Making money and doing good - the rise of sustainable and impact investing

Written on the 7 August 2018

 

There is no doubt that interest in responsible investments is growing. Not only in Australia but globally, investors are increasingly interested in how a company makes its money not simply how much it makes.

Whilst some investors may focus on the longer-term viability of a company and its behaviour, others may hold particular values they want their investments to mirror. How these two strategies play out in the investments context can be different.

Just making money is no longer enough
Even at the highest level, investors are shifting from only looking at short-term returns to a broader focus on long-term value creation, including the impact a company is having on those around them.

In his 2017 letter to the CEOs of the companies his firm invests in Blackrock CEO, Larry Fink, highlighted this exact issue noting that "To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate".

A similar sentiment is echoed by Vanguard Chairman Bill McNabb, whose recent Investor Letter (sent as part of the CECP: The CEO Force for Good's Strategic Investor Initiative) included the comment "For too long, companies have sacrificed long-term value creation to generate short-term results, which erodes the sustainability strategic investors seek".

More and more investors are asking CEOs to focus not only on creating shareholder value, but also on long-term vision for the company, and, by extension, the impact it will have on society.

This is not a new idea
Today, many investment managers, including BT, use environmental, social and corporate governance (known collectively as ESG) knowledge and data. It can help to inform the analysis of risk, innovation, operating performance, competitive and strategic positioning, and quality of management, corporate culture and governance and to enhance financial valuation, portfolio construction, engagement and voting practices.

Examples may include a company's interactions with the environment, such as water and air pollution, social factors like employee diversity or safety standards, along with the company's governance structure, such as how the board is composed and compensation structures. This approach seeks to add value or manage risks through broader, more comprehensive investment analysis, decision-making and engagement with companies.

This approach is providing measurable results
Investor-led initiatives have resulted in change at some of the world's biggest companies. For example last year, investors successfully influenced oil and gas company, Exxon, to be more open about the effects of climate change on its business, by improving is disclosure of climate-related risk.

In December, engagement provider Hermes EOS, who advocates for change in global companies on behalf of investors, released its key themes for engagement in 2018, which included climate change, diversity, remuneration and human rights. Focusing on ESG issues allows investors to make a positive impact, or at least encourage the companies they invest in to make these changes.

There are opportunities for everyone
For retail investors, navigating the world of responsible investment can be complex, terms like ethical, sustainable and impact investing are often used interchangeably by investors seeking to ensure that their money is invested in companies or funds that mirror their values and beliefs. In reality, these terms each related to a specific type of responsible investing depending on what the investment is trying to achieve.

Arguably, the most well-known responsible investment strategy amongst retail investors is ethical investing. This strategy's primary purpose is to exclude certain industry sectors, companies, practices or even, at times, and countries that meet specific criteria from a fund or portfolio, based largely on the client's preference not to be invested in these activities. Traditional ethical investment strategies seek to avoid issues like tobacco, weapons, gambling, and pornography, however, investors are increasingly interested in strategies that avoid sectors linked to climate change or human rights abuses.

Sustainable investing, in contrast, is a type of responsible investing that considers ESG issues in an investment, alongside standard financial measures when assessing a company's performance. This might include how a company approaches employee relations, executive remuneration and anti-money laundering legislation, how it manages strategic issues such as climate change, or how it manages corruption.

Sustainable investing as an approach that explores further to reveal broader risks and help to identify greater opportunities. It naturally lends itself to longer-term investment horizons and strategies. The attractive consequence of this approach is that as more investors use a sustainable strategy in their investment decision-making, more and more companies will be encouraged to behave sustainably and address ESG concerns and opportunities in their business.

You may also have heard about the rapidly developing field of impact investing. Impact investments preference the social or environmental purpose of an investment over or alongside its financial results. While this is a developing concept, and there is still discussion around the definition, many investors agree that intentionality of the investment is important. That is, that an impact investment should be aligned to creating a positive social or environmental impact, it cannot simply be a bi-product of business-as-usual behaviours. Impact investments may target a specific social or environmental issue (think homelessness or renewable energy) or may be more broadly themed, for example focusing on businesses that have a measurable social impact across a range of areas (for example diversity, job creation or medical research). Whilst there are currently few opportunities to access impact investments for most retail investors, many people are attracted to the idea of investments that aim to deliver a positive outcome as an alternative, or complement to traditional philanthropic funding.

For Impact Investing - it is still early days
Traditionally impact investments have been largely in the bond market. Being larger scale, these have been targeted towards investment funds, charitable foundations and philanthropic family trusts. The idea originated in the UK, where Social Benefit Bonds have been issued since 2007 to target specific social outcomes where transitional government funding wasn't available. Social benefit bonds are usually issued by or in partnership with government, with the funds raised used to address a specific social issue or concern, for example, education or training for disadvantaged young people or re-offence rates in prisoners. In many cases, the return is based on agreed performance outcomes, which reflect the money saved by the Government or service provider.

This year, the first social benefit bond will mature in Australia. The 10 million Social Benefit Bond (SBB) was issued by the Benevolent Society and the NSW government in partnership with Westpac and the Commonwealth Bank and sought to support between 300 and 400 vulnerable families across NSW avoid unnecessary removal of their children into foster care. Over the first four years of the bond to 30 June 2017, the Benevolent Society's Intensive Family Support service achieved an 89 per cent preservation rate (children remain home with parents) for families referred to the program. At the time, this made it among the strongest performing intensive family preservation services in the world. With the bond maturing this year, many eyes will be on the final results, both social and financial as an early indicator of effectiveness of this type of impact finance.

Interestingly however, in Australia, green bonds make up the vast majority of impact offerings. Originating from the European Investment Bank in 2007, the first Green Bond in the Australian market was a $300 million five-year issue from the World Bank in 2014, managed by Westpac. By 2016, global issuance of green bonds had reached US$88 billion ($113 billion) according to the Climate Bonds Initiative¹. Green bonds function like normal corporate or government bonds, however the issuer commits to use the funds raised for an environmentally beneficial purpose, typically low-emissions energy sources or improved energy efficiency. Because a green bond shares the issuer's credit rating, it usually offers similar returns as the issuer's regular bonds, and are largely targeted at institutional investors.

The idea is progressing into other asset classes, with opportunities developing in the listed equities space around the globe. Investment managers are beginning to design strategies that make the most of listed equities' accessibility, scalability and liquidity by investing in companies that also deliver a measurable impact. These strategies tend to invest in companies where their core product or service addresses a social or environmental challenge, and where they are expected to deliver a financial return. These can range from innovative health providers to renewable energy companies.

One example is Wellington Management's Global Impact investment strategy, which invests in global equities across 10 investment themes under three pillars: life essentials, human empowerment and the environment. As the number of companies addressing global social and environmental challenges continues to increase, strategies like this may become more mainstream.

What can retail investors do today?
While specific impact investments may be difficult to access for many investors, more traditional investments can still be used to make an impact. We know that that there are often factors outside of the standard measures of business and financial performance that can influence the viability of a company from an investing perspective. Considering responsible investment strategies, allocating a portion of your funds to a dedicated sustainable or ethical option, or even personally investing in those companies known for involvement in social or environmental projects are all possibilities to consider and discuss with your financial advisors.

You can find more information about BT's approach to sustainability here.

1. Climate Bonds Initiative

Jessie Pettigrew, Senior Manager Sustainability - BT and Madelaine Broad, Portfolio Analyst, Investment Specialist - BT

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Disclaimer
Information current as at 12 March 2018. This document has been prepared by Westpac Financial Services Limited (ABN 20 000 241 127, AFSL 233716). This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. ©Westpac Group 2018