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Inherited Wealth

Making your investment have an impact

In the latest in our series of articles on inherited wealth, discussing Impact investing, a new form of investing for those who want to do their part to make the world a better place. 

Planting image

by
Charles Stanley

in Inherited Wealth

20.03.2019

Impact investing is a new form of investing for those who wish to assist in making the world a better place. It is the development of a long tradition of philanthropy and altruism by institutions and wealthy individuals.  It is a small, but growing, movement in the investment world and much of the momentum behind it is popularly attributed to the demands of the more public-spirited and socially aware Millennial – which includes anyone under 35 years old. 

However, this sort of investment behaviour has been around for many years.  In the first half of the 20th Century a number of public-spirited US companies engaged voluntarily in some form of philanthropy, either through altruism or in recognition of the commercial value it brings.  This wasn’t always easy, as before a court ruling in 1954, companies could only make donations where it directly furthered their stockholders’ interests.  After that companies tended to shy away from such self-interested behaviour and settled into a pattern of ‘enlightened self-interest’.  This idea of charitable or ethical behaviour by corporates is nowadays very familiar.  There are various examples of companies supporting charitable causes or rewarding consumers for doing business with them by linking it to a charitable donation – the M&S Sparks card is a classic example which gives a penny to the customer’s chosen cause every time they shop.  It is interesting to note that this sort of thinking and behaviour was taking place as long ago as the 1950s so perhaps it isn’t just due to the millennial generation after all!

Late in the last century, a new form of investing emerged which allowed investors to focus only on a group of companies which behaved in a socially responsible way.  This was the advent of ‘ethical investing’.  The ethical concept encompasses multiple possibilities and has always been difficult to narrowly define.  Charities in particular embraced ethical investing from early on to reflect their goals; for example, religious charities typically avoided arms manufacturers, tobacco companies or more esoteric sectors such as contraceptive manufacturers.  Other unpopular areas include animal-testing and exploitation of under-age labour.  In more recent years ’ethical’ has broadened out into ‘ESG’; Environmental, Social and Governance.  This approach demands responsible behaviour from corporates and examines their performance in terms of issues such as  their treatment of employees and customers, remuneration structures for staff and management, anti-corruption measures and the ultimate disposal and recycling of their products.  ESG-focused investing puts significant power in the hands of the investor, but it ultimately remains only an indirect way to ensure that good things are being done with the money you invest.  A more direct and far more observable way to achieve your specific ESG goals is via ‘Impact Investing’. 

Impact investing has gained a substantial following, although it is still a long way behind ESG.  The 2018 GIIN (Global Impact Investing Network) study points to well over $228bn of impact investments already in place and new investments being made to the tune of $40bn per year. One of its main attractions is that it provides a more direct route to supporting and furthering your ESG goals as well as giving you a chance to actively measure the impact you have made.  For some, especially professional teams at large endowments who have been charged with investing the endowment’s money effectively, this is very attractive compared to merely giving your money to a well-meaning third party and hoping that it will be used wisely.  Some investments provide better information than others, so before investing it is important to decide upon which objectives are key to you and then look at the way in which the company or fund you are backing has set performance targets and metrics to measure and report on these goals.  Ideally, there will be some existing literature or sample reports so that the investor can judge the quality of reporting before investing.

There is, however, a catch.  While mainstream ESG investments or funds concentrate on public and liquid markets, impact investments tend to be made into private equity or debt, venture capital and infrastructure projects.  These investments set out to address some of the world’s most challenging issues such as creating sustainable agriculture and providing basic housing, so they target both developed and emerging markets and offer a range of return expectations and volatility levels.  Like other more niche investments, this will include the potential risk of failure and complete loss of capital.  The table below which reflects feedback from 208 impact investors, shows that the three biggest risks of these types of investments lie within: the business model/management competence, the country/currency exposure and the problem of selling/exiting:

Liquidity is a real issue with many of these types of investment as they are private and unlisted.  This does not preclude investors who prefer more flexible and liquid investments, although they will need to do so via a fund – which may have its own liquidity constraints and only provide redemptions at a significant discount.  There are a few publicly-listed impact investment assets available, but this is a tiny proportion of the total market; the vast majority being in the private equity or venture capital space.  Around 20% of investments are made by individual accredited investors as the following chart shows, with the bulk of investments coming from institutional sources. 

Bearing in mind the risks, a big question most investors will ask is “How do impact investments perform financially”?  The 2017 Annual Impact Investor Survey by GIIN showed that no respondents stated that they sought enhanced investment performance in return for the higher risk they were taking.  16% were happy to take a much lower rate of return as the cost of their philanthropic investment policy, while 18% accepted that they should expect returns somewhat below-market.  The remaining 66% were more hopeful and looking for ‘risk-adjusted market returns’ – potentially quite a big ask as it would imply a significantly above-market return in nominal terms to offset the increased risk being taken.  The fiduciary responsibility imposed on the trustees or officers of the many of the institutions involved in the survey makes it hard to surmise whether they genuinely expect to receive attractive risk-adjusted returns, but there is no reason why a well-structured and well-managed impact investment should not perform as well as a conventional investment.  As evidence of this, the following year’s GIIN report shows that only around 10% of investments are underperforming initial financial expectations (and that just a tiny proportion are not meeting the impact targets).

In general, if caution is a stronger instinct for an investor than social awareness, they should stick to well-researched public investments in stable business sectors in order to keep risk under control.  This ensures that they have plenty of information about the progress of their investment and the business environment which affects it.  They can sell out rapidly if things start to go wrong.  This is not the case with most impact investments and well-meaning investors wishing to make an impact should be aware that, while some they choose may turn out to be hugely successful, they will take on different types risks which they may not be used to.  As a result they may have to accept lower levels of liquidity, more price volatility and potentially poorer risk-adjusted financial outcomes than are available from mainstream investments.  Despite all this factors, while the negatives may deter the faint-hearted they should not put off wealthy individuals and endowments who can afford to tie up a small amount of their capital for the longer term so it can be used to improve the world for all of us.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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