School strikes for climate action, inspired by 16-year-old Swedish activist Greta Thunberg, represent a clear signal of young people’s growing awareness of critical macro issues facing the world today.
Millennials and younger generations live in a society with rising inequality and mass migration, dominated by concerns around global warming, causing destructive hurricanes and other weather disasters. This extreme environment is shaping the next generation’s world view, influencing aspirations and investment behaviours.
Younger cohorts, as well as other age groups, are increasingly mindful how financial returns are generated, expressing a desire to generate positive impact on society and the environment through investment activities, aligning them with personal values or goals.
In combination with the Paris accord, where 195 nations agreed to undertake to keep global temperature rises this century as close as possible to 1.5°C above pre-industrial levels, a powerful catalyst for raising consciousness have been the 17 sustainable development goals (SGDs) set by the UN in 2015 for the year 2030. Built on the principle of “leaving no one behind”, the closely interconnected goals represent an ambitious, universal call to end poverty, protect the planet, and ensure all people enjoy peace and prosperity.
Filling the gap
But time is running out and the funding gap is huge. SDGs currently face annual funding shortfalls of $2.5tn. Private banks claim they have a role to play in helping to hit the SDGs, through mobilising private capital to meet demand for impact investing.
“People care less about generic topics than specific causes they hold dear,” says Mark Haefele, CIO at UBS Global Wealth Management.
“They want the chance to leave their mark on issues they are passionate about,” such as eradicating poverty or achieving gender equality.
New investment opportunities are increasingly created to align with these and other SGDs, which are becoming a “common lexicon” among both private and institutional investors, says Marisa Drew, CEO of the impact advisory and finance department at Credit Suisse. For instance, a client who cares about the ocean might highlight a focus on SDG14.
“People are using the SGD framework and language when investing, to express their aspirations and things they care about,” she says, reporting increasing client awareness of impact investing to reach both financial returns and positive environmental and social outcomes.
While most private investors like the idea of investing for impact, they still prioritise market returns.
“Investors may start by focusing on market returns, with impact secondary in their minds. But when they see the power of their investments, they become the biggest ambassadors for impact investing,” adds Ms Drew.
In response to client feedback, Standard Chartered Private Bank recently launched an ‘Impact Philosophy’ framework along with its investment offering, promising a “structured roadmap” to help clients mobilise capital towards achieving SDGs.
“The financial system has the potential to be a major catalyst in the sustainability revolution,” says Didier von Daeniken, global head, private banking and wealth management at Standard Chartered.
Mapping strategies to SDGs has also been the latest development at Banque Safra Sarasin, which manages most of its assets by integrating environmental, social and governance (ESG) considerations. The Swiss institution has grouped SDGs into four big clusters, namely ‘energy transition’, ‘catering to basic needs’, ‘empowering people’ and ‘preservation of natural capital’.
“We analyse data of corporates in which we invest, and look at how much of their turnover in goods and services is generated to reach a specific sustainable development goal, which makes the impact more tangible,” says Jan Poser, the bank’s chief strategist and head of sustainability. This may mean, for example, measuring the numbers of vaccines a healthcare company provides to lower income countries.
Parallel strategies
Investing sustainably or moving towards impact investing may not be a binary decision for clients, believes James Purcell, head of sustainable and impact investing, Chief Investment Office at UBS GWM.
Clients often run different strategies in parallel or migrate step by step. Investing in debt issued by the World Bank or other development banks is often a starting point for generating impact.
World Bank bonds, which finance social and economic development in developing countries, are triple A credit rated, similar from a financial prospective to US treasuries, and therefore a “fantastic substitute” for high grade bonds or Treasury exposure, says Mr Purcell. Yet, many investors are unfamiliar with this asset. One of UBS’ initiatives has been to partner with the World Bank, “mainstreaming” the use of these instruments.
Typically, impact investing lends itself to private markets because investors add fresh capital to companies’ balance sheets and can influence their business strategy.
The small size of impact managers, the reduced scale of investment opportunities, as well as illiquidity, have traditionally been major hurdles, despite recent improvements.
“In recent years, there has been a step change in the scale of private equity and impact investing, and we have seen arrivals of top tier, first quartile managers with significant resources, for due diligence and impact measurement,” reports Mr Purcell. These include KKR and Capital Generation Partners, which have raised hundreds of millions of dollars.
Another development is the emergence of aggregators and platforms, such as Align 17, working with smaller impact investors to source global investments, while using third-party industry experts to vet them, and offering co-investments.
Impact can also be generated through public markets by actively engaging with corporates. “Beyond casting your vote, it means using your voice as a share or bond holder to engage the company and look for opportunities where you can improve the sustainability, and simultaneously, the profitability of the firm through dialogue and collaboration,” says Mr Purcell.
Testament to the huge demand for sustainable and impact investing solutions is the growth of UBS’ “fully sustainable” discretionary mandates, launched in 2018, funded with SFr1.2bn ($1.2bn) of assets of legacy portfolios, today holding SFr4.5bn. These core portfolios include equity engagement strategies, run by Hermes IM and BMO GAM, but also allocation to pure impact strategies such as development bank debt and green bonds, as well as more traditional sustainable strategies, using ‘best in class’ approaches, for both equities and fixed income.
