This note explores the potential of impact investing in liquid equities to achieve both financial returns and significant social and environmental impacts.
It first examines the distinctions between impact investing and ESG strategies, highlights the differences between impact-aligned and impact-generating approaches, and discusses their implementation in investment portfolios. actions.
Impact investing and ESG
ESG (integration or best-in-class) focuses on how companies operate (the “how”) while impact investing is about creating a portfolio of companies providing solutions (the “what”). ) to improve specific social and environmental outcomes, guided by frameworks such as the UN SDGs or the EU Taxonomy. The intentionality associated with impact investing leads to a targeted investment universe with biases toward certain sectors and smaller companies, resulting in higher tracking error than in ESG strategies.
Impact Alignment or Impact Generation
Busch et al. (2024) distinguish between impact-aligned and impact-generating strategies, both of which aim to produce impact but differ in their extent. Impact-aligned strategies assess impact at the (invested) company level (e.g. tonnes of CO2 emissions avoided by investing in a renewable energy producer), while impact-aligned strategies Impact measures the contributions of both the company and the investors (for example, investment in company X helped create 100 jobs). Listed asset strategies generally fall into the category of impact strategies, while private asset strategies are impact generating. Indeed, the contributions of private investors are easier to evaluate because they generally have more control and more additionality.
Financial performance
Impact-focused strategies derive their long-term performance from:
- Cash flow growth forecast for leaders in social and environmental solutions (e.g. solar energy).
- Lower cost of capital due to lower exposure to future risks (e.g. transition risks) than companies that supply products that are harmful to the environment and/or society.
However, in the short term, there are divergences between impact (represented by our impact score) and alpha, as shown by the slight negative correlations in Table 1.
Figure 1: Relationship between expected impact and expected alpha
Source: Asteria. Data as of September 30, 2024. The universes are made up of companies whose products and services contribute to SDGs 6, 7, 9, 12, 13 and 15.
To generate financial return alongside impact, we focus on companies that are in the upper right corner of Figure 1. This ensures that our capital is used efficiently, supporting companies that are likely to succeed and drive significant environmental change.
Finally, we mentioned above that impact investors face a concentrated investment universe. It is therefore essential to build portfolios of impact actions that are as diversified as possible. There are two distinct ways to improve the level of diversification. First, by mixing portfolio impact objectives. Indeed, sector orientations and factor exposures (e.g., growth versus value) differ across impact themes, resulting in low correlations of market excess returns across impact themes.
Figure 2: Historical correlations of market excess returns for environmental impact themes
Source: Asteria. Benchmark: MSCI ACWI. Impact-themed portfolios are equally weighted. Calculation period: January 2012 to September 2024.
The second source of diversification is the number of positions. Indeed, by relying on a large number of positions (100 to 120), the long-term performance of the portfolio will tend to be more constant over time and its risk will be lower. A systematic approach increases the chances of success if one decides to follow this approach, because it allows one to effectively cover larger investment universes.
Conclusions
Impact investing in liquid stocks offers a powerful approach to aligning financial goals with social and environmental goals. Although impact investing presents challenges, such as a concentrated investment universe and greater tracking errors, strategic diversification, strong portfolio construction, and careful company selection can mitigate these issues. Ultimately, impact investing not only contributes to a sustainable future, but also allows investors to benefit from the growth of industries that shape that future.
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