Impact investing, the double dividend season is coming soon

Although there is some way to go, the evolution of the ESG regulations brings back a mature and profitable impact market. According to Lenfers (Vontobel), there are two ways to explore it: diversification and selection. With special attention to Europe

by Giulio Zangrandi

From ESG investing to impact investing. But as long as it is listed. For Marco Lenfers, Client Portfolio Manager of the Vontobel Global Impact Team, the new frontier of sustainable investing passes through this junction. And not even the recent wave of reclassification or the controversy in the United States, which also have an impact on this trend, can stop the change in sight. All the more so, since 2008 legislation has been making progress towards making data more objective and harmonized. That's why with Global Environmental Change, Vontobel’s fund born just 15 years ago, is aiming for a "double dividend". Selection, diversification and a focus on Europe are the keys to achieving it.

The Global Environmental Change fund is celebrating 15 years. How has the sustainable investment industry changed from its launch?

In 2008 there was already some interest in ESG topics, andthere were already managers who were trying to incorporate them into their investment processes, but the limited amount of data available made it difficult to demonstrate the environmental validity of their strategies. One example comes from our own experience. Although the Global Environmental Change fund was launched in 2008, it is only since 2016 that we have been able to formally measure the positive impact of our positions: indeed, it was on that date that the carbon footprint was introduced, which was ?followed by the development of an indicator to quantify potential avoided emissions. Without these metrics, today we could not say that we are allocated to 30 companies with good reporting and reliable data. On the other hand, looking at the regulatory environment, it is true that regulation still appears insufficient, but it cannot be denied that interventions by the legislator have improved the situation: just think of the SFDR regulation dedicated to the so-called deep impact. Additionally, standardization is set to increase further in the coming years because companies will be forced to do more reporting.

Regulation is therefore making progress. Still, the recent wave of reclassifications in the fund industry or the ESG backlash in the US cannot be ignored. Do you think it is precisely those factors such as overly strict regulation and lack of data standardization, which could be an obstacle to the growth of the sector?

The lack of standardisation certainly complicates matters because it makes it difficult to identify an unambiguous definition of sustainability but also to find similar (or at least comparable) data and strategies within the same Sfdr category, be it Art. 8 or Art. 9. This can then create a barrier for the clients who find it difficult to choose the most suitable approach for their impact objectives and may be discouraged from relying on a manager. This is why it is crucial that information becomes increasingly available and that companies start to report in a uniform manner. Only this effort can in fact allow the industry to take that definitive step forward that is still missing: moving from ESG investing, which has now become a mainstream trend, to impact investing. As for the ESG backlash in the United States, I think it boils down to the different approach required of an asset manager when operating in such a vast area that is divided into states with so many different habits (not only financial). In general, it is a segmentation and marketing logic that should be applied to sustainable investments in a broader sense.

Impact investing marks the end of the industry's transition path. But how far are we from the finish line and what is the inclination of the industry to undertake this change?

A survey that Vontobel recently conducted among 200 institutional investors and wealth managers globally shows that the majority of European respondents, as well as those in Asia and the US, have begun to include impact investing in their portfolios and want to further increase their allocations ?over the next three years. And as wealth managers respond to the needs of their clients, it can be inferred that interest from the retail segment is also on the rise. All this evidence leads us to believe that impact investing is on the verge of a higher growth season than the industry average.

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In terms of portfolio strategy and allocation, what are the best ways to ride the trend? How is Vontobel moving in this direction?

Impact investing started with microfinance initiatives in private markets. However, the challenges that our world faces, primarily those summarised by the UN SDGs, cannot be addressed by continuing to operate exclusively within these boundaries. Venture capital must continue to be used to finance and bring to light ideas that would otherwise remain untapped, but it is only by working in the listed universe that those ideas can be scaled up. And, in this respect, fixed income is just as important as equity: from green bonds to social bonds, via any instrument that can meet the financing needs of companies with the potential for growth and positive impact. In terms of asset allocation, therefore, the key lies in creating a portfolio that includes equities, bonds, private market instruments such as microcredit and real estate. Sub-themes are another matter. The weather anomalies that are increasingly affecting many countries keep investors' focus on the environment and push managers to engage in the fight against climate change or the containment of emissions. At the same time, however, other needs are beginning to emerge. And they add new challenges to the industry. Interest in social sustainability issues such as inclusion or gender equality clashes, for example, with the lack of sufficient data standardisation. Similarly, the increased sensitivity to biodiversity clashes with the difficulty of finding companies, both in private markets and on the stock exchange, that have solutions to preserve ecosystems or at least do not damage them with their business models.

At Vontobel, we started in 2008 with an environment-related strategy. Ten years later, in 2018, we took a further step forward with the introduction of the first comprehensive set of impact indicators published annually. Our first strategy that also looks at social factors dates back to 2019, while the latest initiative is the fifth report released at the beginning of October.

How to make a selection in such a broad and diverse context as sustainability?

We are constantly looking for what we call a 'double dividend', i.e. an investment in global equities that combines environmental and social benefits with financial returns. This is because we are active managers and aim to generate alpha. We follow a bottom-up selection process that focuses on companies that have innovative and unique sustainable solutions that are also scalable and profitable once they are up and running. Using internal models, we then develop five-year forecasts to assess factors such as cash flow generation, margin growth potential, and upside potential.

How is the Global Environmental Change fund constructed?

We have identified six areas that represent the most scalable sectors but also those where the most innovative and defiant solutions exist: clean energy infrastructure, building technology, low-emission transport, energy efficiency, clean water and lifecycle management. Companies must provide processes or products that are consistent with one of these categories to get on our radar. At the portfolio level, we have a target of 50-70 stocks while the asset allocation sees us underweight the US with 50% exposure versus 70% of the Msci index. We also hold a small allocation to China, South Korea and Taiwanese stocks but it is Europe where we are overweight. This is because we believe there are interesting providers in the Old Continent.

Which will be the most important markets in the future?

Asia is growing a lot geographically, but we are clearly seeing a generalised interest from wealth managers and institutional investors such as sovereign wealth funds and large pension funds, who are increasingly developing strategies related to tackling climate change for their portfolios. This does not detract from the fact that Europe remains the largest market and that the United States remains an extremely large country with a wealth of opportunities from a forward-looking perspective: for this reason, we launched an American mutual fund a month ago

How can the macro outlook influence impact investing??

In a recent survey of ESG investment strategies, we asked institutional investors and wealth managers whether a short-term rate hike would cause them to change their plans, and the answer was a clear no. We agree with this statement: in general, further monetary tightening is bad news, especially for those like us who run a long-only global equity strategy. The biggest danger is that higher rates will limit future growth, but we see no particular impact on most companies. Even the rise in oil prices in the wake of the tensions in the Middle East can paradoxically be read as good news because it makes companies involved in climate change more competitive than hydrocarbon companies.