The impact investing industry continues to grow, primarily driven by new fund launches, investment flows, and market demand. But a recent market breakthrough – the introduction of independent impact verification – promises to unleash a torrent of new institutional capital flows, helping mainstream the practice of impact investing while simultaneously levelling the playing field for all impact investors.

As the urgency of the world’s social and environmental challenges becomes more stark by the day, institutional investors are increasingly turning to impact verification to efficiently sort and compare impact products and to have confidence that impact claims will translate to impact outcomes. 

Trust is the main barrier to the growth of impact investing

There has been dramatic growth in the impact investing industry in just the last few years. By one measure, according to the Global Impact Investing Network (GIIN), the total amount of assets under management with an impact focus is approximately $715 billion, up from $502 billion a year earlier.

By another measure, a recent report by the International Finance Corporation (IFC) estimates that impact investing in private markets could be as large as $2.1 trillion, but only about a quarter of that is consistently measured and managed for impact. An earlier IFC report suggested the potential investor appetite for impact investing across both public and private markets could be as much as $26 trillion.

Other positive signals of market growth include the growing number of large private equity firms launching impact funds (for example Apollo, Bain, Blackstone, KKR, TPG, etc.), which has helped spur more institutional investors like Prudential and the New York State Common Retirement Fund to allocate a portion of their portfolios to impact. More allocators are sure to follow, especially since investors are more influenced by peers than perhaps any other data point.

Despite this exponential growth, the impact investing market still falls far short of the scope and scale needed to address our urgent social, environmental, and economic challenges embodied in the UN Sustainable Development Goals (SDGs). The challenge appears even more daunting when considering that evidence is lacking as to whether those investment funds are actually contributing to the SDGs as much as they claim.  For impact investing to evolve from a niche to a mainstream practice, much more institutional capital will be needed from the pension funds, sovereign wealth funds, corporations, and foundations of the world.

However, the lack of trust in the impact label still represents a significant barrier for asset owners looking to allocate to impact. To unlock capital flows, asset owners need a way to identify best-in-class impact investors and to have confidence that impact claims will turn into impact results. In other words, the impact investing market needs a reliable tool to fight impact-washing.

Impact verification is a game-changer for the market

The solution to these market barriers is independent verification, just as it has been in just about every other commercial market. Consider that every product or service market that achieved scale – whether automobiles, organic produce, or rated bonds – has done so thanks to a set of shared standards and a mechanism for holding market participants accountable to those standards.

The impact investing market has no shortage of standards, but what’s been missing until recently is a third-party accountability mechanism. The Operating Principles for Impact Management, launched by the IFC and a group of 60 founding signatories in April 2019, represented a game-changing moment for the impact investing industry because they included a requirement for all signatories to regularly and independently verify their alignment with the principles.

BlueMark has seen first-hand how transformative verification can be for the impact investing market. We began verifying a few of our clients shortly after the impact principles were introduced, and in 2020 launched an independent impact verification business called BlueMark to meet the growing market demand for high-quality and incisive verification services. To date, the BlueMark team has completed 20 impact verifications, including 16 verifications for signatories to the operating principles, representing about 40 per cent of the verifications published to date.

We specifically designed our verification methodology to address the barriers preventing more institutional capital from flowing to impact. Instead of simply providing a ‘check-the-box’ service, we approached each verification assignment with the same level of rigor that institutional investors approach the due diligence of fund managers. We sought to strengthen trust in impact investing by bringing three specific benefits to the market:

  • Accountability – By evaluating whether impact investors’ practices and performance are aligned to accepted market standards
  • Discipline – By encouraging transparency, adoption of industry best practices, and shared learning that continuously raises the bar for performance
  • Comparability – By establishing benchmarks and ratings that allow stakeholders to compare different approaches to impact investing on a consistent basis

These benefits represent more than just a nice-to-have for impact investors; for the impact investing industry to scale with integrity, we need asset managers and asset allocators on the same page when it comes to understanding and executing on best practices.

Right now, it tends to be the allocators pushing for independent verification. Indeed, we have had multiple institutional investors come to us asking to conduct an impact verification, either to evaluate an  existing impact manager in their portfolio or as a way to diligence a prospective manager prior to making an allocation. This embrace of verification signals that institutional investors struggle to differentiate between the many different impact funds in the market, and shows the value of an authoritative third-party voice that can help streamline portfolio management and allocation decisions.

