October 6, 2022
The planetary and social challenges we face are becoming increasingly urgent. Where we previously considered climate change a vague problem, we increasingly notice its impact in our daily lives. Think of the glacier you used to ski on every year that has now melted, your cruise along the Rhine severely impacted by low water levels or forest fires near the campsite you were going to holiday at.
The need for innovative solutions to these problems has never been greater, and the world of investment faces many challenges: how will the sector evolve in the face of an ever-changing world, and how will our definition and measurement of impact evolve?
Themes of the future
More and more impact funds and capital managers want to engage in impact investment. A few themes stand out in this respect. Our outlook is as follows:
- Biodiversity and climate change
Climate change is one of the greatest challenges of our time and the sector is strongly committed to decarbonisation. Many initiatives are underway to convert the risks that exist into a financial upside.
Using the meat industry as an example, in a survey conducted by Changing Markets Foundation, 200 respondents working in the investment industry worldwide were asked a number of questions on this topic Of the respondents, 84% agreed that a lack of climate mitigation could lead to stranded assets in the meat and dairy sectors. 61% of respondents called this risk "a distinct possibility" and another 23% considered it "very likely". These findings demonstrate the need for investors to push for better climate adaptation and mitigation plans from the food companies they invest in.
Alternative energy and energy efficiency appear to be the most prevalent issues in impact funds. In general, investors have been allocating more capital to environmental themes for some time. Due to recent world events, most notably the war in Ukraine, we expect this trend to accelerate as companies and investors seek to move away from dependence on oil and gas. In addition, the next growth area within the impact investment universe is likely to be biodiversity, or the natural habitats of the world. Funds are now coming to the market that provide capital for land managers to expand forests or restore peatlands and for farms to sequester carbon and engage in regenerative practices.
There is growing evidence that the obesity pandemic, in addition to cheap industrial food available everywhere and our sedentary lifestyles, also has a cause in deterioration of our gut bacteria. The reason for this is that our diet is deficient in nutrients. In addition to ecology, regenerative farm health is therefore something that is increasingly being documented in research, as this article also shows.
- Social issues
Impact is increasingly about social issues as well. COVID-19 has exposed many inequalities in society. On the social front, there are many problems to solve, such as inequality, poverty, the digital divide, financial inclusion, access to education and basic healthcare, security and affordable housing. We see a growing number of companies and investors focusing on this theme, such as social or healthcare real estate funds.
The issue of income inequality, for example, is the subject of various discussions, ranging from different types of taxes to more creative solutions. A new word that is appearing more often is "pre-distribution", an idea that states that income inequality should be structurally prevented instead of trying to rectify it with taxes and benefits. For example, company profits are first distributed to employees before shareholders are compensated. It is an idea that fits within the Benefit Corporation idea. This article from Forbes explains the role that the investment world can play in this.
Investing for the long term
Now that impact is a hot topic, impact investors are also entering the field looking for 'impact unicorns': companies that contribute on a large scale to solutions for key challenges and also want to make a lot of profit quickly. In contrast to the digital market, in the world of impact it is not desirable that a handful of large companies realise all the important evolutions. It is better to eventually have many impact companies, of all sizes, that together create positive impact. With the increase of capital from the digital world, impact investors are now coming more into contact with scale fast and leverage ideas. That is good news in a way, but we need to see the impact philosophy more broadly than just investing in large impact companies. Now more than ever there’s a need to invest in real impact innovation. This innovation can often be found at really small companies like startups and impact ventures.
It is also about a change in our economic thinking, about investing for the long term, about engagement and about an ecosystem that is prosperous for many. The biggest reason behind the rise of impact investing, in our view, is that it fits perfectly with some of the most powerful macro trends in the global economy. For investors, it is also the best way to invest in long-term sustainable growth. It attracts more capital and more talent to the sector.
Definition of impact under pressure
An important question when it comes to the future of impact investing is how measurement and reporting will evolve. More and more data is available, so measuring and reporting impact can and must become more transparent. The European Union is also starting to issue directives that will make it compulsory to communicate transparently about sustainability efforts.
This makes the question of how impact can be uniformly measured and thus how impact is defined more urgent. Five aspects that are important in the current definition are under pressure:
- Who benefits from the impact?
In the current definition, intentionality is important: do you invest in a certain solution with the intention of tackling planetary and social challenges or not? But the positive impact of investing in solar panels to make money is just as big as investing in them to save the earth, which raises the question of whether intentionality belongs in the definition of impact investing per se.
In addition, we often look at the positive impact of investments on "underserved communities" - i.e, communities that face barriers and difficulties in accessing and using financial and medical resources. This can be caused by socio-economic factors, extreme poverty, geographic isolation, religion, sexual orientation, gender identity, race, and ethnicity, among others. Investments in medical centres in Africa, for example, may be less impactful in Europe, but in Africa they make a world of difference.
With the current measurement methods, it is also very difficult to measure the additionality of investments: if there are a lot of candidates to step into an impact fund, your euro probably makes little difference, so it is better to invest in other funds. We also don’t always know where the impact is greatest; think of the famine in Africa: of course you can send food parcels, but you can also ensure less drought by investing in irrigation, you can invest in the knowledge of the farmer so he can use seeds that are more resistant to drought or you can give money so that people can move from dry areas to other areas. Fortunately, the impact of this large number of options is getting increasingly calculated more accurately by all kinds of organisations. Thus, in the future, it will become increasingly clear what is the best investment.
Timing is also an important issue when we talk about impact investing. Over what period are we going to measure impact? Because if you give someone a food package once, that impact will be the greatest in the short term, but if you teach someone to produce more food, that positive impact will last much longer.
Finally, positive impact can be caused by several parties at the same time. If a company, thanks to the capital of an investor, reduces carbon and makes a product that enables customers themselves to use less carbon, who is responsible for that impact? The customer, the investor or the producer?
There are many questions that impact investors are actively addressing so we hope to move to an era in which impact will be central.