From investing in harmful industries and fossil fuels, to fueling inequalities by channeling wealth through secondary markets and maximizing short-term profits at the expense of long-term value creation, the huge amount of money finance moves every day has very little to do with the real economy. And when it does, it’s for the most part without consideration for the type of economy we want to build. The more you look, the more you get to realize how much there really is to rethink in the way the financial sector creates value for the few, and extracts from the many. Impact investing intends to move finance from being part of the problem to becoming part of the solution.
Short-term profit vs. long-term change
Setting aside the most speculative approaches, traditional sustainable investing ultimately does not take a particularly sophisticated approach: while the financial tools and investment analyses might look very sophisticated, investors’ concerns ultimately do not go beyond seeking short-term, ’adequate‘ risk-adjusted financial returns. Sustainability concerns are only translated into short-term financial risks.
Reset the economy - Investing in radical change
In the coming months, in a new series of articles and podcasts, we will explore the contours of such an economy, and the ways to get there. Join us in building the economy of the future.
This approach of prioritizing short-term financial gains has shaped the industry over the years, and any institution in the field is affected and constrained by return expectations. At the same time, this clearly influences the decision making of businesses, compelling them to bow to investors’ preferences often at the expense of long-term business sustainability. It is such a rooted approach, with established mechanisms, that it takes substantial efforts and quite some courage to make the necessary U-turn and move away from this mindset. But it is, indeed, necessary, if we are to rethink and reset our economy, starting from more conscious capital allocation and return expectations. The impact investing movement is there to indicate the first steps in a different direction. While still operating under market return expectations, impact investing actively balances risks and returns with the intention of investing today for long-term, positive change.
Let us be clear: this is not a complete game changer, but it’s a first, decisive step towards a more radical shift in the financial industry to finally start investing for good. As Tim Jackson, economist and professor of sustainable development, recently pointed out in a conversation with our Chief Investment Strategist, Hans Stegeman, the concept of investment itself needs rethinking. We should move away from the idea of investment as a way to achieve (financial) profit towards the notion of investment as a ’commitment to the future‘.
The right stakeholders
Committing to the future also calls for rethinking who the stakeholders are whom financial institutions should be accountable to. While generally institutions respond to their shareholders and clients, this does no justice to the broader impact that investment decisions have on economic dynamics and on society, as well as on the environment. It is not for nothing that we have seen a rise in climate change litigations in recent years, not only in the face of private companies, but also, for example, of pension funds and other investors. The focus of litigations is still on the stability of the financial system itself and its exposure to climate-related risks, not least because legislation is still not explicit in setting clear fiduciary duties for financial institutions beyond their shareholders. However, these actions are at the very least increasing the costs of inaction for companies and investors, but also point to a new paradigm that gradually broadens the responsibilities of private actors.
The right direction
Expanding the time horizon of investments and broadening the list of stakeholders for financial institutions in line with the ’commitment to the future’ adds an extra dimension that not all investors are well enough equipped to take into consideration. Because what does positive change, what does a sustainable economy that works for all look like? If not (only) for profit, what exactly should we invest for? Here is where the United Nations’ 17 Sustainable Development Goals (SDGs) come into play. Adopted in 2015, these goals are a call to action for all economic players to tackle several challenges mankind is facing. They are not a roadmap, however, leaving room for different approaches and solutions. Impact investing therefore requires institutions to be explicit and put forward their views on a sustainable economy. And while acknowledging that awareness and knowledge of sustainability are constantly evolving, and that sustainability itself can assume different forms and priorities depending on the context, impact investors need to be able to count on a robust system of values, a reference system on which to define coordinates and set a clear direction for the future they envision. Such a system cannot be built overnight.
Investors increasingly incorporate Environment, Social, and Governance factors in their investment decisions, what is generally called ‘ESG investing’. There is one big difference between impact investing and ESG investing, and here’s why we think ESG investing is not good enough. By taking a best-in-class approach or integrating ESG factors in investment processes, ESG investors might be able to decide whether a company or investment is better than another in relative terms. This, however, does not necessarily bring us closer to the economy and the society we want. If we keep on investing in the most ‘sustainable’ arms producers, how are we ever getting closer to a society where weapons are not around? How can we lose interest in something when we have an interest in it? Doing better in relative terms is only doing less bad, which clearly is not good enough. Impact investing goes a step further by focusing on solutions to the world's most critical sustainability challenges and thus seeking to do good in absolute terms.
The right tools
All in all, impact investing is considerably more than just allocating capital to investments with positive impact. It is about using financial instruments and stewardship to create system change. In our new podcast, Bill Burckart calls this system level investing.
It starts with addressing a systemic problem, e.g. climate change or inequality. From there the investor sets goals and determines focus (for instance, on climate targets, living wages or financial inclusion). Both the goals and the focus are likely to lead towards the choice of the most appropriate asset class: financial inclusion will be mostly invested in through private debt and equity. For climate change, there are more options. Project finance in energy and climate projects creates new renewable capacity. The same can be said for some listed opportunities. Yet, engaging and setting targets for carbon reduction for other companies is also part of addressing the same systemic problem.
Impact investors need to have a clear vision on the transition towards a sustainable economy, steward investees in that direction through direct and collaborative engagement with companies, by using their shareholder voting rights and directly engaging with companies, but also by raising their public voice to advocate the change they aim for. Moreover, to support the transition a systemic approach to investing is emerging among impact investors. This means that they look at investment opportunities at a system level, by considering the trigger points that activate systemic, paradigm shifts, and which activities can trigger and reinforce positive sustainability trends.
A good investment
There is a strong need to reset current investing practices, and an increasing number of tools to do so. Working within the financial system as an integral part of our economy, being aware of the broad effects and responsibilities that derive from capital allocation, is the very first step to make finance and investing more sustainable and forward looking.
Finance is a powerful instrument and it should do more than just increase the balance on our bank accounts: fostering positive change by also delivering non-financial (social and environmental) returns. Building a resilient, more sustainable, and inclusive economy sounds like a good investment.
Investing in radical change
Download our vision paper and find out how you can contribute to the transition towards a more sustainable and resilient economy.