Lessons learned from impact verification

The early evidence from these impact verifications shows their transformative potential to scale the market. In April 2020, we published our initial findings based on 13 verifications in a report titled, “Making the Mark: Investor Alignment with the Operating Principles for Impact Management.” Although a small sample size, some critical trends about best practices and shared challenges came into sharper focus.

For instance, we found that impact investors generally excel at articulating their impact intentions and have made significant strides to operationalise those intentions across their investment portfolios by aligning their investments with the Sustainable Development Goals (SDGs) or other accepted market standards. However, impact investors have more work to do when it comes to engaging with investors to support the achievement of impact, including monitoring unintended impacts and aligning incentives with the achievement of impact.

The most common theme from these verifications is that impact investors are committed to continuously making improvements to their impact management practices, a process made possible through independent verification. Anecdotally, we have heard from several clients who went into the verification exercise expecting to receive high marks, only to realise how much work they still have to do to align with best practices. This self-realisation is an important part of each investor’s individual impact investment journey and the impact investing market as a whole, helping to constantly raise the bar by holding everyone to a continuously rising standard.

Some may argue that a requirement for impact verification represents an additional and unnecessary cost of entry, especially for asset managers looking to launch or market their impact funds. But we believe that for impact investing to succeed and help bring about a fundamental reshaping of our financial systems, independent impact verification is as essential as the auditing of financial performance.

The overlapping crises of the past few months – from climate change to COVID-19 to racial injustice – have taught us that our social, environmental, and economic systems are inexorably intertwined. A few more billion dollars into impact funds won’t come close to meeting the urgency of the moment. We need impact investment at scale, but impact investment that is ingrained with the kind of processes and practices necessary to scale with integrity.

The best way forward is a system-wide commitment to transparency and accountability. Impact verification is a key step in that transformation, and will help unlock not just billions of dollars, but trillions of dollars of capital.

Christina Leijonhufvud is the chief executive of BlueMark, a Tideline company that provides impact verification services for investors and companies.

 

The global macro-economic future remains precarious amongst huge uncertainties according to the head of the capital markets department at the IMF, Tobias Adrian, who warns of fragilities including the disconnection between the real economy and financial markets, and growing debt, as potential interruption to future growth.

Global growth is projected at 5.2 per cent in 2021 according to the IMF with wide negative output gaps and elevated unemployment rates this year and in 2021. According to the recently release world economic outlook from the IMF, A long and difficult ascent, after the rebound in 2021, global growth is expected to gradually slow to about 3.5 per cent into the medium term.

According to the most recent report, global growth is projected at -4.4 per cent in 2020 which is a less severe contraction than was forecast in its June world economic outlook. Importantly in its October outlook, the IMF says the pandemic will reverse the progress made since the 1990s in reducing global poverty and will increase inequality.

Speaking at the launch of the global financial stability report this week, Adrian who is financial counsellor and director of the monetary and capital markets department at the IMF, said policy makers have made bold unprecedented action to safe guard the financial system.

“For the moment near-term financial stability risks have been restrained thanks to extraordinary monetary policy and massive fiscal support,” he said. “That dramatic action has stabilised global financial markets, boosted investor sentiment and maintained the flow of credit. Critically the size of policy support has helped prevent the destructive micro financial feedback loops that were so prevalent in the financial crisis in 2008.”

However, Adrian says that some pre-existing vulnerabilities are now intensifying representing potential headwinds to the recovery.

“Risks to growth are still tilted to the downside and the probability that global growth will fall below zero in 2021 is close to 5 per cent. This tail risks suggests the economic future remains precarious amidst huge uncertainties.”

He says there is a risk that recent policy actions may have unintended consequences beyond policy makers stated objectives.

In particular he points to the persistent gap in financial markets where rising stock market valuations and the weak performance of the real economy are disconnected.

“This gap is hopefully going to narrow as the economy regains steam. But if the recovery is delayed, if it takes longer than expected to get the virus under control then investor optimism may wane,” he said. “Policy makers face a tradeoff in decision making between support needed today and implications of rising vulnerabilities for growth in the medium term.”

Adrian also pointed to the higher and increasing levels of debt in some sectors pushing solvency risk into the future.

