Investing in a better world

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Can investors contribute to sustainable development?

Especially millennials, the generation that reached adulthood at the beginning of 2000’s want to spend and invest according to their values, seeking to do something good. Banks and fund managers offer them impact investments, such as funds focused on climate-friendly technology or healthcare. In Finland, Sitra, the Finnish Innovation Fund has made institutional investments familiar with impact investing. The first “Social Impact Bonds” (SIBs) and Green Bonds are already on the market.

However, impact investing is only just beginning in Finland. In the Western financial markets, it is an established, growing phenomenon. For example, Black-Rock, the world’s largest asset manager, and Goldman Sachs, an investment bank, make impact investments. In 2018, members of the Global Impact Investment Network (GIIN) managed approximately $ 230 billion in investments. It is more than four times the state budget of Finland. The amount doubled from the previous year.

The more established investing for impact is, the more advanced are procedures and instruments in use. The impact of financing is assessed ex ante and reported afterwards. The return of the management company may be tied to the achievement of impact. However, important issues for the keen impact investor are still open even on Wall Street. What actually are impacts, and how are they measured? Can I compare investments and investors?


Impact investing is a special, more challenging part of responsible investing

All business has impacts on society and the environment. They can be harmful, such as pollution and human rights violations, or beneficial like jobs and improved transport links. An investment is responsible if it does not harm the environment or society.

Impact investing is a type of responsible investment, but it goes further. Therein, achieving good impact is the strategic objective of the investor. The impacts are monitored in the same way as other key financial indicators. The investment is expected to yield both profit and impact.

But what is an impact? Jobs for women, voting power for company employees, or cutting greenhouse gas emissions? Perhaps the answer is simplest in Social Impact Bonds (SIB). In these, the investors finance the implementing company to produce the agreed service or project. If the goal of the project (for example, the employment of young people) is achieved, the public authorities will pay investors in proportion to the saved public (employment) costs. The number of effects to be monitored are often relatively small.

Financiers seeking broader impacts can list up to hundreds of investment specific effects and impacts and their indicators. These are nowadays often linked to the United Nations Sustainable Development Goals (SDGs). However, there are 17 of them, with more than 160 indicators. The challenge is to identify in a reliable way the goals that the investment contributes to.

The impact should be evaluated, preferably even measured. To that end, economists have developed different kinds of cost-benefit models. However, they are heavy and expensive to implement. And not all those interested in impact investing want a monetary price for something they value.

For example greenhouse gas emissions, produced energy or taxes paid are, at least in principle, measurable. However, many phenomena perceived as effects or impacts are qualitative. How do I know if my investment contributes to the realization of human rights?

Even if the financier wants to know the impacts of an investment on the surrounding society, obtaining the necessary information is often difficult. For example, a lender’s access to monitoring information usually ends when the loan is paid off. The debtor company may not be interested in reporting on its activities after that.


There are many sorts of impact investing

As with in financing generally, there are many different instruments and methods in impact investing. Most are still for professional and institutional investors only, but some are also available for private investors. Different instruments have very different characteristics. The impact is the simplest to follow when financing focuses directly on one company through one instrument (although even this it is not easy). If you have a fund that invests in dozens of companies, possibly in different sectors or countries, with different absolute and relative size of the amount, and with different risks, it is much harder to know what kind of impact your money will have. Would the effects have occurred without the loan or equity investment in question? What exactly is attributable to this share of the financing package?

Most funds branded for private persons invest in publicly listed companies in developed countries. Information on them is often relatively easy to obtain due e.g.  to the disclosure requirements imposed by stock exchanges. The available information is sufficient for sophisticated assessment tools, even artificial intelligence.

Assessing and following the impacts of investments in unlisted companies is more difficult. In private equity investments the information on companies is usually not public or directly applicable for impact assessment. On the other hand, private equity investors often have a significant stake in the company, and are involved in its governance, so they are well placed to influence the company and ensure that the impact is realized. In order to be credible, investors should disclose to the public how impact is assessed. Too bold, unjustified claims about great impacts can lead to reputational suicide.

Impact investing is most challenging in the poorest countries – where it is most needed. Due to the underdevelopment of societies, business can have a strong negative or positive impact, so the investor can cause catastrophes or truly create well-being. Legislation on corporate information disclosure and responsibilities is often incomplete or non-existent, requiring information to be retrieved on the spot. What impact did the financed waste-to-energy project have on local waste pickers and sorters? Were consumers getting new, better or cheaper services? Were the rights of a nearby village community violated? Assessment cannot be derived from academic research, calculated using artificial intelligence, or aggregated from information available on the Internet. Evaluating impact can become costly.

Development finance institutions such as Finnfund, Swedish Swedfund and Dutch FMO, working in developing countries, are often at least partly public-owned and regarded as development policy instruments by their governments. They are therefore often expected to have much broader impacts than purely commercial financiers.


Efforts are being made to harmonize impact investing

There is still a lot of uncertainty in impact investing. It would be important to determine what should be considered as impacts, and how they can be measured. For example, the World Benchmarking Alliance (WBA), which is funded by governments in the Netherlands, Denmark and the United Kingdom, develops industry-specific standards for how companies contribute to the UN’s Sustainable Development Goals. Work is already underway in areas such as food production, agriculture and the automotive industry with regard to the climate impact. The GIIN Network of Impact Investors, international development finance institutions and banks and the UNDP have also started their own harmonization programmes. Also featured in the field is U2 frontman Bono. The singer, who, according to media, has joined forces with a major US-based venture capital firm, TPG, announced in January that the collaboration was expanding to impact assessments in a new company Y Analytics.

One should also be able to compare investments and investors. The Impact Management Project (IMP), which involves international organizations, standardization organizations and investors, is developing an impact classification system that can be used for this purpose. It would help in classifying companies and their financiers to those that (a) cause or are likely to cause damage, (b) avoid causing damage, (c) benefit stakeholders, or (d) contribute to resolving sustainability or development problems.

A consensus still needs to be reached on how to use impact data. How are returns, impacts, and risks balanced in an individual investment and on the portfolio level? How does the impact information influence the choice of investments and exiting from them? What does the fund do if the impacts do not appear to be occurring? The IFC, a member of the World Bank Group, has published principles for the management of impact investments, to which financiers can commit.

At its best, impact investing directs private capital to important goals. However, those interested should look at where they are putting their money. At the very least, greater clarity should be found on the core issues of defining and measuring impact and managing the investments. As long as financing cardiovascular disease prevention, refugee employment, or weakening Donald Trump can all be marketed as impact investments, the sector needs harmonization.

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