An approach known as "impact investing" is becoming increasingly popular in the investment world. In this article, we'll look at the challenges and opportunities of integrating impact into listed equities.
More impact from listed equities is needed
In the impact investing industry, there has been a growing trend towards the idea that, in order to have a significant impact on the world, it is necessary to move at scale and engage mainstream investors. Given the growth needed in assets under management, listed equities are an inevitable choice as an asset class even though many argue that it is difficult to do impact investing with listed equities.
Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return(*1). This definition seems to suggest that impact investing is applicable to any asset class. However, listed equities account for less than 20% of global impact investing, which is small considering that the approximately 50% of total assets under management is in listed equities.
Why is this difficult?
Why is this difficult? Ultimately, it is because listed equity investing is typically driven by profitability, and the definition of impact investing does not fit well with it. The Government Pension Investment Fund (“GPIF”) has stated that it does not make impact investments. The following is an excerpt from the GPIF ESG REPORT 2022 (*2) which explains the logic behind this decision:
"[GPIF’s mission] is to contribute to the stability of the national pension system by managing and investing the pension reserves entrusted to us by the pension beneficiaries, who are the people of Japan, and paying our investment returns into the national treasury…We are prohibited by law from managing pension reserves for any other purpose. This is referred to as the ‘prohibition of consideration of issues except for those that benefit the pension beneficiaries’."
In other words,
"…GPIF’s sole mission is to generate investment returns. It cannot invest for the purpose of creating an impact."
Interestingly, however, immediately after the explanation for not making impact investments, the report mentions the following idea:
"[W]e believe the act of investing does affect investee companies’ corporate value through business activities of our investee companies generating a social and environmental impact which creates revenue and costs eventually leading to impact on corporate value…GPIF does not invest in impact, and yet we suppose ourselves as among the most impact-focused of all investors."
In other words, this is a complex situation in which other considerations are prohibited, while GPIF has a strong interest in impact. GPIF has therefore organized all this within the framework of "ESG investing".
It may be that the focus is on impact, but it is difficult to fit this into the definition of impact investing when the goal is to increase investment returns with a large number of unspecified stakeholders.
Definition doesn't fit well
The fact that the most pro-impact investor (and one of the largest in the world) says that they "don't do impact investing" doesn't mean they don't want to do it, but rather that the definition doesn't fit well. They might say, "we consider impact within the framework of ESG investing, so we don't need to call it impact investing".
We observe other situations where the story is complicated by the fact that the definition of impact investing is incomplete.
For example, the world of impact investing uses the term "market rate". The idea that socially minded investors place less emphasis on economic returns is referred to as “Below Market Rate”, while the opposite concept of impact investing that aims to earn at least the market return is referred to as “Market Rate”. In the world of more traditional active investing, the basic rule is to aim for above-market rates, and allowing below-market rates from the start would be a significant exception. The fact that these rules and exceptions are combined into a single category of "impact investing" seems to be interpreted differently by different people. In the commentary on impact investing, one rarely sees a discussion of the criteria for determining whether to go above or below market rates, but for mainstream investors, this is a very important point of contention.
At Cadira Capital Management, we incorporate an impact investment framework into sustainable investing, but we find it very difficult to design an investment process that aims for above-market rates by applying the framework as it appears in the textbook of impact investing. For example, it is necessary to narrow the investment universe to a specific theme, but narrowing the investment universe does not fit well with generating high quality performance over the long term. In the case of listed equities, performance is also measured daily against many comparable measures, such as stock indices and similar funds. Academic approaches such as portfolio theory are well developed and highlight the difficulty of achieving market returns while applying the impact investment framework as it is.
A way forward
There is no need to lament the fact that the definition and framework of impact investing are incomplete. If they are incomplete, we can simply improve them, and even if they are not called impact investing, we can engage in activities that create value for society.
Our portfolio managers try to ask questions about impact when they interact with companies in IR meetings. They also explain the impact of portfolio companies in monthly reports and other materials for our clients. Each of these activities may be a small step, but we believe they add up to a positive impact on society.
Ultimately, it would be good if everyone in the investment chain contributed to society in some way. If the industry as a whole becomes more ethical, we may not need to use the term "impact investing" at all.
*1 https://impactinvestment.jp/en/index.html
*2 https://www.gpif.go.jp/en/investment/GPIFESGReportFY2022E02_2.pdf, Page 8
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