“Renewed liquidity pressures could easily morph into insolvencies especially if the recovery is delayed. The resilience of the banking sector is likely to be tested. Our analysis shows that some banking systems may suffer significant capital shortfalls, and a large number of firms and households won’t be able to repay their loans,” he said. “We also have concerns about the non-bank financial sector institutions which now play a growing role in credit markets in advanced economies including its riskier segments.”

He said the increased links between corporations, banks and non-bank financial institutions imply that at some point fragilities could spread through the entire financial system.

“After the pandemic is under control a robust financial sector reform agenda should focus on rebuilding bank capital buffers, strengthening the regulatory framework for non-bank financial institutions and stepping up prudential supervision to contain excessive risk taking in a lower for longer interest rate environment.”

Adrian called for policy makers to carefully sequence their response to build a bridge to a sustainable recovery. He said as economies reopen, monetary policy should remain accommodative to sustain the recovery and liquidity support should be maintained.

“A robust framework for debt restructuring will be critical to reduce debt overhangs to resolve non-viable firms,” he said.

Importantly Adrian called for the immediate policy agenda to be mindful of one over-arching objective: the transformation of today’s carbon intensive economic model and a transition to a greener, cleaner and more stable economy.

CFA Institute recently released the report Climate Change Analysis in the Investment Process to help investors gain the knowledge needed, and understand the resources available, to better incorporate climate change analysis in the investment process. The report includes a survey of global CFA Institute members and showed that 75 per cent of C-level executives surveyed believe that climate change is an important issue. However, only 40 per cent of all survey respondents (a larger sample size) say that their firms currently incorporate climate change analysis into the investment process. This gap between aspiration and the current level of practice on climate change integration at global financial firms speaks to the need for more resources to train today’s analyst and portfolio managers in climate change related analysis.

Climate change will have a substantial economic impact on earth in the coming decades, and the longer it takes to mobilise action around mitigating climate change, the larger the bill will become.

A recent Morgan Stanley report estimates that $50 trillion dollars will have to be invested in order to reach net zero carbon emissions goals by 2050. In a 2019 speech, Sarah Breeden, then the Bank of England’s executive director of International Banks Supervision, stated that if no action is taken to mitigate climate change, losses could be between $4 trillion and $20 trillion.

These substantial economic and investment costs that will be shouldered by global society can be aided by the financial community doing what it does best – efficiently allocating capital. At this point however, there are large gaps in climate data. Financial professionals need complete, comparable and accurate data on climate change from companies in order to do the job of efficiently allocating capital when it comes to the issue of climate change.

Unfortunately, the tools needed to incorporate climate change into the investment process are either lacking or are not well known by many financial professionals. In the survey mentioned above, of financial professionals who say they do not incorporate climate analysis into the investment process, 57 per cent say that this is due to a lack of proper climate related investment and analysis tools.

However, this is changing. With standards like the Sustainability Accounting Standards Board (SASB) focusing on material climate issues and the Task Force on Climate-related Financial Disclosures (TCFD) providing a framework for engagement around climate issues, more tools are being made available. The IFRS currently has a consultation paper out on sustainability reporting because it realises the importance of getting sustainability accounting right, so that externalities such as climate change receive the proper accounting treatment.

From accountants and auditors to portfolio managers and analysts, financial professionals have an important role to play in addressing climate change. This will take increased investment in education and training, as well as concerted engagement with companies and policymakers to ensure that what gets measured, gets managed.

CFA Institute has detailed the following steps that financial professionals, issuers and policymakers can undertake to help financial professionals include climate related analysis in the investment process.

  • A price on carbon: To underpin robust and reliable carbon pricing, CFA Institute calls on policymakers to ensure that regulatory frameworks for carbon markets are designed to deliver transparency, liquidity, ease of access for global market participants, and similar standards across jurisdictions.
  • Carbon price expectations included in analyst reports: CFA Institute recommends that investment professionals account for carbon prices and their expectations thereof in climate risk analysis.
  • Increased transparency and disclosure on climate metrics: CFA Institute recognises the coalescing of the investment industry around the SASB and TCFD standards for climate-related disclosures, which are the most relevant and succinct climate-related disclosure standards that address the materiality of climate-related risks.
  • Engagement with companies on physical and transition risks of climate change: CFA Institute suggests that investors should engage with issuers to ensure that climate data, scenario analysis, and related disclosures are sufficiently thorough to support robust climate risk analysis in the investment process.
  • Education within the investment management profession: Investors need to continue to educate themselves about climate change to provide the climate-related analyses clients require.
  • Policymaker involvement: Investors need to continue to urge policymakers to craft regulations to ensure that investors have the tools they need to do the work of finance.

