Impact investment: Capital as a catalyst for change

Oliver MacArthur Aon’s impact research lead and Geri McMahon, head of responsible investment solutions at Aon, argue that impact investing offers a win-win scenario for portfolios, people and the planet.

The economic environment, financial markets and asset prices are all increasingly influenced by global megatrends, such as climate change, shifting demographics, the rapid advance of technology and digital communications, and political tensions worldwide.

At the same time, investor awareness and appetite to address environmental and social issues through pension scheme investments is rising. Protecting and securing the retirement income of employees and scheme members will, more and more, need to take account of these influences — impacting the investment decisions, fund offerings and member engagement strategies that trustees and sponsoring employers may adopt in future. Impact investing is one way in which to meet these challenges.

Designed to provide investment returns while driving positive, sustainable outcomes for society and the planet, impact investments differ to traditional investments by having dual objectives against which they are measured: they are required to deliver a return on capital and make demonstrable progress towards their stated environmental and social aims. Put another way, impact investing is more than merely excluding ‘sin stocks’ from investment portfolios. It is about investing in well-run companies that provide products and services that positively impact the world around us.

The case for impact investing

Global megatrends pose long-term challenges, and opportunities, that will reshape the world, societies and economies of the future. These challenges include tackling climate change, increasing access to quality education and affordable housing, enabling financial inclusion, advancing healthcare innovation, alleviating hunger and poverty, as well as driving renewable energy growth.

Allocating capital to companies whose products and services address these challenges can play a significant role in shaping the future for good. For example, capital flows to impact investments with stated ‘climate action’ goals have the potential to play a significant contribution to meeting the climate change crisis.

The IPCC suggests that investments in green projects to the estimated value of $2trn (£1.4trn) per annum, over the next 20 years, are needed to successfully tackle the crisis. In addition to driving measurable and positive responses to these challenges, impact investments offer the potential for competitive risk-adjusted returns. Organisations with a positive impact on environmental and social outcomes are increasingly considered to be better positioned to benefit from improved management of ESG risks and to bolster economic and market performance.

In its Annual Impact Investor Survey 2020, the Global Impact Investing Network highlights that 88% of respondents report meeting or exceeding their financial expectations and over two thirds of respondents seek risk-adjusted, market rate returns for their assets. The potential benefits flow from being part of the solution – and, as new opportunities arise, driven by regulation, innovation and consumer preferences, the valuation of financial assets will likely respond.

Exploring opportunities in publicly traded equity

Pension scheme investors should look to actively engage with impact investing and seek out those investment opportunities which offer the rewards of risk mitigation, financial returns and impact. Public equity investment approaches are becoming increasingly prominent and are democratising impact investing beyond private markets.

Public equity impact investors can benefit from diversified equity portfolios investing across a broad and liquid investment universe in developed and emerging markets. As public equity markets increasingly focus on sustainability issues to price companies alongside their financial characteristics, early adopters could expect to benefit from a favourable tailwind to financial returns over the medium-term.

As well as growing concerns over global megatrends and corporate transparency, increasing regulation and policy actions are beginning to influence investor preferences and momentum is building in terms of innovation and the available solutions offered. The changing market dynamics are increasing demand for companies aligned with a more sustainable future while lowering investment demand for unsustainable companies and increasing their cost of capital. Impact investing offers the opportunity to deliver a ‘win-win’ for portfolios, people and the planet. It is important for trustees to understand how their publicly traded equities could be invested in a more impactful way and the potential financial advantage on offer

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