Impact investing prepares for its revolution

In an article we published entitled "Impact Investing - What’s all the fuss about?", we discussed the drivers of growth in impact investing. In this article, we take a step further by exploring some of the themes underlying the impact investment opportunity set across social and environmental causes.

We previously identified the race to net zero as a key driver of demand for impact investments that aim to address global warming. This has elevated climate change to be the main theme in environmental impact investments. But there is a lot more required to care for our environment than just solving climate change.

" Climate change, biodiversity loss and social inequality are all problems which impact investments can help solve. There is relentless demand now to fix these problems.update content here".

Protecting nature is seen by many as an overlooked environmental imperative, but its fast catching up in recognition status to climate risk. The World Economic Forum estimated more than half of the world’s gross domestic product (US$44 trillion) is moderately or highly dependent on nature and its ecosystem.

According to UN Secretary General António Guterres, “we are well into the Anthropocene extinction. The rate of species loss is tens to hundreds of times higher than the average of the past 10 million years – and accelerating.

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Over a million species of plants, mammals, birds, reptiles, amphibians, fish and invertebrates are at risk – many within decades.” The problem is no less acute in Australia as it is overseas, according to the 2000-page 2021 State of the Environment report which was recently released for Parliamentary review.

It found that Australia has one of the highest rates of species decline among nations in the Organisation for Economic Co-operation and Development (OECD). Worse still, we are losing more mammal species than any other continent.

Natural capital

Just as net zero pledges have created climate change investment opportunities, commitments to end deforestation by 2030 from more than 120 countries (covering 95 per cent of the planet’s forests) will necessitate a drive for ‘natural capital’ investments.

Investing in regenerative agriculture is one avenue for impact investors wanting to address climate change and protect biodiversity. This entails funding farming practices that rejuvenate the soil where crops are farmed, potentially resulting in both positive environmental and financial outcomes.

These come in the form of ecological restoration, potentially valuable carbon credits and premium priced vegetables. The produce is so sought after, farmers can lock in valuable off-take agreements for it. That is, the produce is already sold before it has even been grown.

Whilst still a small and immature investment area, we expect many more such investible natural asset strategies to become available in the coming years – watch this space.

Social housing’s attractive features

Social housing targets underserved and vulnerable people in society. Many lives have been changed immeasurably by safe and secure housing, enabling escape from domestic violence and homelessness or provided facilities to meet physical and mental wellbeing needs.

But there is a massive under-supply of social housing in Australia, which includes aged care, affordable housing and specialist disability accommodation. These are all relatively new sectors of the property and infrastructure market in Australia – particularly specialist disability accommodation which has only been investible for a few years.

Aside from investing in a meaningful cause, specialist disability accommodation can offer investors inflation-linked, government-backed revenues that help to significantly reduce credit risk. Even investors who aren’t explicitly seeking social or environmental benefits from their investments may be attracted to the high single-digit yield and low correlation to mainstream assets which specialist disability accommodation can offer.

We delved further into this sector last year in an article we published on specialist disability accommodation.

Another common theme in impact investing is focused on empowering women and girls under the banner of ‘gender-lens’ investing. More than a billion women globally lack access to credit or a standard bank account. Micro-finance lending has aided in the rise of some successful female-run businesses. These businesses are often as basic as selling vegetables at a small market.

Another strategy has been the use of social impact bonds to finance programs that reunify families (in particular mothers and children). Again, this isn’t philanthropy; investments have been structured to fund these causes which can offer market rate returns.

Investors fund such programs up front, with State Governments only paying for successful outcomes. This represents a saving for them compared with otherwise funding foster care. So, it can be a win/win/win for Government, investors and reunited families.

The chart above summarises the four key impact investing themes mentioned above, which we have lined up with the investment strategies that are currently the most prevalent vehicles for achieving these impacts in private markets.

These themes can also be captured in listed markets (eg. equities), but it is important to note though for listed markets, securities are purchased in businesses which already exist (and have already funded impact).

Whereas with private markets strategies, investors can maximise their impact because these assets are traded on the primary market. This means every dollar you invest provides additional impact.

Financing the transition to a lower carbon environment, restoring our environment and improving the lives of the vulnerable. It’s all good right? Well not quite. Not all impact is created equal and there are a lot of fund managers jumping on the ‘impact bandwagon’. Many ESG (and more specifically impact) outputs fall short of their promises.

Beware the greenwash

Greenwashing is now a well-known term in investing circles; it can be described as over-stating the green credentials of a fund or fund manager. It has become such a problem that regulators across the globe are now conducting detailed investigations into suspected offenders.

The European Securities and Markets Authority has released guidance to national regulators across Europe for addressing greenwashing while the US Securities Commission is considering which disclosures should be made by funds espousing “ESG”, “sustainable” and “low carbon”. The Australian regulator ASIC has released a new guide on how to avoid greenwashing when offering or promoting sustainability related products.

Impact washing is a type of greenwashing whereby an investment product overstates the impact to society or the environment that it is realistically capable of achieving. For an impact investment product to be true to its label, it must be able to measure its impact objectives set up front.

It doesn’t have to always meet its targets, as things like COVID-19 might impact supply chains. But there needs to be genuine intent and a clearly defined strategy for achieving impact (ie. the softer factors which are less easy to measure).

Delving into the underlying investments and really understanding their impact thesis is an important step in gaining comfort that it really is an impact investment.

ANZ Private uses a specialist impact consulting team (Australian Impact Investments) who apply as much due diligence to the impact thesis as they do to the investment proposition. They use the Impact Management Project framework to measure both the expected and actual quantifiable impact outcomes.

Other risks

ANZ Private advocates for such robust approaches to impact measurement and management to avoid impact wash.

Regardless of impact outcomes there are always investment risks and you may lose some or all of your capital. The risk factors for all investment classes differ and careful evaluation and detailed due diligence are critically important when considering any investments.

Climate change, biodiversity loss and social inequality are all problems which impact investments can help solve. The relentless demand we’re now seeing to fix these problems, coupled with efficiencies brought on by technological advances, are driving a powerful investment thematic.

Sir Ronald Cohen, a pioneer in venture capital, calls this “the impact revolution.” He says, “investors will come to realise that we are able to increase returns not in spite of impact, but because of it”.

This article was originally published by ANZ Private Bank’s Insights