ESG Investing – along with Sustainable Investing which is also known as Socially Responsible Investment (SRI) -- is one kind of Responsible Investing (RI). ESG Investing seeks to avoid harm while Sustainable Investment seeks to benefit all stakeholders in a general way. To date, Responsible Investing and Sustainable Investment have relied on a self-defined approach to assess the effect of policies and practices. This general, qualitative assessment is imprecise and makes accurate comparison between businesses impossible. This kind of well-intended investing only hopes to make positive environmental or social impact. Despite this lack of measurement, large investment groups in search of impact opportunities have focused on Responsible and Sustainable Investment estimated to be at US$22 trillion in 2018 and growing at 20% a year.
What is Impact Investing?
Impact Investing aims to bring specific solutions to meet the challenges affecting lives and the planet. It sits somewhere between philanthropy which focuses only on impact and responsible investing which focuses on profit with low impact. In contrast to ESG or Sustainable Investing, Impact Investing is defined by vigorous and transparent measurement of both positive and negative impact. It demands tangible and concrete results and leads to actual change experienced by people and the planet.
Quantitative measurement of impact has been achieved in pay-for-success interventions such as social impact bonds but has yet been applied to businesses that have varied activities. Big investors have focused on investing in ‘green bonds’, which fund companies spending on environmentally friendly projects. The green bond market is estimated at US$350 billion in 2018 with US$160 billion raised in 2017 alone.
Despite Impact Investing’s smaller size, it is significantly influencing investor thinking. It is leading investors to realize the importance of measuring impact across all investment categories, including but not limited to Responsible, Sustainable and Green Bond investment; and to appreciate that only when investors can measure impact in a standard way, they can make really meaningful comparisons between various investment opportunities.
Over the last 20 years, we have seen the rise of numerous initiatives to establish shared fundamentals for defining, measuring, and quantifying impact. One of the most promising impact measurement approaches, advocated by The Global Steering Group for Impact Investment (GSG) and the Impact Management Project (IMP), involves weighing conventional financial accounts for impact. It is done by applying impact coefficients to sales, employment costs, cost of goods sold to arrive at an impacted-weighted profit; and then doing the same for assets.
The aim is for these impact coefficients to be set by an Impact Accounting Board according to the new Generally Accepted Impact Principles (GAIP), in the same way that Generally Accepted Accounting Principles (GAAP) are set. It is hoped that before long, every company will publish impact-weighted accounts alongside its financial ones. Net impacts will be quantified and tied to the achievement of social goals such as the UN Sustainable Development Goals (SDGs). If this happens, impact will assume its rightful place alongside profit in decision-making.
Impact Investing vs. ESG Investing
While the above draws the distinction between Impact vs. ESG Investing, Impact Investing is often mistakenly or inadvertently treated the same as ESG Investing. The Covid-19 pandemic has accelerated interest in environment, social, and governance (ESG) issues in 2020, and Financial Times predicts that this will intensify in 2021. ESG ETF assets alone have doubled in 2020 from 2019 to more than US$120 billion.
The ESG boom is now driven as much by risk management as activism – Covid-19 has shown Wall Street and companies around the world the dangers of ignoring so-called “externalities”. Since the dawn of the Industrial Revolution and especially during the last 50 years, companies have focused relentlessly on profit maximization and investor returns – financial capital -- while largely ignoring natural capital, social capital, intellectual capital, manufacturing capital, and human capital’s contribution to our world.
Milton Friedman’s famous New York Times Magazine article in 1970 on Social Responsibility of Business has more influence on this thinking than anything else imaginable: “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Unfortunately, his view on corporate social responsibility has been carried out so relentlessly and to such an extreme that many executives have forgotten that corporations have responsibility to other stakeholders, future generations, and the planet -- not just investors.
The Future of ESG Investing
There are big problems facing the ESG sector such as a lack of accounting consistency, different policy approaches amongst different continents/countries, too much money chasing too few viable investment products, and the difficulty of deciding how to balance the “E” against the “S” of ESG investing. There will probably be some ESG-related scandals and greenwashing in 2021, but it is clear that ESG is moving from the margins to the main stage in investing.
The sooner we come together to adopt pay-for-success impact models by establishing Outcome Funds to pay for the impact achieved by transformational tools such as Social Impact Bonds (SIBs), Development Impact Bonds (SIBs), Environmental Impact Bonds (EIBs), the better we – governments, big companies, official development aid agencies, the World Bank Group and other development banks, and philanthropies – can address costly social and environmental problems and challenges.
We should also support social entrepreneurs who are profit-with-purpose entrepreneurs. Investors generally assume that they cannot deliver attractive financial returns. In reality, it is possible to supply cheaper products and services to underserved populations. Some of those who have tapped into huge latent demand have met with faster growth and higher profitability than those that serve mainstream markets at higher prices. An example is Unilever’s foray into India.
While Impact and ESG Investing may be one way to have impact, all of us -- consumers, pension savers, philanthropists, investors, entrepreneurs, social sector organizations, governments, and big company leaders -- can act to speed the impact investment revolution. Imagine if you could become a billionaire by removing plastic from our oceans and using it to create affordable housing. Imagine millions of young entrepreneurs could work on improving infant and maternal mortality, illiteracy, malnutrition, access to electricity and water while building billion dollar companies at the same time. Imagine investors buying shares in big companies mainly because they deliver affordable food products that improve the nutrition of underserved consumers. Imagine governments only spending money on programs that work.
Impact Revolution
We can act now on multiple fronts to advance the Impact Revolution as follows:
As consumers, we buy products and services that help improve lives and protect our planet;
As pension savers, insurance policy holders, investment portfolio owners, we push our investment managers to make not only Responsible and Sustainable Investments, but also Impact Investments of not less than 10%;
As entrepreneurs, we develop innovative businesses that deliver and measure positive impact and run them in a way consistent with our values;
As managers and employees of companies, we set impact objectives and track them;
As citizens, we lobby our governments to encourage and mandate investors and businesses to make decision based on risk-return-impact; adopt common impact accounting and reporting standards; and direct unclaimed assets in banks, insurance companies, and investment funds to Impact Capital providers; and
As philanthropies, governments, big companies, official development aid agencies, the World Bank Group and other development banks, we establish Outcome Funds to pay for the impact achieved by SIBs, DIBs, and EIBs.
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