It's on to the next frontier

THE past year has seen a dramatic acceleration in the adoption of environmental, social and governance (ESG) factors in portfolio managers' investment processes. Today, a vanilla global equity or multi-asset fund is likely to at least blacklist sectors such as coal and munitions.

Some firms have systematically integrated ESG factors into all their active mandates.

In short, investing with an ESG discipline has become mainstream. Arguably, it's time to consider the next frontier - impact investments.

This segment of the sustainable investing (SI) universe is defined by the Global Impact Investing Network (GIIN) as investments made with the intention of generating positive and measurable social and environmental impact, along with a financial return.

Impact investments are a niche and relatively nascent segment of SI, where frameworks and standards for defining, measuring and reporting impact are evolving. Still, institutions, pension funds, family offices and ultra-wealthy individuals have embraced it, fuelling the growth in impact assets from US$502 billion in 2019 to around US$715 billion in 2020, as estimated by GIIN.

This is a small fraction of the size of the entire sustainable and responsible investing universe of US$30 trillion at the start of 2018, according to the Global Sustainable Investment Alliance (GSIA).

Traditionally, impact investing is done via private markets such as private equity. Asset managers scour for unlisted enterprises whose products and services explicitly address social and/or environmental needs. These needs include sustainable farming, financial inclusion, food sufficiency and poverty alleviation. Impact funds' appeal includes a clear articulation of the investment theses, and a commitment to measure and present concrete evidence of impact. Plus of course a return objective that may be comparable to other PE funds.

THIS Wealth edition's main profile is of Temasek-backed ABC World Asia, which has raised S$405 million for a PE impact fund. To date, it has invested S$98 million into five companies. Elsewhere, there is also the Asia Impact Investment Fund (AIIF), managed by UOB Venture Management in partnership with Credit Suisse. AIIF II raised US$60 million in its first close late last year and aims for a total of US$100 million at its final close this year.

The good news is that impact investing isn't the sole preserve of PE or private markets. Traditional asset managers are increasingly eyeing this space, and there are impact funds invested in public securities which are open to retail investors.

FOR instance, the United Sustainable Credit Income Fund offered by UOB Asset Management is invested in the RobecoSAM SDG Credit Income Fund. The portfolio is invested in securities issued by companies which contribute in varying degrees towards the United Nations Sustainable Development Goals (UN SDGs).

Schroders also has an offering, the Sustainable Multi-Asset Income Fund, with comprehensive impact reporting. Here are some distinguishing features of ESG and impact investing.

ESG AND IMPACT

ESG investing takes a number of approaches, from simple exclusionary screening to best-in-class selection and ESG integration. The latter, as defined by GSIA, involves a systematic and explicit inclusion of ESG factors into investment analyses.

BlackRock's Emily Woodland, co-head of sustainable investing (Apac), says there is no single approach to ESG integration as the sourcing, assessment and incorporation of sustainability considerations will depend on portfolio objectives, investment style and asset class. Sustainability-related data, she adds, provides "an increasingly important set of tools to identify unpriced risks and opportunities".

UOBAM, for one, uses a proprietary SI framework to guide the integration of ESG factors, and this is consistently applied across the investment process, says Victor Wong, head of Asia ex-Japan ESG. "Referencing the SASB (Sustainability Accounting Standards Board) materiality map, we developed our own materiality map to assess companies' material ESG factors, and to evaluate their performance using ESG metrics to ensure sustainable growth."

Schroders associate investment director (ESG) Claire Herbert says: "We view integration of ESG factors as a fundamental, necessary component of investing, rather than a feature that qualifies a fund to be classified as green or sustainable."

With impact funds, on the other hand, ESG factors are a baseline in terms of screening potential portfolio companies. But just "ticking the ESG boxes", as David Heng, chief executive of ABC World Asia says, is insufficient.

The fund's Impact Report 2020 says: "Our portfolio companies also need to drive significant environmental and social outcomes and comply with our impact thresholds."

Geir Espeskog, co-head of BlackRock sustainable investing (Apac), says impact investing and ESG investing are distinct but complementary concepts. "ESG is about how a company - any company - operates and is managed. Is it good to its environment? Is it good to stakeholders?... Any company, no matter its business, can be a great ESG company.

"An impact company by contrast is specifically making goods and services aimed at solving important environmental and social problems. Effectively, ESG is about how companies go about doing what they do, whereas impact investing is about what they do to address social and environmental problems... Impact investing comes with a specific intention and necessitates that investments be managed towards that intention."

IMPACT MEASUREMENT

This may well be a key difference between ESG and impact funds. While both have coalesced around UN SDGs to define societal or environmental objectives, ESG-integrated funds may not specifically measure impact, or set impact thresholds. Some, however, do disclose metrics such as the portfolio's carbon footprint.

But for impact funds, intentionality (clear focus on SDG impact objectives) and impact measurement are key features.

BlackRock's Global Impact Fund, for example, spells out the respective exposures of the portfolio that further SDGs. Here are some highlights of its annual impact report published in May: Its portfolio holdings delivered education and career training to 142 million students and job seekers; provided affordable housing to 600,000 families; enabled financial services access to 114 million unbanked and underbanked individuals. The fund is available to retail investors.

Schroders' Sustainable Multi-Asset Income's monthly updates include disclosures on its sustainability profile in terms of the net benefit or harm to society per US$100 of revenue, in addition to the portfolio's carbon profile compared to a composite multi-asset index. It also provides a SDG profile of the fund's debt holdings, and a graphic representation of active stewardship (engagement and voting) by the fund, updated quarterly.

Schroders' impact funds draw on tools from its proprietary ImpactIQ suite, such as SustainEx and ThemEx. SustainEx puts a financial value on the impact that companies have on society and enables an assessment of the financial consequences of the impacts on profitability. ThemEx measures companies' positive or negative contribution to themes including diversity, health and responsible consumption.

Pictet Asset Management has managed sustainable thematic funds for decades, predating the UN SDGs. Steve Freedman, head of research and sustainability (thematic equities), says: "As the portfolios focus on providing solutions to environmental and social problems, they are relatively straightforward to map onto SDGs... Typically, our themes are aligned with multiple SDGs. This mapping is made available as part of our impact reporting."

Pictet's end-2020 sustainability and impact report for the water strategy details the strategy's exclusion policy; specific impact reporting and exposure to SDGs; and active ownership including proxy voting and engagement.

IMPACT THESIS

This is a another key differentiator between an ESG-integrated portfolio which typically does not have an impact objective, and an impact investment.

An impact fund takes its raison d'etre from its impact theses, which has to be carefully conceived and articulated. As AIIF I's 2020 impact report says: "In two decades of impact investing, many investors have been disappointed by strategies that promised too much but drifted from their missions. The AIIF's robust impact policy sought to avoid this by defining eligible business models and sectors."