Impact investing – social, ecological, and financial returns in one
15 March 2019Reading time: 7 minutes
More and more investors around the world are factoring sustainability into their investments. For many, simply avoiding alcohol and tobacco conglomerates, arms manufacturers or companies that are particularly damaging to the environment is no longer enough. There is a solution: impact investing. It allows investors to support companies that are committed to solving social and environmental problems – and, contrary to enduring prejudice, they can do so without compromising on returns.
Younger people care most of all about investing sustainably
Sustainability is steadily gaining importance among investors, giving rise to a real growth trend. In a 2018 survey of 22,000 investors in 30 countries, London-based asset manager Schroders included questions on the topic of sustainable investments. Some 64% of respondents said that these now make up more of their portfolios than they did five years ago. Younger people, also known as millennials, care most of all about investing sustainably. Its significance is illustrated by Norway's sovereign wealth fund, which has around EUR 877 billion invested in over 9,000 companies spread across more than 70 countries. Thanks to its sheer size, the fund has the power to influence political and corporate decision-making, and this has led its managers to base their investments on sustainability criteria. The investment guidelines are aligned with international standards such as the UN Global Compact, an agreement between the United Nations and the corporate sector to make globalization more socially and environmentally responsible. Impact investing goes a step further.
Impact investing: earn money while solving problems?
Impact investing is not just about social and ecological returns, it also expressly targets financial ones. These aims are derived from key understandings reached by supranational organizations like the UN, the Organisation for Economic Co-operation and Development (OECD), and the G20. The UN formulated 17 Sustainable Development Goals (SDGs) in 2015 as part of its 2030 Agenda for Sustainable Development. The SDGs include ending poverty in all its forms, ensuring inclusive education, achieving gender equality, ensuring availability of water and sanitation, combating climate change, and protecting the environment. They make it possible to draw up a range of impact categories or themes that can help investors to find out whether the companies or sectors they are interested in are compatible with impact investing. A selection of these are outlined below:
Alternative energy sources
Alternative sources of energy are a very important topic these days, and wind and solar power are by no means the whole story. This category includes companies offering products or services that promote the development or production of renewable energies and alternative propulsion systems. Companies generating a certain share of their revenues from raw materials, technologies or infrastructure for the production and distribution of clean hybrid fuels, hydrogen, fuel cells, and other alternative fuels can also fall into this category.
The last few years have clearly demonstrated that humanity is desperate to find alternative sources of energy. Germany heralded the end of the nuclear age back in 2011 and has started shutting down coal-fired power plants this year. Other countries have also drafted timetables for exiting the era of fossil fuels.
Energy efficiency
Finding renewable and environmentally friendly sources of energy is of course not enough on its own. The way we use this energy also has to become much more efficient. This is where companies that help to minimize the impact of energy production on nature and reduce energy consumption come in.
Industrial production needs to continually increase its efficiency, for instance through the way it uses turbines and motors, more automation, more efficient controls, greater digitalization, and system optimization.
Sustainable transport infrastructure, enhanced efficiency in local public transport, and more efficient traffic management are also key challenges for the future, along with planning and constructing environmentally friendly/sustainable buildings. In fact, "green building" is an industry in its own right, covering the planning, construction, renovation, upgrading, and purchase of properties that qualify as "green" in accordance with local standards (BNB and DGNB in Germany, MINERGIE & NNBS in Switzerland).
Impact investing themes:
Sustainable water supplies
There are already more than 7.6 billion people living on this planet, and the UN predicts that the global population will rise to almost 10 billion by 2050. Some regions already have to contend with droughts and water shortages. This should lead to heavy investment in water infrastructure around the globe. Products and services to reduce improve the availability, quality, and reliability of water supplies and to monitor and measure water use are urgently needed in many parts of the world.
Environmental protection
Humanity is now starting to realize that it only has one planet, so protecting the environment has become a major issue. Pollution must be prevented or reduced, less waste must be produced, and the extent of recycling must be increased in as many areas as possible. The public discussion about plastics has shed light on just how pressing the waste problem is. This is likely to create a surge in demand for companies that collect, reuse, and recycle the waste resulting from consumption. Topics such as regenerating, cleaning up, and decontaminating natural habitats should continue to occupy politicians and business leaders alike for years to come and generate good business for companies working in these fields.
