Impact investing: how innovation, regulatory nudges and increased awareness can spur growth and leadership from life & pensions and wealth managers

Environmental, social and governance (ESG) programs have generated an enormous amount of attention in recent years, both within the insurance industry and beyond. Impact investing, a related but distinct area, has also attracted increasing attention, though it has captured only a fraction of the capital flowing to ESG funds.?

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Baseline research conducted jointly by the Impact Investing Institute (III) and EY shows that impact investing is still in its infancy in the UK. Consider that UK insurers control approximately ￡4.5 trillion in assets, roughly half of all assets in the UK. The vast majority of those assets, ￡4.3 trillion, sit in life insurance and pensions. But today less than 0.5% of those assets are allocated to impact investing, despite clear upside for insurers and society alike.?

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Recently, I hosted a podcast with Sarah Gordon , former CEO of the @ImpactInvestingInstitute @Impact InvestingImpact Investing Institute, and

cyrille langendorff , who is associate director of Phitrust , chairs the @French National Advisory Board (NAB) and represents France on the executive committee of the GSG Impact for Impact Investment. This post will recap some of the key points from that discussion, particularly how to expand impact investing into the mainstream.?

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The difference between ESG and impact investing

It’s important to recognize the differences between impact investing and ESG. According to the #GlobalImpactInvestingNetwork (#GIIN ), impact investing involves “the intention to generate positive, measurable social and environmental impact alongside a financial return.” Such investments can include debt and equity in private and public companies, with flexibility to target a range of returns based on investors’ goals.

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In contrast, #esg is often used as a screen or filter for investments, as when funds avoid companies or sectors viewed as environmentally or socially harmful (e.g., tobacco, oil and gas). Similarly, ESG principles can define minimum governance standards that all investments must meet (e.g., board diversity).?

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Impact investing is focused on delivering a positive impact in addition to financial returns, rather than just complying with or aligning to a set of principles or broadly defined goals. Some analysts view impact investing as the next stage of ESG, with investors holding themselves accountable for and offering more transparency about the actual outcomes. Historically, much impact investment has been made in private markets, while ESG has maintained a more public profile and offers more options for retail investors today.

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To qualify as impact investments, #GIIN stipulates that asset managers and other investors demonstrate:??

·????Intentionality of investment choices and outcomes

·????Measurability

·????A clear process to measure impact

·????Financial returns

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Many ESG-related investments (e.g., green funds, social, sustainable and sustainability-linked bonds) do not meet the #GIIN definition due to their lack of proven criteria for intentionality and measurability. #GIIN categorizes these types of investments as impact-aligned, rather than as impact investments per se. Again, #ESG and impact investing are related, but independent endeavors.?

To be clear, it’s still early days for impact investing; there are no current standards or common data sources for tracking, measuring and comparing social and environmental impacts. Challenges surrounding metrics are something that ESG and impact investments have in common.?

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Lessons learned in France?

UK asset managers and insurers wondering about the future of impact investing might look to France, where solidarity finance, a precursor to impact investing, dates back to the 1980s. Solidarity finance is a concept that seeks to use the mechanisms and practices of traditional finance to support the real economy and improve the standard of living for more people.

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The first solidarity-based products were launched by an association called #Finansol . Established in 1997, the #Finansol label validates that investment funds and other financial services products have certain solidarity characteristics. The legally mandated launch of employee saving schemes in 2001 helped spur adoption of what we now call impact investing in France; the introduction of solidarity-based 90-10 funds within those schemes was the key.?

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These funds are 90% invested in listed securities and 10% in social businesses and non-listed securities that are recognized by French regulators as fulfilling a number of criteria. Though workers were not required to choose a 90-10 fund, most did, largely because it reconciled with their view of doing good, investing in social entrepreneurs while still investing in the market. In 2008, a new law expanded the system to other types of employee saving programs.?

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Today, these employee savings funds have €14 billion under management in solidarity-based investment funds, with 5% to 10% invested in solidarity-based organisations. According to Langendorff, “there is too much impact investing money in France and not enough projects to finance. We need more social businesses to take that money.”

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The rigorous vetting and labeling of impact investment has been key to success. There are particular guidelines on salary levels, governance and profitability thresholds and caps. The criteria are different from one financial product to the other. In place for 25 years, the labels are being updated in conjunction with FAIR , an organization that unifies different stakeholders in France with the goal to support more inclusive finance for better social and environmental impact.?

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A recent market sizing in France concluded that €6.1 billion of assets meets the strict criteria definition of impact investing, representing growth of more than 20% over the last few years. More growth can be expected as new regulation requires insurers to offer a 90-10 investment fund in their life insurance products, which attract a great deal of assets thanks to their tax advantages.?

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The state of impact investing in the UK today

UK investors might consider how the French model could apply to various asset classes appropriate for impact investing. Currently, ￡58 billion of assets under management meet the definition of impact investment, according to the III-EY study. That is a low number considering that the UK is one of the world’s largest and most mature financial centres, with roughly ￡9 trillion in total assets, and that responsible investing and sustainable finance have been important market themes for quite some time.?

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There are plenty of potential sources of capital for expanding impact investing; public sector and local government pension schemes, corporate defined benefit and defined contribution plans, personal pensions, investments, life-insurance products and annuities and endowments all have ample capital that could be allocated to impact investing. Some of these sources offer direct investments, while others offer pooled investments. There is a general consensus that direct investment into “hard assets” is better aligned to impact investing than pooled investments.?

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In the near term, government and corporate defined benefit schemes and annuities are the most likely sources for impact investing, thanks to their high proportions of direct investment, high exposure to longevity, morbidity risk and their need for real assets and long-dated, steady yields.?

