Impact Investing is linked to the concept of Environmental and Social Governance (ESG). It has been strongly growing in recent years as an idea and as a business model. Yet many investors have either not researched it in depth, or do not know about its increasing importance. Today we will discover important recent evidence of outperformance, and learn that you can no longer ignore ESG in your investing strategy.
What is Impact Investing?
Impact Investing (II) has been around for many years. It arose from ideas such as Environmental and Social Governance (ESG), Corporate Social Responsibility (CSR), Triple Bottom Line (TBL), Stewardship, Sustainability and the like. ESG refers to the balancing of financial, social and environmental factors in an organisation, usually a large corporation. This balancing involves giving equal weight to financial and non financial factors in all decision-making.
ESG balancing is now occurring, not just at the governance level, but throughout the organisation, including strategy and the core business model. With innovation, ESG is occurring in start-up companies, as well as large listed corporations.
This century is already being characterised by disruptive trends and complex problems, such as climate change. These problems are acting as a catalyst for fast, pervasive changes. With problems, such as climate change, ESG is emerging as the dominant corporate model.
A Return to Stewardship
Throughout legal and business history from about the beginning of the 20th Century, there has been a needless distinction between profit and purpose. A needless distinction existed between focusing on just shareholder interests, and broader issues, such as the environment. Much of this thinking grew out of the first and second industrial revolutions of the 18th and 19th Centuries.
Today, given globalisation, and the complex inter-relationships of social, environmental and economic factors, we can no longer think in terms of simple dichotomies. We can no longer think in linear terms. For example, if a coal or oil company just focuses on short term profits at the expense of the environment, not only it will its continue to harm the environment, but this harm will threaten the long term profits, and potentially the survival of the company itself. There will come a time, where the market has shifted. Demand has shifted to cleaner energy forms, such as renewables, and the traditional oil company is unlikely to survive.
We are already beginning to see this change as more enlightened or proactive managers of oil and gas companies see that is it better to return to an older principle of Stewardship. If we steward all resources, if we balance economic, social and environmental factors, we can better achieve short and long term profits. If we creatively balance competing factors, we can design win-win-win outcomes. We overcome simple win-lose outcomes. It will be these companies, these managers, these investors who will not only succeed financially, but will succeed ethically, socially and environmentally. When we marry profit and purpose, we and our enterprises become stronger. This convergence is a turning point in our recent history. In fact, it is a return to older principles of Stewardship.
For example, consider E.ON Energy, a Germany energy company that originally focused on gas, but is now building wind farms in the Baltic Sea and beyond. In fact, Germany in 2017 had 38.5% of its energy coming from renewables (Graupner 2019), with a possible push for 100% in coming years.
Companies like E.ON, and Germany’s push towards renewables, are not only being proactive about climate change, they are making fundamental economic changes. They are marrying risk with opportunity, marrying profit and purpose. Insodoing, they are adding significant value for their investors and other stakeholders alike. There is a shift from exclusion to inclusion.
Recent data is showing a steady outperformance of ESG companies. The Responsible Investing Association of Australasia (RIAA) in its 2018 Benchmark Report (RIAA 2018, pp.1-2) gave us the following clear evidence of the rise and outperformance of ESG companies and related investment portfolios:
- ESG is now 55.5% of all assets professionally managed in Australia.
- Core Responsible Investment Total as an investment approach in managed funds grew by 188% from 2016-2017.
- Australian Average Responsible Investment funds returns: 5 year 11.7%, 10 year 5.4%, compared with the S&P/ASX300 index of 10.02% and 4.0% respectively.
- International Average Responsible Investment funds returns: 5 year 16.1%, 10 year 5.4%, compared with Large-cap International Funds, 16.9%, and 5.4% respectively.
Interestingly, the outperformance in Australia is ahead of international funds. This is despite a deadlock of government climate change policy over the last decade or so. Clearly, the business and investment communities have moved ahead of government policy.