Nutrition, healthcare, hygiene, education, and microfinance
Besides environmental factors, social aspects also play an important role in impact investing. Access to staple foods must be assured. The impact investing universe also includes companies making educational products such as learning software, books, and other materials that students and teachers need, as well as those working to improve hygiene standards or treat major diseases.
Get into impact investing with a single transaction
This promising investment theme could give rise to interesting and potentially lucrative opportunities for investors with a long time horizon. This is the rationale behind the MSCI World IMI Select Sustainable Impact Top 20 Index, which covers ten segments with relevance for impact investing: (1) alternative energy, (2) energy efficiency, (3) green building, (4) sustainable water, (5) pollution prevention, (6) nutrition, (7) major disease treatment, (8) sanitation, (9) SME finance, and (10) education. For each segment, two companies that generate more than 50% of their revenue in that segment are included in the index. Companies can of course be involved in more than one impact category, and they can also be ruled out of contention as sustainable investments on the basis of certain criteria. This happens, for example, if even a small proportion of their revenue is derived from the manufacture or sale of harmful products such as alcohol, tobacco, firearms, coal, oil or natural gas.
Over the years, recognized methods of assessing companies' sustainability have become established in financial analysis. The key term here is ESG, which stands for environmental, social, and governance. Classifying companies in accordance with ESG criteria enables investors to select the most ecologically, socially, and ethically sound firms for their portfolios. The index provider MSCI uses its own ESG ratings, which it divides into three groups: laggard (CCC and B), average (BB, BBB, and A), and leader (AA and AAA).
In addition, the MSCI ESG Controversies concept makes it possible to identify companies that are involved in businesses investors might object to or that hold stakes in firms failing to comply with international norms and principles. A color scale (red, orange, yellow, green) for ESG controversy flags indicates the extent to which a company has been or still is involved in controversial activities and violating international standards.
Only companies with an ESG rating of A or higher and a green or yellow ESG controversy flag make it into the MSCI World IMI Select Sustainable Impact Top 20 Index. Investors can rest assured that the selection process is rigorous, and not just any company can be included. Stocks must also meet additional requirements, including a free float-adjusted market capitalization of USD 500 million or more. Those that successfully negotiate the ESG and controversy filters and have the requisite liquidity and market capitalization must then pass a quality test. They are analyzed and ranked using three financial metrics: leverage, return on equity, and earnings variability. The stocks included in the index are equally weighted. The MSCI World IMI Select Sustainable Impact Top 20 Index includes the following companies, among others:
Johnson Matthey: Johnson Matthey is based in London and sells catalytic converters and a range of technologies for low-emission and zero-emission engines and industrial plants. One in three new cars worldwide is fitted with a Johnson Matthey catalytic converter. The company also recycles precious metals such as palladium and platinum.
Badger Meter: Water scarcity is already a big problem in many parts of the world, making improvements to water infrastructure essential. A key factor in this respect is precise measurement for efficient water management. Badger Meter of Milwaukee in the US state of Wisconsin specializes in flow metering technology that helps to save as much of this vital resource as possible.
Novo Nordisk: The global population is growing at a fast pace, and so is the economic strength of emerging markets. As this growth continues, certain "diseases of affluence" like diabetes are spreading. Novo Nordisk, the world leader in insulin, can be trusted to meet patients' needs.
The all-in-one impact index
These companies are standard-bearers of impact investing. They and others like them were the inspiration behind the MSCI World IMI Select Sustainable Impact Top 20 Index, which is calculated and published by MSCI Inc. MSCI has more than 30 years' experience in ESG analysis and over twice as many clients as any other provider.
Investors can track the MSCI World IMI Select Sustainable Impact Top 20 Index with a participation certificate that offers almost 100% participation in the index's performance – both on the upside and on the downside. With a single transaction, they invest in a diversified index comprising 20 corporations that are committed to sustainability and to solving the challenges facing humanity.
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23/03/2023 21:44:23