Impact investing in Europe stands to benefit from a surge in demand from fiduciaries, driven by stakeholders’ and beneficiaries’ quest for solutions in a world upended by the coronavirus global outbreak, according to a recent report.
The pandemic, according to research from Cerulli Associates, highlights many of the challenges that impact investors have been seeking to combat for years, from population density to the absence of rights for low-paid workers. Supporters of impact investing – already one of the fastest-growing areas of asset management – believe that a surge in demand from fiduciaries could push it into the mainstream.
For a long time, impact investment was hindered by the fact that many impact funds put positive outcomes ahead of market returns. This left the sector dependent on discretionary capital, because most asset owners have a fiduciary duty to achieve returns.
In recent years, however, impact investment has sharpened its focus on returns. The entry of renowned return-seeking firms into the sector has further bolstered its commercial credentials.
Nevertheless, the sector still faces significant headwinds, not least a scarcity of asset managers offering impact strategies – a challenge that Justina Deveikyte, associate director, European institutional research at Cerulli, believes stems, in part, from the legacy of prioritizing impact over returns and the reliance on discretionary capital.
“The dearth of managers means that fiduciaries keen to invest in impact cannot achieve scale or put large checks to work. Instead they face the prospect of investing with hundreds of small managers and higher transaction costs,” Deveikyte says.
To operate effectively in the impact space, asset managers need to develop a different set of skills to those used in traditional investment. They need to be able to measure impact as accurately as they measure returns.
“Impact requires portfolio managers to analyze risks, such as carbon footprints and governance, the potential impact of a new product on society, or future policy change alongside their PE [price-earnings] ratios, dividends, earnings forecasts, and so on,” she says.
Impact is difficult to measure and, unlike financial returns, is difficult to compare. For example, some clean-energy investments could reduce a business’s carbon footprint, but also destroy jobs; a polluting industry setting up shop in a low-income area would have a positive impact on jobs, but bring unwanted environmental consequences. Nonetheless, measuring impact will bolster the role that fiduciaries can play.
The growth in impact investment will lead to a shake-up in asset management as firms redefine their value propositions to address customers’ new needs. In addition, asset managers need to develop impact products across asset classes.
Most impact investment lies in alternatives and private markets rather than fixed income or public equities. In the event of future market sell-offs, investors may need to further rebalance their strategic asset allocations away from private markets and alternatives into equity – this could have negative implications for impact investing.
However, investor interest in listed equity products targeting impact is growing. Illiquidity and difficulty accessing alternatives and venture have resulted in an increase in the number of large investors looking at impactful companies in listed equity.
