent on high-quality data. While indicators around impact performance are still new, specialist consultants are working to address some of these shortcomings, and are building standardised metrics that are reshaping the financial markets.

As a signatory to the Singapore Stewardship Principles for Responsible Investors, we also stepped up our responsible investing efforts during the year. We have begun incorporating ESG considerations into our screening of Asian and Singapore bonds, and investment-grade US corporate bonds, in addition to our active investment research and evaluation processes for equities.

Our impact investing strategy is centred on the research and identification of companies that can contribute to the United Nations Sustainable Development Goals, such as those committed to creating innovative sustainable products to reduce consumption and waste.