Evidence in the US and beyond is similar. Eccles and Klimenko, leading researchers from Harvard, (Eccles and Klimenko 2019, p1) state: ‘[a]ccording to a 2018 global survey by FTSE Russell, more than half of global asset owners are currently implementing or evaluating ESG considerations in their investment strategy’ (emphasis added). They conclude ‘capital markets are in the midst of a sea change.’
The rise of ESG fits neatly with what some leading economists have been predicting for some time. For instance, Jeremy Rifkin, who has advised Germany and the EU for many years now, has called this shift part of the Third Industrial Revolution- TIR. His book by the same name, (Rifkin 2013) is a watershed text for all proactive investors, managers and policy makers. Rifkin examines three key technological areas, which may be called the ETC sectors: Energy, Transport and Communication. When these sectors undertake massive change and converge, there is historical evidence for large, broad based business, economic and social disruption.
In the 21st Century, these shifts are already clear. In Energy to renewables; Transport to electric or driverless vehicles, and in Communication to the internet and digital including AI or robotics. Rifkin documents strong evidence for such changes, for instance, in the continued rose of the Internet of Things (IOT) and 3D Printing.
Alongside the TIR, we are seeing the emerging trend of the Closed Loop (or Circular) Economy. These are companies, or an economic model where the entire production or value cycle is closed. There is no waste, things are made, re-used, and value is added at all stages. Writers have been thinking about such business and economic models for years. They are similar to systems we observe in nature. In nature nothing is wasted. Natural systems are the most efficient, dynamic systems we know. In business, we are already seeing examples of closed loop models in the value chain, such as the Maker-Platform Operator model. For further discussion here you might like to see Kortmann and Piller 2018 in the Reference list below.
The implications for investors and managers are clear. There is risk and opportunity that not only need to be managed, they need to be at the core of our short and long term thinking or strategy. It is now clear, there is more risk in ignoring the evidence and doing nothing.
Profit Married With Purpose
There is risk in ESG and there is opportunity. We can no longer ignore the evidence by hiding behind risk. We must see the implications and seize the opportunities. All risk and all opportunity can be appropriately managed. Things may not change in a couple of years, but the evidence shows tectonic plates have already shifted. We cannot be flat-footed or in denial by adhering to models or theories of the past. Change and disruption are perhaps our only constants for the next few years, as we move through this transition. From renewable energy to electric vehicles, biotech and beyond, business is leading the charge to, not just manage problems such as climate change, but to devise new, dynamic business models for a better world. Investors who marry risk and opportunity will be the long term winners. When there is change, when we think outside the box, when we refuse to follow the crowd, we find not only an edge, we find a higher level of success. Here we find profit married with purpose.
“In nature nothing is wasted. Natural systems are the most efficient, dynamic systems we know.”
By Lee Spano, Creatness International www.creatness.com
Eccles, R & Klimenko, S 2019, ‘The Investor Revolution’, Harvard Business Review, viewed 29 May 2019, < https://hbr.org/2019/05/the-investor-revolution >.
Graupner, H 2019, ‘Baltic Sea’s largest wind farm officially opened’, DW, 16 April 2019, viewed 29 May 2019, < https://www.dw.com/en/baltic-seas-largest-wind-farm-officially-opened/a-48352482 >
Kortmann, S & Piller, F 2018, ‘Open Business Models and Closed-Loop Value Chains: Redefining the Firm-Consumer Relationship’, Berkeley Haas, viewed 29 May 2019, < http://cmr.berkeley.edu/browse/articles/58_3/5820/ >
Responsible Investing Association of Australasia (RIAA) 2018, Responsible Investment Benchmark Reports- 2018 Australia and New Zealand, Fact Sheet, viewed 29 May 2019, < https://responsibleinvestment.org/resources/benchmark-report/ >
Rifkin, J 2013, The Third Industrial Revolution, Griffin Charles & Co Ltd, UK.