Mainstreaming impact investing: What do investors want?

SEVERAL major sustainability themed events will take place in Singapore this week, including the International Finance Corporation's Green Finance Week, Temasek's Ecosperity Conference and Sustainable Solutions Expo 2018. How we can mainstream sustainability investing in order to achieve impact at scale has become a major topic in the investor community globally as well as in Asia.

Historically, private wealth investors in Asia have lagged behind their North American and European counterparts in their involvement in impact investing. This has changed significantly in the past few years. In 2016, wealthy individuals in the Asia-Pacific invested US$55 million into Credit Suisse' main impact investment fund launched in partnership with Singapore's UOB Venture Management. Last year, Singapore's largest local bank DBS offered its first impact investment to private banking clients who went on to buy 60 per cent of the US$8 million Women's Livelihood Bond created by the Impact Investment Exchange (IIX), the world's first listed exchange for impact investing companies based in Singapore. Over the three years to 2016, impact investing grew by more than 25 per cent in eastern and South-east Asia.

Environment, social and governance (ESG) considerations have gone beyond being a theme for private wealth investors to being adopted within the core portfolio of institutional investors. In Japan, Prime Minister Shinzo Abe has been implementing his three-arrow policy, with the third arrow - structural reform - considered as a long-term sustainable growth strategy. The Japanese government enforced a corporate governance code on all major business corporations, and "stewardship code" on major investors. Japan's Government Pension Investment Fund (GPIF), the world's largest pension fund with over US$1.3 trillion in assets under management, believes that ESG aligns with governmental policy. GPIF is trying to grow its portfolio implementing ESG, by creating an ESG index and monitoring the ESG implementations of its asset manager. It recently raised its allocation of ESG investments to 10 per cent of its equity holdings, up from 3 per cent in July 2017. Such GPIF activities can also be found in many business corporations and other Japanese big players.

While asset managers see significant interest from most types of investor, especially foundations, endowments and family offices, the mainstreaming of impact investing is also reflected in the growing interest from sovereign wealth funds and pensions funds. How do these investors view impact investing?

1. There is a common consensus that sustainable investing does not have to be semi-philanthropic. While they can be, in general most believe there does not have to be a contradiction between a company's commercial attractiveness and its potential to generate positive social or environmental impact. In fact, it can be argued that sustainability-minded businesses are better positioned for long-term value creation. Achieving dual financial and societal returns is crucial to mainstream institutional investors.

2. Risk management is closely scrutinised. Traditional barriers institutional investors face include small fund sizes, and limited investment scope, which exceed their risk appetite. Instead, what they seek is "institutionalised risk", which can be sought through large and proven investment platforms, global deal flows and investment opportunities, and diversification across asset classes, regions, and sectors. The result has been a growing professionalism in the field, which - together with institutional-quality platforms - is necessary to deliver on both financial and social and environmental impact.

3. There is a growing awareness and shift in mindset that sustainability is a global pursuit rather than a cause siloed to developing countries. The establishment of the Sustainable Development Goals (SDGs) as a follow-on to the Millennium Development Goals (MDGs) was an attempt to take a more globally inclusive approach to sustainability, building on the notion that all social and environmental objectives are inter-connected. Investable sectors such as clean tech, health care, renewable energy and education provide scalable investment opportunities in developed markets, which are well suited to institutional investment mandates.

4. Institutional investors are increasingly taking a cross-asset class view of impact investing, catering to a spectrum of risk tolerance levels and return expectations. Last year, GPIF and the World Bank Group announced their partnership to provide practical solutions to catalyse the development of sustainable fixed income markets, a reflection of its commitment in advancing the integration of ESG considerations in all asset classes of its portfolio.

5. There is a recognition of direct and verifiable impact through majority/control private ownership and governance. While there has been a trend in the marketplace towards impact investing through public equities and debt markets, private markets continue to provide the most direct and verifiable impact through the active management of assets.

In public markets, sustainability considerations are mainly pursued through stewardship, advocacy or in some csases activism; however, unless the investment is significant in size, activist in nature, and the company itself malleable, impact verification is difficult and in many cases indirect. In contrast, sustainability considerations in private markets by majority/control investors can be pursued through direct governance as part of the value creation plan. As compared to public markets where a lot of traditional shareholder engagement is focused on process, the private ownership model is well positioned to drive returns - financial, social and environmental - through entrepreneurial governance and active value creation.

This raises the next topic on measurable impact. Impact investing returns can be distilled into two components - the financial internal rate of return (IRR) and the societal IRR. While the financial IRR can largely be attributed to short-term cash flows, societal IRRs, relatively speaking, are the longer-term benefits. Through this lens, illiquidity is in fact an aid to the cause because it promotes a longer-term mindset, which is conducive to entrepreneurial governance and value creation.

In public markets where investors tend to own a small stake of each company, investment stewardship groups such as Blackrock's 70-strong team, tend to focus on engagement with companies through public shareholder engagement such as proxy voting. On the other end of the spectrum, control investors in private market follow a very different playbook, by taking advantage of the governance premium afforded, while offering investors a global cross-asset-class portfolio solution with institutionalised risk. The mainstreaming of sustainable investing needs all these differentiated approaches.

Kevin Lu chairs the Impact Committee of Partners Group's SDG-focused fund PG LIFE.

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