Why is impact investing treated so differently? | Linchpin
Reasons to invest in impact investments
Impact investment has become a hot topic within pension funds in recent years. This is partly due to the sterling work done by organisations such as Pensions For Purpose and the Impact Investing Institute. Both organisations are undoubtedly forces for good, so what I write below should not in any way be taken as critical of their work.
There is lots to like about impact investment. Pension funds nowadays control almost unimaginably large amounts of money. Their primary purpose must be to generate returns so that pensions are paid on time. However, that does not mean they cannot also be used to improve the planet and societies we all live in. As market capitalism responds to the world’s problems by looking at broader objectives than just the financial return, finding ways to identify and measure these non-financial metrics is increasingly important.
Impact investing is consistent with government nudges, whether it be the recent climate disclosure requirements passed in law, or whether it be the Prime Minister and Chancellor’s open letter to pension funds to invest more in infrastructure and the financing of British enterprise. At a more local level, councillors in the more deprived areas of Britain are often keen to find ways to have a positive local, or in the modern jargon, ‘place-based’ impact on their local communities.
The challenges to impact investing are solvable
Of course, it is not as simple as that, as we wrote in Room 151 in the summer in response to the Chancellor’s letter. Trustees and those with similar responsibility for pension funds have a legal duty to focus on their fiduciary duty to pay pensions. At local level, there is potential for conflicts of interest; the small scale of many impact investments can be a problem for large pension funds, and there may be a mismatch between the risk appetite of pension funds and what some impact investments are offering.
I am firmly with Pensions For Purpose that none of this is unsolvable. Pension funds are not philanthropic organisations, but they can and do obtain a financial return at an acceptable level of risk when investing in ‘impact’ strategies. Problems of scale and conflicts of interest can be solved by working with third parties, whether (in the case of the LGPS) the pools or the private sector. Some of the risk can be diversified away by investing across the U.K. rather than just in a local area.
Why Linchpin is sceptical about the impact bandwagon
My scepticism is more about how the bandwagon treats impact as an objective in its own right. I have a similar issue with ESG and sustainable investments. They are both worthy and appropriate prisms through which to look at any investment. In the case of ESG, the focus is on avoiding investing in companies whose business model is not sustainable long-term. Few would disagree that this is an essential part of risk management. In the case of impact investment, the lens is focused on the return side: can this investment provide returns to society in addition to the financial return the pension fund needs?
My point here is to question whether allocating to ‘impact’ should be treated differently to any other investment. It may well be helpful to use the term ‘impact’ in order to identify and highlight a set of investment opportunities which have particular characteristics. But that is much the same as talking about Japanese equities, or about value stocks.
For example, ‘impact’ characteristics include offering investors ways to obtain returns beyond the financial ones, something which may become increasingly important in the future. The concept of ‘additionality’ may be used as a criterion to decide whether or not something should be included within the asset class. And an investor may choose to monitor exposure to ‘impact’, much as they do to a sector, a country, or a factor.
The challenges might include the difficulty of measuring this impact or (for place-based investments), the often disproportionate time needed to invest in a relatively small scale investment and to address any governance concerns. The sharing of good practice in these areas is one of the helpful functions which organisations such as Pensions For Purpose provide.
Everyone should be impact investing
I am comfortable with the idea of using impact as a descriptor for these kinds of investments. But I disagree with the thesis that impact investments should be treated any differently from other mainstream investments. Managers may wish to draw investors’ attention to a fund’s objectives by labelling it as impact, but it seems to me there is a growing amount of virtue signalling by marketing departments jumping onto the impact bandwagon.
Moreover, labelling impact as a separate category constrains the scope to allocate. If it is considered as another aspect of mainstream investment, there is no fundamental reason why all investors should not allocate to impact or place-based investment. Indeed, the most recent legislation on climate disclosure is moving in the direction of forcing pension funds to allocate to companies who are actively helping us towards net zero. In the future, measuring impact more broadly might become another disclosure which pension funds are obliged to make.
So we are not sceptical at Linchpin about the benefits of impact investing, but about the bandwagon which seems to want to treat impact investing as something separate from a standard investment process. If that means Linchpin is yet again swimming against the tide, then I am happy to do that.