Growing trend
More than 90 per cent of private banks expect ESG investing to rise in the years to come, with 56 per cent predicting clients’ allocations to grow by more than 20 per cent over the next three years, according to PWM’s 2019 global asset allocation survey of 43 private banks, managing combined assets of $10tn globally. Growth rates expected for impact investing are slightly lower, but still significant, albeit from a lower base (See Figs 1- 3).
While there are barriers to the uptake of this investment approach, the role of the adviser is key, believe private banks’ CIOs in our survey.
This result mirrors UBS’ survey of 5000 HNWs, 90 per cent of whom believe their financial adviser has a significant role in shaping how they engage in sustainable and impact investing.
“More than educating clients, it is about having a discussion around values and considerations around legacy, which may come in the form of investments,” states Mr Purcell.
There are two ways of channeling capital into SDGs, believes Swiss Bank Lombard Odier, which recently received ‘B Corp’ certification for corporate sustainability.
The first involves directing additional capital to reach those goals, generating positive, measurable impact on the society or environment. But this element of additionality is a “luxury” the world can no longer afford, explains Bertrand Gacon, head of corporate sustainability at the Swiss bank. It must be combined with bringing SDGs into mainstream investments.
“Given the scale of the challenges we face, we need to find ways of mobilising mainstream investments into the SDGs,” he says. This includes investing in listed equities and bonds to transform investment decision making, driving corporates to redesign core missions and refocus business to add more value to society.
“Only then will SDGs and impact investing become mainstream,” adds Mr Gacon.
A key barrier today to adoption of sustainable investing, confirmed by PWM’s 2019 GAT research (see Fig 4), is investors’ fears that investing in these strategies may sacrifice returns.
“The dialogue between investors and professionals is yet to be fully developed,” acknowledges Patrick Odier, senior partner at Lombard Odier.
To enhance this dialogue, the bank has introduced a reporting grid, indicating the ‘carbon intensity’ of clients’ portfolios. Other factors are also being explored, including water wastage and energy consumption.
“What is important is that we translate SDGs into investment ideas that can cater to clients’ different sensitivities, there is no one size fits all,” says Mr Odier.
These solutions may take the form of green bonds, or a global health bond aimed at eradicating major illnesses. Collaborating with the International Committee of the Red Cross (ICRC), Lombard Odier recently launched the world’s first high-impact private debt transaction, structured as a private loan transaction, linking a targeted social outcome to a financial return.
The bank’s private debt fund, investing in companies offering goods and services to low income communities, offers monthly liquidity, meeting client demand for more liquid solutions in this space. Today, private clients are more willing to invest in illiquid products, which they have shunned over the past 10 years, and that should help drive distribution of impact investing products, says Mr Gacon.
The challenge will be to transition from a product-based into a “process” approach, with impact being integrated into analysis of every investment decision, as a third dimension, in addition to risk and return.
Data around the analysis of companies’ practices, which cover the way corporates behave, or treat employees or suppliers is generally available and of good quality.
But, although progress is being made, thanks to technology such as AI and big data, it will take a few more years before standardised data will enable investors to assess corporates’ impact each of the SGDs, the environment and society, says Lombard Odier.
Disconnect
More than 90 per cent of the $30tn which needs to be raised before 2030 to reach the sustainable development goals will be spent in just 40 to 50 developed countries, out of the total 195 countries in the world. The majority of challenges lie elsewhere, in Africa, Asia and Latin America, which are facing generally higher economic and geopolitical risks.
“The biggest challenge we have with regards to impact investing and SDGs is the total disconnect between where the money is needed to reach the SDGs and the investment profile of the money available to fund them, globally,” says Uli Grabenwarter, deputy director, equity investments at European Investment Fund, an EU agency providing finance to SMEs through intermediaries.
Institutional investors adhere to strict guidelines around risk return profiles and liquidity, while private capital is more flexible and patient. But wealthy investors also want to protect capital, while impact investment has been dominated by higher risk products.
Financial intermediaries, such as development financial institutions (DFIs) must take the lead in addressing this disconnect. The solution could combine layers of funding sources, where mainstream capital would fund a specific impact initiative, without having to take the full spectrum of risk associated with it, says Mr Grabenwarter.
This concept of ‘blended finance’ or ‘solution driven finance’ involves using both development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets.
“What the impact investing movement has done really successfully is building a brand,” says Nick O’Donohoe, CEO at CDC Group, the UK’s development finance institution, one of the biggest impact investors in Africa and South Asia.
“Ten years ago, this field was completely unknown and nobody ever thought of anything other than maximising shareholder value. Post the financial crisis, there has been a huge shift in sentiment, with good managers entering the space and huge interest among high calibre people, who want to be part of the impact investment movement.”
Momentum
Sustainable investment assets, including ESG and impact investing, have grown 34 per cent worldwide since 2016, reaching more than $30tn, according to the Global Sustainable Investment Alliance.
A recent report from the GIIN [Global Impact Investing Network] estimates the current size of the global impact investing market to be $502bn, based on collation of AuM data on more than 1,300 impact investors around the world.
“This result underscores the momentum of impact investing, but also the need for continued growth across the responsible investing landscape if we are to address global challenges like those outlined in the sustainable development goals,” says Amit Bouri, CEO and co-founder of the GIIN. The network recently published the core characteristics of impact investing to better define the space of impact investing.
As the industry grows, says Mr Bouri, scale must be matched with integrity, so that good intentions translate into real impact results.
