ESG Turns to Impact

“If you think that the environment is less important than the economy, try holding your breath while you count your money” – a quote by Dr Guy R. McPherson creates an image of the importance of ESG in the complete investment universe. Environmental, Social and Governance – this trio of words have become a heavyweight factor for investor judgement in the recent past. Investors are increasingly applying these non-financial factors as part of their analysis to identify material risks and growth opportunities. Once an unknown parameter ESG has now not only become an important factor of judgement among fund managers but also amongst retail investors, who have started keeping a sharp eye on this.

As they say, “Where there is age there is evolution”, ESG also followed the same path and gave birth to a newer yet more complex terminology of ‘Impact Investing’. Now, ESG was no longer sticking to the compliances, but creating an impact on society. Impact investing is a type of investment strategy that seeks to produce specific positive social or environmental outcomes in addition to financial advantages. This came into existence when investors began to realise the difference between not harming the environment or violating the laws and creating a positive impact on society. Reporting on environmental, social, and governance concerns is now routine practice for roughly three-quarters of the world’s big and mid-cap corporations.However, it is typically limited to information about commitments and processes, with little weight given to the actual impact on consumers or society.

Though the term seems to be less popular among the investors of emerging markets, it has gained great popularity among fund managers in the last decade. Just over a decade ago, JPMorgan and the Rockefeller Foundation, in collaboration with the Global Impact Investing Network (GIIN), produced a paper claiming that impact investment was an emerging asset class with assets under management predictably ranging from $400 billion to $1 trillion by 2020. This then seemed to be an unrealistic ambition, but the clouds were cleared when GIIN in 2020 estimated the impact investing AUM to be $715 billion. The International Finance Corporation (IFC) put the estimate even higher at $2.1 trillion. The emergence of such need and awareness for comprehensive social growth among the investors has also aided in the reduction of “greenwashing”, where companies tried to falsely convey their activities as compliant with ESG norms. 

One of the biggest myths of low returns has been passed on from ESG Investment to Impact Investment. It has become a community perception that social impact creating businesses will yield fairly low returns. A report by McKinsey estimates the IRR of Impact Investment exits from 2010 to 2015 to be 10%, with the top one-third churning out a 34% return. The GIIN’s (Global Impact Investing Network) Annual Impact Investor Survey echoed the same by indicating that the majority of respondents obtained market-rate returns, with 91% reporting their returns met or surpassed their professional expectations.

The future of impact investing can be looked at from different angles. Even though the loss due to the pandemic has created a need for faster returns among investors, there is another side as well. At the outset of this decade, the climate crisis, economic inequality, gender disparity, racial injustice, and other crises-primary targets of solutions supported by impact investments-were already posing significant difficulties to governments around the world. We know that there is a $2.5 trillion yearly funding shortfall in order to achieve the Sustainable Development Goals (SDGs) by 2030. And we all know that the COVID-19 pandemic has shattered and disturbed people’s lives all over the world; it has also made achieving the SDGs even more difficult as governments transfer resources and incur new levels of debt to combat the risks of the virus, including the amplification of inequality. Not only will private impact investment capital be critical to funding the SDGs, but it will also play a critical role in developing answers to problems traditionally viewed as the realm of the public sector, as it grapples with new and unprecedented crises.

The measurement of an impact investment’s global effects is the most contentious aspect. It is critical to accurately monitor and communicate the social and environmental performance of investments in order to claim a legitimate “impact investment.” The main difficulty that this documentation raises is the qualitative and subjective nature of an impact. Standardizing the value of an impact is a key step in improving scholarly debate on the subject for both persons who believe in impact investing as a viable investment philosophy, and those who do not. There have been subjective debates where VCs and PE Managers argued that is the “impact” actually driving the growth of a company. This will continue to remain the biggest barrier as creating a standard metric for measuring impact remains a question for pioneers of this field to penetrate mainstream investing.

Impact investing has piqued the interest of major investors and asset managers, and much of the infrastructure required for it to become a mainstream practise has been codified. However, several flaws remain. Impact-fund managers must take the lead in resolving these issues, with the assistance of investors, entrepreneurs, and governments. By doing so, they may equalise impact investing with other investment options, unlocking the industry’s full ability to respond to global social and environmental concerns.