Impact investing versus ESG investing – aren’t they the same thing?
The difference between impact investing and ESG investing remains a mystery to many investors, but the broader trend towards investing sustainably is gaining ground
Most Asian investors still have difficulty telling the difference between so-called "impact investing" and "environmental, social and governance" (ESG) related issues. In many cases, these two terms are used interchangeably, usually incorrectly.
There are various definitions of "impact investing" - put simply, it focuses on investing in companies with products and services that can generate measurable, beneficial social or environmental impact alongside financial return.
This is different from ESG, which focuses on using environmental, social and governance factors in an entity's operations with a view to enhancing risk management. "ESG investing" is therefore investing in companies with good ESG practices.
"Broadly speaking, ESG is focused on the operations of the company, while impact investing is taking the focus back on the products and services the company is producing. The company still has to have good ESG. It still has to have sound environmental, social and governance practices in its operations. But to qualify itself as an impact company, it has to be selling solutions, products, and services that help in the world achieve its sustainability goals," says Tim Crockford, director at Hermes Investment Management and lead manager of the "impact opportunities strategy".
The "impact opportunities strategy", for example, invests in companies producing products and services based on nine themes included in the United Nations Sustainability Development Goals (SDG). These SDG themes are: water, food security, health and wellbeing, education, financial inclusion, future mobility, circular economy, energy transition, and impact enablers.
One trend that is emerging based on the experience with the "impact opportunities strategy' is that investors are becoming increasingly aware of the benefits derived from thematic funds that are focused on impact investing.
At present, the strategy has a very concentrated portfolio that currently invests in only 29 stocks, mostly mid-caps and small-caps, which are focused on the theme of "health and well-being".
For example, it has invested in a mid-cap German company which is considered a "healthcare enabler" because it provides equipment to other companies which manufacture biological drugs.
"Developing a biological drug is very different from a chemical drug. It's a living protein, a living cell culture, which you then have to take from a laboratory into mass production and that process of scaling up production is very, very tricky. One of the problems is scientists can spend long periods of time doing research on molecules that may eventually fail. By providing the special equipment that is needed they can help them get through this process faster, and therefore discover new drugs faster," Crockford explains.
The "impact opportunities strategy" identifies such companies through a highly selective active management process. Its performance is benchmarked against the MSCI All Country World Index (MSCi ACWI).
Launched in December 2017, the strategy has raised US$175.3 million as of October 26 2018, which Crockford believes is an indication of strong investor interest.
"We were very pleasantly surprised by the mix of investors that we have been able to attract. We started out with one large cornerstone institutional investor, but now we've managed to win about 27 individual wholesale clients and many of those within the private wealth space. Hermes doesn't sell directly to retail but through the wholesale channel that distributes to high net worth investors as well as multi-manager platforms. We have a very broad range of platforms," Crockford says.
One interesting development is that some of these investors did not necessarily have "impact investing" as their priority when they invested in the strategy, but were seeking a thematic fund.
"I think this is a good thing as some those investors, I wouldn't say all of them, had sustainability as their number one priority. There's a nice balance of people who actually just see it as a global thematic, highly concentrated, high alpha product. I think that's a good thing because sustainability shouldn't be just something which is limited to a small area of our industry. It should be something that is inherent in every investor's thinking," Crockford says.