Impact Investing - What’s all the fuss about?

Overview

• In this article, which is part one of a two-part insight series into impact investing, we uncover the drivers of impact investment growth.
• In part two, which we will publish next week, we will explore the themes underlying the impact investment opportunity set.

Impact investment makes up about 2% of total investments around the globe. It is tiny. But it wasn’t that long ago that you could say the same about Responsible investing more broadly. Today you’d be hard pressed to find a manager who doesn’t boast their ‘ESG integration’ credentials (the term now widely used to simply describe ‘consideration of Environmental, Social and Governance factors’). Whilst impact investing is a much smaller component of Responsible investing than ESG integration, the impact investment opportunity set is evolving rapidly, emerging as the latest wave of growth within sustainable investment. By the way, without wanting to get caught up in the nomenclature, we use the term “Responsible” investing, interchangeably with “Sustainable”, “Ethical” and “ESG” investing. Impact is a subset of these generic terms.

In Australia, there was A$29bn invested in impact investments at the end of 2020 – almost five times what it was in 2017, and we expect further growth when 2021 data is released. In a survey of 770 global institutional investors (collectively managing US$27.2t) undertaken by Schroders in March this year, 48% of respondents cited impact as a preferred approach to implementing sustainability – this is up from 34% in 2020.

The rise of the Conscious Investor

A big driver of growth in impact investing has been a shift in mindset for many investors in recent years. Just as consumers are becoming socially and environmentally conscious, investors are too. In particular, studies have found that millennials tend to align both their spending and investing habits with their values. They still expect a market rate of return, and research has now shown that this is achievable. A study undertaken by the Global Impact Investing Network (GIIN) in 2020 showed that most impact investors surveyed, target market rate returns, and the majority of them reported that their investment’s financial performance met or exceeded expectations. If you have the choice to invest in two products which have exactly the same return expectation, but one of them also funds climate mitigation, or a life-changing healthcare technology, the question turns around to “why wouldn’t you choose impact?”  Impact investments can potentially do well and do good.

A number of endowment and foundation trustees have experienced a penny-dropping moment when they discover they can make a significant contribution to the causes they support through what they invest in, in addition to their donations. In some cases, they have found that their investment portfolio has been funding the very problems that their fund has been set up to solve!

Climate Tech Venture Capital to fund Net Zero

Another key driver of demand, and a prominent theme for impact investment, is meeting ‘Net Zero’ commitments. The most recent United Nations (UN) Climate Change Conference (COP26) held in November 2021, played an important part in upping the stakes on addressing climate change and putting pressure on Governments to reach Net Zero. Recent disruption in the energy sector in Australia and abroad will no doubt accelerate this pressure. Most countries have now made commitments – 136 in total, which is double where we were in 2019, and speaks for 88% of current global emission. A growing number of companies have made their own commitments too. So as you can imagine, there is a lot of investment required to get us there. The UN has estimated more than US$125 trillion will need to be invested by 2030 to meet Net Zero commitments.

What does this mean for Impact investing? For starters, it means a heap of new infrastructure and clean technology is required. Brookfield, a big player globally in energy infrastructure, raised over US$15bn for their Global Transition Fund recently, which they claim is the largest private fund raised to support the transition to Net Zero. Venture capital (VC) is the early-stage funding vehicle for most start-up businesses, and this asset class is seeing a resurgence in Australia and abroad, with many focussed on climate technology.

There have been some impressive developments in technology. Wind turbines for instance have been around for over a thousand years, so they aren’t new, but recent developments in their efficiency in generating power, have led many scientists to believe that within a decade, wind will be the least expensive source of installed electricity capacity. To give you a sense of their size and scale, wind turbine blades can measure more than 100m long, with a sweep diameter of the length of around 2 football fields. One rotation can power a house for a day. The Australian Government recently announced plans to construct offshore turbines of this scale.

The Australian Government is relying on technology to help reach its net zero commitment. In funding the Clean Energy Finance Corporation with A$10bn, they created the World’s biggest green bank. There are various other levels of Government support too. For instance, the City of Sydney has provided a grant for a new shared workplace innovation hub for climate tech start-ups opening early next year in Circular Quay. The Greenhouse Tech Hub aims to support 100 businesses in the next decade and joins various other shared workplace hubs for start-ups in Sydney and Melbourne. According to research by Giant Leap, an Australian VC firm, over the last five years the number of start-ups with impact objectives has increased by 50% in Australia and now accounts for almost a quarter of all funded Australian start-ups. De-carbonisation accounts for a lot of the impact objectives.

Climate Salad, a climate tech network in Australia, has estimated that 20,000 climate tech jobs have been created in Australia alone in the last 3 years. They expect it’s likely to rise to 30,000 jobs in a year’s time, and 100,000 by 2030. A slump in venture capital funding and devaluations in unlisted tech start-ups in June this year resulting from inflation and recessionary fears may see those estimates fall, albeit climate and green tech companies dominated the VC investment volumes that month. Matthew Rennie from Rennie Partners (a net-zero investment advisory firm) attributes climate tech’s resilience to the access it tends to have to multiple “value pools”. For instance, de-carbonisation solutions which make transportation more energy efficient, also have synergies for other sectors such as mining and food. Whereas traditional tech companies typically can only solve problems for one set of customers.

What else?

A healthy climate is only one ingredient (albeit a critical one) for a resilient environment. Impact investment managers are creating investible solutions to solve other environmental problems, such as the Planet’s diminishing biodiversity. In our next article we explore this theme, as well as themes in life-enhancing (social) impact investments. We also tackle the prickly subject of greenwashing, which is getting a lot of attention from investors and regulators at present.