Matt Orsagh is senior director, capital markets policy at CFA Institute

Watered-down shareholder participation at AGMs, due to virtual meetings during the pandemic, is sounding alarm bells at APG, the largest pension fund in Europe, where collaboration with other asset owners and organisations is the beating heart of its ESG strategy and a central tenet to its stewardship response to the pandemic.

Virtual annual meetings may be the pandemic norm, but Dutch asset manager APG is concerned about the consequences of lost face-to-face engagement and the ability of investors to collaborate to put pressure on companies to change.

“In our view, AGMs as they are now can only be an interim solution,” said Claudia Kruse, managing director, global responsible investment and governance, APG, Europe’s biggest pension fund in an interview with Top1000funds.com.

The majority of AGMs that APG has attended since the shut down due to the pandemic are one-way webcams, simply speeches that don’t involve two-way dialogue. Nor is the advance voting process as effective according to Kruse.

“We’ve participated in 10 webcast AGMs and sometimes put forward questions as part of a collective engagement, but of course the votes are cast in advance,” she said.

In other cases, questions are not put forward as part of collective engagement, and interaction between the board and retail investors is also lost. Possible solutions include hybrid models where investors can participate virtually in conjunction with a smaller physical meeting, said Kruse.

However, she said success here requires innovation and commitment by companies and boards and has revealed a disparity between different regions.

“In Asia, AGMs largely went ahead. In other countries we have seen more postponement or webcasts,” she said.

Her comments echo growing investor concerns that online AGMs, as well as postponed meetings and meetings being held behind closed doors, are stymying shareholders’ ability to participate as company owners. Only 36 per cent of questions posed to companies by shareholders at virtual AGMs in the US in 2020 were addressed at the event, according to Miriam Schwartz-Ziv, a lecturer at the School of Business Administration at the Hebrew University of Jerusalem in a recent study. It’s an issue on the PRI’s agenda where the stewardship team is advising signatories on how to navigate virtual AGMs and make sure their voices are heard.

“We are working with investors on guidance to navigate the virtual AGM season,” said the PRI’s Fiona Reynolds.

It’s no surprise watered-down shareholder participation is sounding alarm bells at APG. Collaboration with other asset owners and organisations is the beating heart of the asset manager’s ESG strategy and a central tenet to its stewardship response to the pandemic. APG has signed the PRI’s investor statement on the COVID response and under the Human Capital Management Coalition (an organisation comprising 28 global investors with a collective $4 trillion under management) engages on labour rights thrown into the spotlight by the virus, most recently with Amazon.

Looking ahead she sees opportunities for collaboration with DFIs like the European Investment Bank, the World Bank and the Nordic Investment Bank structuring investable COVID recovery loans.

“There is a real opportunity for investors to work with DFIs to design instruments we as investors can invest in and allocate capital to where it is needed for a sustainable recovery,” she said.

Elsewhere, APG’s collective asset owner engagement with the world’s worst polluters through Climate Action 100+ has encouraged companies like Shell to change, while membership of the Institutional Investors Group on Climate Change’s (IIGCC) Portfolio Alignment Initiative currently brings together 70 investors to help design and model asset allocations to fit Paris alignment by 2030. Closer to home, APG is leading the investor contribution to the Netherland’s National Climate Agreement, working to achieve measurable 2030 targets amongst all Dutch financial institutions.

Most recently APG is seeing the fruits of a partnership with Japan’s GPIF, PGGM and Norway’s Norges Bank on the Carbon Real Estate Monitor (CREM) and the exploration of decarbonisation pathways for global real estate come to fruition.

As APG continues its route to a climate neutral portfolio by 2050 and Paris alignment by 2030 the focus is on scenario analysis and strict targets, says Kruse. Recent pledges include a target to cut the listed equity portfolio’s carbon footprint by 40 per cent by 2025, phase out exposure to coal and tar sands and built a $15 billion allocation to in SDG 7 (clean energy) by 2025.

