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  • Hedda Pahlson-Moller and Cécile Sevrain

Unpuzzling ESG from Impact Investing

In the momentum around the evolution of sustainable finance and its alphabet soup of acronyms, Hans Rosling’s (R.I.P.) book Factfulness* (the stress-reducing habit of only carrying opinions for which you have strong supporting facts) presents a quandary: our minds automatically seek binaries – the us vs them, good vs bad. We have an intrinsic need to cram people and things into ill-fitting buckets. This is particularly difficult when a movement is… in motion, which is the case for SRI (which in a telling example stands for Social and/or Sustainable Responsible Investment, depending what part of the world or sector you are in).

Which brings us to the most common queries we get at TIIME: so what’s the actual difference between impact investing and ESG investing? The itch to bucket is absolute. ESG (often confusingly interchanged with SRI) has all the mainstream headlines with the ‘trillion dollar’ markers and institutional machinery. Impact investing is often overlooked (clocking in at a mere 500 billion) or moonlighting as the ‘I’ of SRI. Other times the ambiguity around ‘impact’ misplaces the activity with philanthropy – another ill-fitting bucket. So it may be worth reviewing the definitions – and differences.

Impact investing is an investment strategy with an unambiguous definition from the GIIN (Global Impact Investing Network) who calculated the aforementioned market size and reinforced by the community for private investors, aptly named TONIIC: “Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.

The operative words here are intentionality – impact by design and not by default – and measurability (yes you can measure if you know what you’re doing, but that we will tackle in another article). Fundamentally it is capital focused on addressing societal challenges anywhere (and we really mean everywhere) and across a range of asset classes and return expectations. Many impact investors endeavor to deploy ‘patient capital’ with a longer investment horizon.

Rockefeller Philanthropy Advisors (who have been credited for coining impact investing in the late 90s) have put together an overview of the drivers and motivations for impact investors that include addressing wicked problems (such as poverty and climate change) or more focused challenges (such as education in remote areas). There are also strategies focusing on populations, (including women, children, the elderly, youth, or refugees), or place-based investors funding different issues within a geography (a continent or region, a village or neighborhood). Other approaches include seeking institutions (advocacy organizations), innovative solutions (tech for good), ‘general good’ – and of course - investment performance. This isn’t philanthropy..

Impact investors may have a thematic approach (such as the UN SDGs) that can include set objectives, strategies and theory of change – which investments will have the most impact on the issues they are seeking to solve. At TIIME we invest in an overarching objective of addressing Inequality/Inclusion/Integration (which covers a mix of SDGs) with multiple strategies such as financial inclusion, workplace integration solutions and an explicit gender-lens focusing on women and girls. The same goes for our approach towards climate change, which includes a range of forestry to innovative technologies in energy conservation and distribution.

Now for ESG – Environmental, Social, Governance – effectively a lens on the EXTRA financial issues (it seems unfitting to stick to the term NON-financial’ as these issues clearly have a financial impact) that each business or investor faces. It’s an assessment of the elements regarding factors related to the stakeholders and externalities that exist beyond the brainwashing of the ‘shareholder doctrine’ (effectively only shareholders should be catered to at all cost) and the limited accounting tools that cannot grasp intangible assets – and inherent liabilities (see footnote**). Let’s explore this lens that investors are scrambling to leverage to improve their risk analysis and identify a new alpha that will help investors ride out these turbulent market times.

Environment – with global attention on climate change and international efforts to stem carbon emissions and pollution, resource consumption, clean air/water, etc, the inevitable impact of business operations on the environment is under scrutiny (take a look at the Ecological Footprint for perspective). Woe to the organization that expects to avoid the repercussions of the growing army of Planet & People policing that has gone beyond the standard watchdogs.

Social – what was traditionally considered the ‘soft’ element – the effect a business has on people issues, not just within the company, but those affected across the value-chain and beyond. When planetary boundaries meet social issues (climate migration for example), there’s a whole other layer to tackle… There have been attempts to pit Social against Environment in a zero-sum game model – but like Human Rights, it’s not pie. They intrinsically link together – see the UN SDGs as a case in point. We wrote an article on People vs Planet to address this.

Governance – often taken for granted as a given, yet still evolving and debated in terms of best practice and nuance. Beyond KYC/AML filters applied for #nobrainers like corruption and harassment, there are new elements related to transparency, culture and diversity that are being highlighted as drivers for performance. Without good governance, the E and S don’t stand much of a chance…

Concrete examples of risks and opportunities around ESG are found in a series of reports and articles building the business case for sustainability. But in short, we’re talking business risk, financial risk, reputation risk. And on the flip-side the opportunities of capturing new markets, customers, talent and… investors!

So ESG is a new set of glasses that allow the traditionally near-sighted to look further into the future – where climate change is no longer a theoretical threat, when millennials and women are also driving investment and business decisions, regulation across ‘non-financial’ aspects strengthens and new standards emerge. It can help investors seek out companies (and funds) that have a more holistic view of their responsibilities – by future-proofing themselves to the basics of regulatory change, adapting consumer requirements and the hunt for talent. ESG investing comes in many flavours. One can ‘ESG invest’ with negative screening – excluding the poor performers or filtering out industries or geographies. More savvy investors can also add positive screening on best performance within the ESG domain and focus on companies leading the charge in innovations that directly address societal challenges.

You can obviously apply the ESG lens to your impact investing, so they are in no way mutually exclusive! But ESG screens primarily focus on the processes of a company – not the output or impact of the company’s product or solutions. However, the available ESG ratings are often sourced from a small group of data providers, creating the additional challenge of having different rating mechanisms (with limited information to understand their rating approach).

Back to Impact investing for a full circle – it is equivalent to frontier market investing in the domain of SRI, as it seeks to generate a positive societal return and not just screen out select ESG performance. As we explained above, the impact investor has a clear mission to intentionally and measurably address benefits that accrue to society. There are endless examples of awe-inspiring companies driving positive societal impact through sustainable business models.

The inevitable concern about alleged ‘trade-offs’ of financial returns when there is impact embedded in business, have been addressed by both GIIN and TONIIC and others with data-driven proof. The founders of TONIIC have published the performance of their impact portfolio (KL Felicitas Foundation) mapped both across SDGs as well as financial performance beyond benchmarks. But here is an important reminder: impact investors may or may not care to beat market standards. There is a broad spectrum of expectations on risk/return that adapts to the profile of the investor – this is non-conforming to the binary and dichotomous model of investor vs philanthropist. There are impact-first and finance-first impact investors. Some call it concessionary vs non-concessionary. And a new interesting model proposed by EVPA, has a framework of ‘investing FOR impact’ vs ‘investing WITH impact’ to navigate discussions with Venture Philanthropists and Social Investors.

Obviously Hans Rosling was right, we inevitably find a binary or a bucket to lock into at every level. The more we can discuss and develop the continuum of S(R)i**, the more comfortable it will get to facilitate the transition. We’ve perhaps allowed a few too many flowers to bloom and it’s thwarting the development of the ‘impact revolution’ and its endeavor to tackle ‘cowardly capital’ (a manifesto!). To mobilize ‘traditional’ capital to address societal challenges - yes, that includes climate change - we need to be clear with our intentions and language.***


* Factfulness - haven’t read it? take the test and if you don’t ace it, you gotta read it – deal?:

** Until there is a cradle-to-cradle pricing built into products and the most basic impact analysis – the good and the ugly - of business operations in a basic ‘triple bottom line’ assessment, we are working with arbitrary numbers…

*** We are obviously not the only ones making noise on this: The Case for Simplifying Sustainable Investment Terminology.

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