In Dec 2018, delegates from almost 200 nations met at a UN climate change summit in Poland to discuss the 2015 Paris Climate Agreement.
The discussion centred around the accord, which aimed to limit global temperature rises at less than two degrees Celsius above pre-industrial levels. According to a recent UN report, on current projections we are set to fall well short of this goal.
Climate change has been a problem for decades, said Therese Niklasson, global head of environmental social governance at Investec. In the past, the planet has been able to cope with the “enormous stress” an acceleration in economic growth has done to it.
Since the turn of the century, though, the dynamics have changed. “Up until about the 1990s, we were effectively a small world on a fairly big planet,” Niklasson explains.
“Today, we’re a very large world on a small planet, and we are approaching these tipping points in terms of planetary boundaries and what we can use from our planet to continue growing the way that we have.”
Investment Industry Gets on Board
Now, these Sustainable Development Goals have become a more regular part of the investment parlance. Not only is their more interest in ESG and ethical investing, but impact investing is likely to be the next big driver of growth.
There are a few key nuances between impact and ethical, such as the screening methods used. While ethical products tend to be focused on negative screening – excluding companies involved in the manufacture and use of things like weapons, alcohol and tobacco – impact funds on the whole use positive screens.
For many of the asset managers paving the way for the growth of impact, the Sustainable Development Goals play a key role. Tim Crockford, manager of the Hermes Impact Opportunities fund, defines impactful investments as “one whereby the company we invest in is selling a product or a service that is directly meeting one or more of the 17 UN Sustainable Development Goals”.
Others agree, but there are many more nuances than simply that. “Sustainable Development Goals in themselves are not the solution, but they provide us with a framework to think about all the sustainable development issues in a more holistic way,” says Niklasson.
Impact investing has been prevalent within public markets for a long time, but it’s taken a while to catch on in private markets. A trend is accelerating now. Impax Asset Management have been at the forefront, with its Impax Environmental Markets (IEM) fund now almost 17 years old.
Others are catching on. Hermes launched their fund last December, while M&G last week introduced a Positive Impact fund, both of which invest in equities.
Institutional investors have been demanding mandates like this for a while now. But, according to Jon Forster, co-manager of Impax Environmental Markets, interest is also now coming from wealth managers and retail investors, a change that is reflected in the changes to his trust’s shareholder register.
“We’re seeing this inter-generational transfer of wealth, and the youngsters care and want this to be a part of their investment decision,” he says.
Performance can often be an area of scepticism with funds trying to do good. Clearly, the goal of investors is to make money, whether that be income to draw on in retirement or capital gains to build up a pot over the longer term.
Data show these funds are delivering. Since Hermes launched its Impact Opportunities fund, both that and the Environmental Markets fund have returned just over 8%, compared to the MSCI All Country Workd Index’s loss of 4.13%.
As these vehicles are long-term in nature, though, a better representation would be comparing the Impax fund with the MSCI All Country World Index since its launch in February 2002, which shows returns of at 198% and 135% respectively.
These figures are important to highlight, says John William Olsen, co-manager of M&G Positive Impact, particularly if impact investing is to gain mainstream acceptance. “We can still aim for a good equity return while we generate a positive impact.”
Profits With Ethics
For Forster, performance is the first and foremost consideration. “The overarching objective is to have better growth and performance compared to global equities. Any impact is output of what our companies do, rather than a specific objective.”
Crockford agrees: “We’re measuring ourselves against the broadest global benchmark we can find, and we think we’re going to beat it, not in spite of the fact that this is an impact product, but because of it.”
Crockford will run his investable universe through a framework to ascertain whether their impact is intentional first. Once they have passed this, he puts his “investor hat” on.
That word ‘sustainability’ pops up again, but this time not in the context of the Development Goals. “Sustainability is also about continuing as a going concern and therefore creating value for all your stakeholders, of which shareholders are one.”
Valuation discipline is also “absolutely key”, though he notes that, being long-term investments, most of the value created by each firm is well after most analysts’ forecasting period – typically two or three years – has ended.
With all of these impact funds choosing a broad equity index to benchmark themselves against, it follows that the funds’ returns will not follow those of their comparator indices. Impax’s tracking error, the amount returns deviate from its benchmark, for example, is around 7.5%.
They also tend to have a bias towards emerging countries because, as Crockford asserts, “the Sustainable Development Goals are almost implicitly biased towards developing nations”. Olsen adds that emerging market companies tend to have much clearer impact intentionality. “They are more impactful simply because society needs them more in those countries.”
While this means the holdings can be at the mercy of the risks of emerging markets more generally, a lot of the holdings will actually be listed on exchanges in developed countries that derive the majority of revenues from emerging nations.
Clearly, then, they are punchy offerings. They are very much long term in their outlook, too, although sell discipline will dictate profit-taking where stocks become overvalued. “If you treat this as a long-term investment and if you keep your eye on where the world is heading in the long term you should be rewarded,” says Forster.
3 Impact Stock Picks
One company shines bright for all four impact investors, and that is Danish renewable energy firm Ørsted (ORSTED). Interestingly, as the national power generator of Denmark, the company’s roots were in fossil fuel production. But it transitioned the business towards green energy around a decade ago and it is now the leading player in offshore wind production.
Offshore wind turbines are tricky to install, being structures with towers the size of The Gherkin and blades with a wingspan twice that if an Airbus A380. Being a first mover in the space, says Crockford, means its expertise is vital for wind farm operators.
It currently owns or partially owns most of the farms offshore the UK, Germany and the Netherlands, but is now looking beyond Europe and towards the US and Taiwan. That should provide it with plenty of future growth opportunities.
It does trade at a premium to the market on forward 2019 figures, at a price/earnings ratio of 24.3 times. Some anlalysts think it is “justified by best-in-class fundamentals, reflected by the highest earnings growth and returns on capital”.
The war on plastics is one of many themes being played by Impax. A number of countries currently run a deposit scheme for plastic bottles, where consumers pay a premium for the product that they then receive back once recycled. Forster says there is talk about bringing that over here.
“We’re looking at the opportunities in the infrastructure – the people who make the sorting machinery and the reverse vending machines; as well as new materials like bioplastics,” he explains.
Two firms in the portfolio tapping into this are Norwegian firm (Tomra) which is the dominant player in the first area he mentioned; and Corbion ( CRBN )a Dutch company producing polylactic acid, the building block for bioplastics.
US-based provider of childcare and early education Bright Horizons (BFAM)is a pick of M&G. The firm operates in the US, UK and the Netherlands and has contracts with big employers to offer childcare and other dependent care solutions as part of employee benefit packages.
This helps to support female employees by enabling them to continue to participate in the workplace after having children. “Greater female participation in the labour force is supportive of economic growth, while children are provided with quality education and care,” say the managers.