To meet the challenge, APG is planning sweeping new hires across responsible investment, she concluded. ”

We plan to hire an additional 100 people of which 70 will be in portfolio management including responsible investment. We are keeping our focus on long term.”

Pension funds need a generation of investment professionals that are willing to be brave and less conservative than their predecessors if they are to move to the systems level perspectives on investment that is required for better returns and societal outcomes, according to the co-head of the Thinking Ahead Institute, Marisa Hall.

ESG 3.0 will require systems level thinking on investment, and intentionality to work on the system, rather than just ESG portfolio integration, she said in a Conexus Institute Exploring Big Ideas webinar.

The Thinking Ahead Institute encourages both bottom up and top down thinking to solve systemic problems and let “a thousand flowers bloom”. Its aim is to mobilise capital for a sustainable future and it sees merit in seeing the investment industry and its connected parts as a system

“We are working on ESG 3.0 around the need for systems level investing and systems perspectives on investment. As an investor you can work directly on the system which leads into better and stronger investment results,” Hall says. “What we are talking about is instead of having ESG in the portfolio we are calling for greater intentionality to work on the system, and then get additionality and value creation within your portfolio.”

She says to effect change leading pension funds are executing through multiple touch points including capital allocation and strategic tilting, engagement, bottom-up security selection and top-down systems level engagement such as influencing industry groups, looking at mandate design, longer-term time horizons, governance and organisational design.

“Pension funds need a holistic approach and a mindset that focuses on intentionality to change the system,” she says. “They need to do more than just delivering pensions for members. Delivering what’s best for your members and the sole purpose test is linked to doing good for society and the environment and maintaining that social licence to operate. How do you achieve that? You need a generation of investment professionals willing to be brave and less conservative.”

Hall says another “big idea” the Thinking Ahead Institute is exploring is the concept of value creation, and translating the measurement of ESG to what it really means to create value for different stakeholders.

“We have been working on this concept of value creation. What is value and who are you creating value for? One of key concepts is that by creating value for a particular group of stakeholders you may be destroying it for another group. Profit for shareholders and externalities an example of that,” she says. “This is what we talk about the concept of 3D investing – risk, return and impact. Every investment decision we make has an impact on society it’s just in the past we haven’t put a weighting on that. We are not just talking about impact investing but the impact of investing, of our everyday decisions.”

She says when asset owners, managers and corporates talk about creating value for clients there needs to be a fuller description of what that means, and that starts with defining the time horizon.

“For example, if you are looking at a benchmark over a year then some of that value has a risk of being reversed. We need to be more transparent about this.”

She called on investors to look at ways to translate granular ESG measurements into value creation for stakeholders, and is an advocate of integrated reporting.

“It’s the concept of double materiality, firms needing to look at how they report on financial metrics and how they create long term enterprise value creation for investors, and balancing that with the impact on people and planet. Beliefs are really important in that.”

She encouraged pension funds to think about their time horizon and the fact that sustainability and long-term value creation potentially requires tradeoffs between current and future members.

“Your role as an asset owner is to understand those tradeoffs and balance intergenerational risks and needs, and that is tied into your role as a fiduciary and also your own career risks.”

In this Fiduciary Investors Series podcast, Amanda White speaks with John Claisse, the chief executive of Albourne Partners. Albourne, which is a leading consultant focused on alternative investments, has been advocating for better practice within the alternatives industry for many years and the discussion covers fee discovery and transparency; new initiatives around diversity and inclusion; and how alternative investment managers can incorporate ESG.

About John Claisse
John Claisse joined Albourne in July 1996, relocated from London to San Francisco in July 2013 and became Albourne Group CEO in August 2015. He is an equity partner and member of Albourne’s executive committee and also chairs the firm’s corporate planning council, which comprises Albourne’s function and region heads. Claisse helped develop the firm’s proprietary risk analytics and was formerly the senior analyst for quantitative equity strategies and multi-strategy hedge funds. He remains a portfolio analyst working with several public and corporate plans, large endowments and foundations. He holds a first class Mathematics Degree and a PhD from Sussex University.
Albourne is an independent advisory firm focused on hedge funds, private equity, real assets, real estate and dynamic beta. Founded in 1994, Albourne has over 250 clients with over $550 billion invested directly in alternative investments.

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

What is the Fiduciary Investors series?
The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.