Investing for impact and higher returns: can one have both?

By Mervyn Shanmugam, CE: Alternatives at Sanlam Investments

Over the past decade the fiduciary responsibilities of retirement fund trustees have expanded significantly to the extent that responsible investing, including sustainable investing and impact investing, is now part and parcel of delivering sound risk-adjusted returns for retirement fund members, while at the same time building a better world for these members to retire to.

However, some scepticism remains around responsible investing’s ability to beat traditional assets in terms of investment performance. We, on the other hand, have no doubt that responsible investing – specifically in the form of impact investing through unlisted investments – holds the key to better risk-adjusted outcomes for retirement fund members. And the body of evidence supporting this viewpoint is growing.

The future is in the hands of today’s trustees

In September 2015, 193 countries signed and adopted the 2030 United Nations (UN) Agenda for Sustainable Development, with the UN estimating that the global gap to implement the 17 sustainable goals ranges from US$3 trillion to US$5 trillion annually.

Already in 2011, the global commitment to sustainable investing was marked locally by the introduction of the Code for Responsible Investing in South Africa, and in 2012 by subsequent changes to the regulation governing South African retirement funds (Regulation 28). These set out prudential guidelines for retirement fund investments to incorporate environmental, social and governance (ESG) factors into their overall risk mitigation and investment decision-making process.

Responsible investing is not philanthropy

It is important to note that responsible investing is not the same as philanthropy, the quest to do good without concern for profit or the expectation of a monetary return. On the opposite end of the capital deployment spectrum from philanthropy is traditional investing, i.e. chasing returns without considering the economic, social and environmental by-products of a particular investment strategy.

In-between these two opposites sit various strategies that can be called on when implementing a sustainable investing framework, of which we list a few below:

• Negative screening: filtering out assets deemed to have a negative effect on society, for example tobacco, arms and gambling;
• ESG integration: overlaying traditional asset selection with ESG scores;
• Thematic investing: aligning a portfolio with a specific sustainability theme, such as climate change or job creation, based on an economic motive or investors’ need to align the portfolio with their specific values;
• Impact investing: choosing specific investments, typically made in private markets, aimed at solving social or environmental problems.
• Sustainable investing: adopting progressive environmental, social or governance practices to enhance value.
• Responsible investing: aiming to counteract risky environmental, social or governance practices to protect value.

With impact investing, social and environmental impact is usually defined as aligning with the UN’s 17 sustainable development goals.

Alternatives are a great fit for impact, responsible and sustainable investing

Impact investing traditionally entails private (unlisted) investments made into companies or real assets with the purpose of making a significant social and environmental impact alongside strong financial returns.

This type of investment falls squarely within the ambit of alternative investments, particularly private equity, private debt as well as infrastructure and unlisted property. The benefits of allocating part of a retirement portfolio to alternatives are well documented and it’s not our intention to present the entire case for investing in alternatives here. We will focus on the importance of allocating to impact investments specifically within the broader alternatives class.

Impact investing can and has generated market-beating returns

Investors who have not yet allocated to impact investing sometimes hold the view that responsible investing sacrifices returns for the ‘do good’ factor. But this is perhaps a moot point. As US-based firm The Carlyle Group points out, internationally the same companies often receive financing from both traditional asset managers and dedicated impact funds. In fact, what Carlyle found when researching a variety of impact investments is that ‘it is precisely the societal goals of the impact investor – diversity and inclusion, environmental sustainability, responsible governance – that increasingly generate the above-market returns sought by the market as a whole.’

Carlyle also argues that it is no longer possible to generate the type of returns investors have become accustomed to without investing for impact, as the tailwinds from falling finance costs, recovering economies, or rising valuations have all but disappeared. In the new economic climate investors have to generate their targeted returns by assisting to consistently build better businesses.

Even when supporting companies with bigger payrolls, impact investing still delivers higher returns

For Carlyle, their past seven years’ performance data proves the ability of impact investing to deliver superior returns, specifically where the investment also led to job creation. Among all US Carlyle investments completed since 2013, every 10% increase in payrolls (excluding the effects of mergers) has been associated with a 21.4% increase in cumulative returns. Among investments where employment growth exceeded 15%, average returns were nearly 60% higher than for investments where headcount declined, on average.

Bringing this closer to home, our experience within the impact funds within the Sanlam Alternatives stable has also demonstrated similar resilient investment performance, particularly during times of crisis.

More evidence that impact investments do not have to stand back when it comes to performance can be found in the Global Impact Investing Network (GIIN)’s report of 2017, GINN Perspectives: Evidence on the Financial Performance of Impact Investments. The report independently reviews over a dozen studies produced by a wide range of organisation on the returns of the three asset classes commonly used for impact investing: private equity, private debt, and real assets.

Impact investing achieves market-like returns for a variety of risk appetites

From the data in the GIIN report (2017) three key insights emerge that reinforce the credibility of impact investing. First, market-like returns are indeed achievable in impact investing, with returns from impact investments comparable to those of similar conventional investments. Second, small funds do not necessarily underperform relative to their larger peers. And third, the impact investment market includes opportunities for investors with varied risk appetites, investment strategies and target returns.

Impact investing also comes with lower volatility

As trustees are well aware, it’s not only the returns of an investment that counts, but also the associated risk with which those returns are achieved. In a study by Oxford University in 2014 Clark, Gordon, Feiner and Viehs found that not only is there a positive relationship between stock performance and good sustainability practices; businesses that are focused on sustainability are also more likely to better manage environmental, financial and reputational risks, which is more likely to lead to lower volatility of cash flows.

Without sustainable growth there is no future to invest in

It’s encouraging that trustees are already thinking beyond traditional approaches to asset class returns, and considering new approaches. Trustees have a fiduciary duty to act in the best interests of those whose assets they are responsible for. Part of this responsibility is anticipating the impact of future trends such as alternative energy and climate change, which materially affect investment performance as well as the quality of life of retirees.

Sanlam has a track record of tackling sustainability with impact funds

Sanlam Investments has several years of experience in the area of impact investing, notably in education, empowerment and SME financing. We’ve also played a significant role in combatting climate change through our partnership with Climate Investor One. Now Sanlam Investments is rolling out a range of alternative strategies explicitly aimed at investing for impact, such as economic growth and job preservation, creation, inclusivity and quality.

To combat the current SA economic crisis, three new impact funds strategies have been launched

Arguably, the biggest immediate crisis that South Africa currently faces is the economic fall-out of COVID-19 and the resultant job losses on an unprecedented scale. It is to combat this downward economic spiral, that Sanlam recently launched three Investor Legacy funds – to assist small to large corporations to pull through the next few years and minimise the rise in unemployment.

All three of these funds are available to institutional investors with an impact investing mindset; Sanlam has also invested R2.25 billion of its own capital to seed these three funds. Each of the three funds has a different mandate and different targeted return, to appeal to a wide range of investors. It’s nearly a decade since the Code for Responsible Investing was introduced in South Africa and the long-term savings industry is increasingly stepping up to its commitment to allocate capital towards the achievement of the UN’s sustainable development goals. Still, not only locally but also globally, it will likely take the industry much more than the next decade to close the funding gap that remains.

At Sanlam Investments, though our various alternative strategies, we align with 12 of the 17 UN’s sustainable development goals and are looking to deploy R35 billion via Climate Change, Water and the Investors Legacy Range over the next 10 years.