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Given the huge amount of assets in corporate defined benefits plans, approximately ￡1.9 trillion, impact investing advocates will be motivated to engage on multiple fronts. For instance, they can work with funds to prove commitment to socially responsible investing and place impact investments within master trusts, with pooled funds and default funds that capture approximately 85% of pension assets. At a corporate level, leading UK brands that are purpose-led can make a difference in driving greater awareness and, ultimately, broader adoption of impact investing.?

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Local government pension schemes, with ￡280 billion in assets, are another attractive source, given new UK legislation requiring 1% to 5% allocations to projects with local impacts. Such investments are commonly referred to as place based. Pensions are also looking to combine their assets to increase impact flows; for instance, the Pensions for Purpose Adopters Forum is composed of schemes and consultants that have adopted III principles and that are interested in collaborating to expand the use of impact investing.?

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Engaging all of these stakeholders to expand impact investing requires overcoming the inherent challenges that have restricted growth to date –?namely, demonstrating intentionality, measuring impact and providing investors with the liquidity, daily valuations and cost data they need.?

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What it will take to get to 1%?

France cracked the code on impact investing thanks to government nudges, favorable tax treatments, rigorous vetting and clear labeling. All these practices offer clear lessons for any market looking to grow and expand their impact investing sectors.?

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Broader awareness is a necessary first step. “We want to move to a world where everyone knows what impact investing is,” said Sarah Gordon of the III. “All money and all investment has an impact. We want people to be much more conscious of both the negative and the positive impacts of their spending and investments.”

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Product innovation will also be key – there must be appropriate vehicles for placing this money. Indeed, 75% of III-EY survey respondents cited a lack of quality impact investing opportunities as a barrier to allocating more funds to impact; even more (80%) said they wanted a greater variety of options across the risk-return spectrum.?The UK launch last year of a green sovereign bond was a promising development in that it met rising demand from pension fund managers for assets that can scale and into which they can shift significant amounts of institutional capital.?

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There’s no doubt that infrastructure for the net-zero economy is one area for investment. Indeed, impact investors can help make up for the huge shortfall of investments in these areas. Social infrastructure –?such as affordable housing, hospitals and schools –?is another priority.?

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Housing has certainly proven to be a popular destination for impact assets. The investment rationale for insurers is strong: these long-dated assets offer stable income streams, which is good for asset liability matching and ideal for insurers looking to hedge risk. That housing is familiar to many asset managers and investors makes it a great starting point for impact investing initiatives. And given the need for more affordable and environmentally friendly housing in the UK and other European markets, it’s relatively easy to demonstrate a positive impact.?

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Locally based pension funds, such as the Greater Manchester Combined Authority, are showing leadership. Nudges from UK regulators have been useful, too. A UK government plan for leveling-up set a target for local government pension schemes to allocate 5% of their assets, which equates to approximately ￡14 billion, to impact causes in their communities. The III and other groups are trying to support smaller local government entities by sharing leading practices and promoting information exchange via adopter forums with asset managers and other impact investors.?

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An enabling policy and regulatory environment is key to long-term growth in impact investing. The Financial Conduct Authority (#FCA ) has released a framework for sustainable disclosures , which aims to provide clarity and rigour around the meaning of impact investing products, how to demonstrate impact and intentionality, and reporting requirements. This is an important move that is being watched carefully by regulators throughout Europe.?

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Insurance companies are uniquely positioned to lead the way in the UK. With auto-enrolment of pensions, more of the UK population has a pension. The vast majority of assets –?85% to 90% by some estimates –?go into default funds, which are not currently required to have impact or sustainable investment options. Including some impact investments in default funds would move the dial in terms of capital allocation.

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So what about the returns?

The lingering perception that impact investing delivers lower returns remains a strong –?and perhaps the biggest –?barrier to adoption across markets. Most pensions consultants find discussing impact investing’s financial returns to be “difficult.” The III’s Pensions with Impact project aims to make it easier for pensions to invest with impact by debunking the myths that impact investing delivers inferior financial returns and is incompatible with trustee and adviser fiduciary duty.

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The performance of 90-10 funds in France suggests those are indeed myths. Studies have shown that the 10% of assets invested in social business did not compromise overall fund performance and was less risky than listed investments across the history of these funds. Further, the non-listed social organisations were more resilient during the financial crisis of 2008. Some of the most well-known impact investments in the UK have delivered market-competitive returns.?

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Of course, impact investing isn’t solely about financial returns, so it’s useful to look beyond the straight risk-return profile. Along a spectrum of capital where investors are seeking impact and return, they can choose to make those trade-offs. For instance, philanthropic investors and grant providers are looking for maximum impact and zero financial return for their money. Impact investing provides another proposition along that continuum. Additional benefits around portfolio diversification and protection against volatility may also boost the case for injecting impact into portfolios, based on very traditional financial criteria.?

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Impact investing seems particularly well suited to this moment in time, with some pushback against ESG investments. A more transparent and robust framework that demonstrates a positive societal impact as well as quantifiable financial returns would help convert skeptics and build greater confidence among those investors ready to put their money where their values are. Such steps will be necessary to take impact investing from where it is today –?a niche investment strategy embraced by a small population –?to an approach with mainstream recognition and appeal. Given the win-win value proposition for investors and society alike, that’s a worthy goal indeed.?

Thanks to our colleagues at the Impact Investing Institutes, esp Sarah Teacher , and to the EY team that was so instrumental in creating the UK's first ever quantification of Impact asset flows--- Ivy Tang, CFA, FRM Matthew Latham Peter G. Kartik Jhanji Natasha Perera