Impact investing, clearly sustainable.
After a decade of strong growth, today’s European sustainable investment market offers a (very) broad range of funds. Some might even say that it is beginning to look more and more like a jungle. Why is this?
Clearing the clutter.
To begin with, there are many different products on offer, using diverse but similar-sounding terms. While words like ‘ESG integration’, ‘E&S characteristics’, ‘Green Transition’ or ‘Sustainable Objectives’ might sound like much of the same, they carry a real difference in meaning—and in how sustainable the goals of the underlying product are.
That’s not where the problem ends. Depending on who you ask, these terms may mean something completely different. In 2018, the European Commission proposed the SFDR to streamline and unify these definitions. But even over half a decade later, no one—neither the investment community nor the regulator—has a clear definition of what constitutes ‘sustainability’. The regulator has created guidelines and set some boundaries, but the ultimate responsibility on what constitutes a ‘sustainable investment’ still lies with the asset managers for the most part.
Finally, individual investment processes often differ significantly, as do policies that decide which ‘unsustainable’ sectors to exclude, each with different scopes or thresholds. Even finding reliable and readily available ESG performance data remains a difficult task.
Because of this vast range of products with disconnected approaches and disjointed definitions, we end up with a fragmented sustainable investment landscape—and a lot of confusion. Clearly, when it comes to sustainable investing, the devil is too often in the details. Separating the wheat from the chaff has become a challenging task for fund selectors and investors alike. This greatly increases the risk that greenwashed strategies with low ESG ambitions end up competing with genuinely sustainable funds. There is a real concern that investors will turn away from sustainable investing, or at least give it less importance in their investment decisions. The market for sustainable strategies urgently needs more transparency and clarity. But how can we reduce the subjective element in the analysis of sustainable strategies? How can we clearly communicate the ESG quality of a portfolio without diving into minutiae? That’s where impact investing comes in.
Measurability & intentionality.
How can impact investing bring clarity to the market? First of all, the goal of an impact strategy is generally clear and to-the-point. An impact fund is a fund that not only seeks to create a financial return, but also has the intention to create a measurable impact, socially or environmentally (GIIN, 2024). Two important terms stand out: ‘intentionality’ and ‘measurability’.
What do we mean by intentionality? Simply put, the intention of the fund must be centred around making a positive contribution to environmental and social issues through its investments. This means it only invests in companies that also have a proven and direct way of contributing to these issues. For instance, Dexcom, a leader in continuous glucose monitoring devices, exemplifies such a company. Dexcom's devices enable patients to continuously monitor their glucose levels throughout the day, empowering them to make informed decisions about their diet, physical activity, and medication. Dexcom’s products directly contribute to preventing other health complications associated with diabetes, demonstrating clear benefits for human health.
Next, let’s look at measurability. While ESG is often approached as a risk mitigation exercise, impact is an opportunity. But both sides of the spectrum need to be measurable to be managed properly. This ensures that the outcomes of impact investments are not just anecdotal but are also supported by concrete data or highly credible estimations. That’s easier said than done. For private equity impact funds, measuring direct impact is still feasible. They often focus on smaller companies, where the positives and negatives are less challenging to calculate. But measuring the impact of larger, publicly traded companies is a whole new ballgame. Like many sustainable strategies, one could simply rely on best practices put forward by companies, their ESG policies, or future commitments. However, these metrics are excessively subjective. While major oil companies can claim that they want to become net-zero emission energy businesses by 2050, for now, most would agree that oil giants would look strangely out of place in an impact fund—regardless of their corporate promises.
To avoid such discrepancies, the impact assessment of these bigger, public companies should focus on objective and concrete aspects. In practice, this involves reviewing their products and services, and determining if they provide direct solutions to environmental and social issues (i.e., a positive contribution) or, on the contrary, if they aggravate these issues (i.e., a negative contribution). An impact strategy should, naturally, only be invested in companies with a purely positive net contribution. However, impact funds not only need to measure whether the company’s contributions are positive or negative, but also concretely determine the degree to which a company's activity aligns with key social and environmental themes —such as the Global Impact Investing Network themes, United Nations Sustainable Development Goals, or other relevant frameworks. This alignment is preferably measured by analysing the company’s revenue sources, or its capital expenditures and research-and-development spending, or other sector-specific selected indicators.
Pure impact.
By combining both intentionality and measurability, impact investment promotes tangible solutions to societal and environmental challenges. As a result, impact strategies are generally characterised by a higher level of ESG ambition and overall ESG quality compared to your run-of-the-mill sustainable funds. The impact approach goes beyond these typical sustainable investment strategies, which mostly focus on companies that perform better on ESG metrics compared to their competitors. While sustainable strategies admittedly may include some impact-oriented companies, these usually make up only a smaller fraction of their portfolios. In contrast, impact strategies exclusively invest in companies driving positive change, achieving a high degree of 'purity' in their investment focus.
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A hierarchy of sustainable solutions
Source: DPAM, 2024
In conclusion, impact investing offers a solution to the complexity created by the many so-called sustainable strategies that have flooded the market. Its definition is clear, its intention is straightforward, and its impact is measurable. It offers a more ambitious alternative to the most common sustainable or ESG strategies. By merging the highest ESG quality standards with objectivity and transparency, impact funds mitigate greenwashing risks and provide investors with access to genuinely sustainable products. As a result, impact strategies proudly feature as the kings in the sustainable jungle—a welcome and impactful addition that cuts right through the confusion.
Disclaimer
Marketing Communication. Investing incurs risks.
The views and opinions contained herein are those of the individuals to whom they are attributed and may not necessarily represent views expressed or reflected in other DPAM communications, strategies or funds.
The provided information herein must be considered as having a general nature and does not, under any circumstances, intend to be tailored to your personal situation. Its content does not represent investment advice, nor does it constitute an offer, solicitation, recommendation or invitation to buy, sell, subscribe to or execute any other transaction with financial instruments. Neither does this document constitute independent or objective investment research or financial analysis or other form of general recommendation on transaction in financial instruments as referred to under Article 2, 2°, 5 of the law of 25 October 2016 relating to the access to the provision of investment services and the status and supervision of portfolio management companies and investment advisors. The information herein should thus not be considered as independent or objective investment research.
Investing incurs risks. Past performances do not guarantee future results. All opinions and financial estimates are a reflection of the situation at issuance and are subject to amendments without notice. Changed market circumstance may render the opinions and statements incorrect.