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Impact Investing: From Niche to Mainstream

By: Anya Jia

· Impact Investing

“I think impact investing can take place in either private market or public market. The bottom line is, it has to be intentional.”

"Large asset owners start to see that integrating environmental, social and governance factors might mitigate long-term risks.”

These are two of the statements made by Patrick Schena, Adjunct Assistant Professor at the Fletcher School of Tufts University, where he is also serving as the Senior Fellow of the Center for Emerging Market Enterprises and Co-Head of the Sovereign Wealth Fund Initiative, in his interview with Diinsider.

As an emerging investment strategy, the definition and implication of impact investing are constantly evolving. Over the past couple years, impact investing has been shifting from an embryonic investment concept to a rich investment ecosystem that is appealing to mainstream investors.

Professor Schena has 30 years of experience in finance, operations, and technology management focused on investment management. He shared his insights into the impact investing and explained the recent evolution of the impact investing, including how institutional investors incorporate impact into their long-term investment strategies and what are the different strategies between private market and public market.

Diinsider: How do you define impact investing?

Professor Schena: Not long ago, impact investing was only associated with private equities and small-scale social enterprises. Over the past several years, we have begun to see pension funds and large institutional investors using the term ‘impact’ and entering into the field of impact investing. I think of impact investing as having a broader definition which can be executed in either private or public markets. Impact investing has three key elements. First, impact investing should be intentional, which means an impact investor must have the intent to drive impact. Second, impact metrics need to be well-defined to enable impact investors to measure outcomes resulting from investment. Third, an impact investor should identify and apply benchmarks against which impact performance can be compared and reported.

Diinsider: How do you define impact metrics in private and public markets?

Professor Schena: In private markets, impact metrics may be defined as Key Performance Indicators (KPIs) at the firm or project level. Therefore, when the investor conducts a portfolio review, he or she can evaluate performance from both a conventional financial perspective against a specified investment index or benchmark, while also evaluating impact outcomes against self-defined KPIs. Over time, the progress of the investment can be monitored and assessed in the context of both financial and socio-economic returns.

In public markets, among traded companies, evaluations are somewhat facilitated by consultancies and data providers who offer environmental, social and governance (ESG) and related rankings as a service.

Photo: Professor Patrick Schena

Diinsider: How can investors build impact benchmarks?

Professor Schena: When we think of impact investing, we should always try to clearly and discretely separate the financial component of an investment from its social impact features. The former is relatively easy to benchmark against a wide variety of commercially available indexes. The latter is complicated by the nature and features of the asset and the precise definition of impact outcomes expected from the investment. For example, some types of impact might involve minimizing certain exposures and so may be “negative”, such as reducing climate exposure by shrinking the carbon footprint of invested assets. “Positive” impact strategies, of course, seek to maximize social-economic gains from impact investing.

Importantly, to be effective, impact benchmarks should be well-defined and as specific as possible. High-level KPIs or loosely defined impact benchmarks can easily mask effective impact performance or hide underperformance or impact risk.

Diinsider: Does impact have to demand financial sacrifice?

Professor Schena:. Over the last 3 years, increasing evidence has suggested that corporations and investors have begun to actively integrate ESG into their overall business models, searching for investible projects that will mitigate the long-term effects of socio-economic risk factors. For instance, an investor with concerns about carbon pricing risk may be especially concerned about such influences on investment performance as markets improve their ability to efficiently price carbon exposures. One option is an indirect approach to ESG which seeks to reduce the number of companies that contribute to – for example – a portfolio’s carbon footprint. A second option is to integrate ESG more directly into an investment strategy by adding investments – such as renewables and other sources of sustainable energy - that contribute more immediately to realizing an investment mandate’s sustainability goals. Hence, we see an increasing number of investors have included ESG in their investment thesis and so “reward” ESG driven businesses with a lower cost of equity capital.

Diinsider: Where do you see the role of sovereign funds for impact investing?

Professor Schena: Sovereign funds are among the world’s largest investors. However, as a group they are not monolithic, i.e. they do not behave similarly. Countries that invest externally are very sensitive to long-term risk. Hence, they have begun to integrate more ESG themes into their portfolios, especially climate related themes. These countries are usually among the largest in scale. I fully expect that over time, they will be more proactive in taking leadership roles and bringing more impact into their investment processes. Recently, several sovereign wealth funds have joined together to establish the One Planet Initiative which is committed to open global dialog and action to reduce the level investment risk posed by climate change.

Loosely, a second group of sovereign funds is focused on investing domestically. These are funds that must serve a national leadership role by promoting sustainable domestic impact that complements other goals including, for example, financial inclusion, economic growth, and so on.

Diinsider: What are the challenges in the public and private markets?

Professor Schena: Even with the increasing number impact ranking and rating companies, measuring and effectively reporting impact remains a key challenge in both public and private markets. In private markets, another challenge – often overlooked – is how to exit impact deals in a responsible and sustainable way. When considering an exit, is priority given to maximizing returns or is care taken in selecting an acquirer who has the desire and capacity to maintain the impact model and dual reporting framework of the investee company? Specifically, one must ask: How will you as CEO insure the preservation of your business’s impact agenda post exit?

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