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Impact investing: towards a better world

Louise Kooy-Henckel
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Wellington’s Louise Kooey-Henckel on investing to make a difference 

Alleviating hunger, expanding access to health care and bridging the digital divide may not be typical investment criteria for most fund managers.

Yet these themes are among the primary objectives of impact investors. Recognising that the world’s major social and environmental problems could be significant business opportunities, impact investing aims to improve the lives of people around the world, while seeking an attractive financial return.

By focusing on positive selection, impact investing differs from socially responsible investment (SRI), which avoids companies that trade in perceived social negatives such as tobacco or gambling, and from funds that invest in companies with favourable environmental, social and corporate governance (ESG) profiles. Impact investors look for companies whose core products and services address what are considered to be some of the world’s largest problems.

Evolution of impact investing

Institutions like the World Bank have been investing in impact-type projects for more than 50 years via private equity or debt investments. However, the noble efforts of non-market players like governments and NGOs appear insufficient to solve the world’s needs. According to estimates, the developing world faces a shortfall of approximately US$2.5 trillion in the amount of funding needed (after government and philanthropic largesse) to tackle the UN’s sustainable development goals.*

Impact investing through public markets (as opposed to private equity and debt) is in its infancy. However, it appears to be evolving rapidly as a new cohort of impact investors expands the opportunity set, giving asset owners new ways to align their capital with their world view.

Importance of innovation

Innovation is the basis for most impact companies, though the businesses vary considerably. While some are groundbreaking early-stage enterprises, many more are established companies enjoying steady growth and competitive advantages, and still others are market-leading durable franchises with what we believe to be stable, defensive market positions. The common factor is that they apply disruptive ideas intended to have a positive influence on the world.

These companies are working to provide a wide range of solutions, from cures for chronic diseases to microfinance or affordable mobile-payment initiatives, from transforming waste into energy or providing non-carbon-based power to developing differentiated solutions for clean-water access, water-loss reduction and water-treatment infrastructure.

Measuring impact

The ability to measure a company’s social or environmental impact is central to impact investing. We want to ensure that impact is core to a company’s mission, that its efforts are sustainable and cannot be duplicated effectively by other means and that its impact can be quantified. Key performance indicators (KPIs) developed for each investment opportunity help us clarify and track a company’s progress towards its impact goals. They also encourage accountability and provide a different way to analyse the company.

For every company in our portfolio, we also monitor and measure management and governance, market position and growth prospects, financial strength and business risk, and valuation and potential stock-price appreciation or depreciation. Our goal is to invest in a diverse set of sustainable impact businesses that can provide competitive returns.

Potential benefits and risks

An impact investing approach could serve multiple roles in a portfolio. First is potential return enhancement. Impact companies typically address large, underserved and rapidly growing markets, and secular tailwinds will probably continue to drive investor interest in this area. Second, because impact companies tend to be under-represented in traditional market indexes, an impact fund can help investors diversify their portfolios. Third, impact is an inefficient and inherently misunderstood area, which allows dedicated investors to uncover potentially attractive opportunities. Finally, investors can use public companies as a liquid complement to private impact investments.

Impact investing has its challenges. Investment horizons are longer — it’s impossible to change the world in six months — and return volatility for individual stocks can be well above average, given companies’ uneven growth paths and reliance on disruptive technologies. However, as with any investment, a well-executed, diversified impact portfolio should help to minimise the negative effects of a single underperformer. And we believe that investors are likely to be compensated for any volatility by potentially attractive returns over the long term.

For more information, please contact Nicola Staunton on 020 7126 6070 or email njstaunton@wellington.com

This material and its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase, shares or other securities. Investing involves risk and an investment may lose value. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. For professional or institutional investors only.

Column sponsored and supplied by Wellington Management

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