Stephanie Sotiriou, senior investment manager and ethical specialist at TAM Asset Management, talks to Adviser-Hub about impact investing and how advisers should position with clients.
What is impact investing?
Impact investing differs from traditional ethical investing in that the focus is not on exclusion, and consideration of environmental, social and governance (ESG) issues is not solely for risk management purposes. This type of investing goes a step further by investing in the shares or loan capital of companies and enterprises producing tangible benefits to society and the environment, alongside an acceptable rate of financial return. Moreover, the focus on intentionality is a key differentiator from other forms of ethical investing, rather than impact being simply a by-product of a process already established.
The term 'impact investing' first came on the scene in 2007 – what have been the biggest changes over the last decade?
I believe the biggest changes to impact investing over the last decade have stemmed from the growing significance of the issues in which it is intended to address, such as global warming, poverty and inequality. As the role for impact investing in tackling these problems has expanded, the methods of measurement and reporting have become more sophisticated. One example of this, is the process of aligning impact objectives to the UN’s Sustainable Development Goals (SDGs), a method being adopted by several newly launched impact funds as part of their measurement and reporting processes. This has helped to enhance the impact management process, whereby investors set goals to improve processes and outcomes. Overall, impact investing has added a new dimension to ethical investing, making it more of a central motivation for many companies rather than merely a ‘tick box’ exercise.
What are the most important things IFAs need to consider when reviewing impact investment strategies?
The limitations of impact investing lie in the subjectivity of its definition. Impact investing often means different things for different people, which means that one person’s definition of impact could be quite different from another’s. For this reason, IFAs need to fully understand a fund manager’s definition of impact when reviewing the strategy to ensure they are delivering the outcomes they have set out to achieve at the onset. When reviewing impact investment strategies, IFAs should also pay close attention to the ways in which impact is measured in order to identify and avoid problems such as ‘greenwashing’, whereby companies may appear to be environmentally responsible or ‘green’ but are in fact not making any meaningful commitments to green initiatives.
Impact investing is a subset of socially responsible investing – does it work as standalone investment strategy or is it always part of socially responsible investing?
I believe impact investing, by its nature, is always part of socially responsible investing – it is essentially socially responsible investing with the added layer of intentionality and measurability, which adds to its credibility. This does not, however, work in the opposite direction i.e. socially responsible investing is not necessarily impact investing. A company may be acting responsibly through corporate practices that promote environmental stewardship, consumer protection, human rights and diversity, however the company may not be acting this way intentionally, while efforts to measure the impact generated may be limited. It is the proactive nature of impact investing that makes it an enhanced subset of socially responsible investing.
What questions should IFAs be asking DFMs/investment partners about their approach to ethical?
With such a wide range of approaches to ethical investing, I think it is very important that the IFA fully understands the angle that the DFM/investment partner is taking towards ethical investing to ensure it is the right approach for their underlying clients. The IFA should be asking how the DFM/investment partner defines ethical/characterises their portfolios e.g. deep green, socially responsible, impact… which will determine whether they are following a more exclusionary process, whereby several sectors may be avoided, or a process focused more on positive inclusion, which may include some of the typical ‘sin stocks’ and may not be appropriate for their client.
Advisers should also ask about the reviewing/monitoring process of funds, to ensure that regular reviews are conducted to assess whether there have been any changes to the ethical investment strategy or screening processes, to be sure that the fund maintains the same philosophy and process set out from the onset.
What are the biggest ethical investment misconceptions IFAs have?
The biggest misconception many IFAs have about ethical investing is that all strategies have an exclusionary focus i.e. they avoid large swathes of the investing universe, which impedes the return potential of these investments. While this may have been true in the early days of ethical investing whereby negative screening was favoured by religious establishments, trusts and charities who had very strong values, there is now a much wider variety of ethical investment strategies which give investors the opportunity to invest in innovative companies providing solutions to society’s current needs.
Perhaps another misconception IFAs have about ethical investment is that their clients are not interested in it. The problem is that many IFAs simply do not ask the question. I believe that if the question is asked and IFAs engage in dialogue with their clients to educate them about the options they have in the ethical investment space, they are likely to see a greater level of interest.
Isn’t ethical less profitable and therefore a harder sell for an IFA?
It is definitely not the case that ethical investing is less profitable – we can see this with a simple comparison of our ethical and mainstream portfolios over several time periods. I believe the view of ethical being a ‘hard sell’ stems from preconceptions about what ethical investing used to be – it is up to IFAs to educate their clients about the options available to them and potential to generate impressive returns whilst doing good for society and the environment.
How does TAM position ethical investment strategies to IFAs?
We do not market our ethical portfolios as being ‘deep green’, rather we consider them to be more socially responsible portfolios. They incorporate several ethical investment strategies including negative screening, positive screening and impact investing. We feel this allows us to appeal to a wider universe of investors who want to contribute positively to the world through their investments, whilst still generating attractive returns. We also give our clients the opportunity to donate a percentage of the profits generated from their ethical portfolio to a chosen charity through our ‘You Give, We Give’ scheme, where we will match their donation with a percentage of our annual management fees.
How should IFAs position ethical investment strategies to their clients?
Advisers should target investors who desire to contribute to social and environmental wellbeing, whilst also generating investment returns. They need to make clear distinctions between the different types of strategies in order to establish which best suits their client’s ideals and values. In terms of performance comparison, they should be positioned alongside mainstream portfolios to highlight that they can compete with ‘non-ethical’ investments.
How can IFAs leverage impact investing to win new clients?
I think the appeal of impact investing is in the ability to see tangible benefits being generated, so IFAs should focus on this when trying to win new clients. They could present clients with examples of impact reports generated by funds, which show quantitatively how the companies they are investing in are generating a positive impact on society/the environment. Strong performance should also be highlighted, as many recently launched impact funds have delivered impressive returns.
What has the period since the financial crisis of 2008 been like for ethical investment?
Ethical investing was very much in its infancy in 2008, so the period since has seen substantial growth and development within this area, in terms of the size of the market as well as the diversity of offerings. The 2008 financial crisis led investors to lose confidence in the stock market, which resulted in a ‘flight to quality’ which has seen growth companies outperform value companies on average, ever since. This has definitely been a tailwind for ethical investments which tend to be more quality growth biased as they are all about ‘investing for tomorrow’ in companies driving growth in terms of social and environmental factors.
The enhancement of regulation that came out of the financial crisis made many businesses sit up and pay more attention to issues such as their corporate governance structures and risk management processes. I believe this contributed to the spark in interest in ESG investing, in particular, giving more emphasis to the importance of the ‘G’ component, which had perhaps been neglected before.
The financial crisis also highlighted the importance of diversity – holding a portfolio full of the same investments such as financial stocks would have resulted in severe losses, whereas a diversified portfolio including socially responsible investments would have most likely helped to protect capital.
I think the most important point which will facilitate even more rapid progress and development in the ethical investing arena is for IFAs to initiate the dialogue with their clients and educate them as to the wide variety of strategies available to them, as well as to dispel some of the myths surrounding ethical investing. As the next generation of investors enter the market, who are increasingly more interested in ESG issues, knowledge in this area will be a differentiating factor which can only be a positive thing for IFAs when attaining new business.