A Case for Impact Investing in Public Equities

As awareness around environmental and social issues has grown, so has the number of investors who deliberately seek to allocate capital to create positive social and environmental impact. Impact investing is as old as the sustainable investment industry, with the bulk of strategies to date having been executed through private equity and debt vehicles. However, as a more diversified pool of investors look to adopt impact investing strategies, fueled by the United Nations’ Sustainable Development Goals (SDGs) and the Paris Climate Agreement, a broader set of asset classes are being considered – here enters public equities.

The Global Impact Investing Network reports that public equity impact strategies experienced one of the most significant growth rates (25% CAGR) across all asset classes from 2014 to 2018. Given the strong interest in impact investing from retail and institutional investors, and the central role that public equities play in mainstream investment strategies, we expect continued growth in investing for impact through public equities.

Solution or dilution?

Momentum aside, can you truly achieve impact by investing in public equities? Some advocates of impact investing have raised concerns around whether such strategies can be meaningfully employed for public equities. Two prominent arguments include:

1. The Disclosure Argument: How can you claim impact when it can’t be measured?

• Impact investment fundamentally requires measurable impact. Data on outcomes and impacts of public companies is not yet reported broadly or consistently. As such, it is misleading to claim impact when it cannot be adequately measured.

2. The Complexity Argument: How can you holistically assess impact across wide ranging business activities? 

• Large public companies engage in many business activities that carry both direct and indirect, positive and negative impacts. Without a commonly accepted approach for aggregating these impacts, it is not feasible to determine which companies are having a net positive impact.

The disclosure argument raises legitimate concerns regarding the availability and quality of impact data reported by public companies, and the related transparency of impact funds holding these companies. However, creative solutions are emerging to bridge this gap. For example, we’ve seen market interest in using revenues derived from sustainable products and services to both identify which companies are contributing to the solutions needed for a more sustainable future, and as a proxy for understanding the relative positive impact created. At Sustainalytics, we track involvement across 12 sustainable product themes such as renewable energy and affordable housing and provide a revenue percentage metric to indicate level of involvement.

We can also apply lessons learned from trends in ESG data disclosure. It was (and sometimes still is) argued that meaningful ESG integration is not possible in the absence of consistent and comprehensive company disclosures. Yet, as more investors incorporate ESG into their decision-making and company engagements, issuers increasingly recognize the importance of measuring and reporting this data – creating a powerful positive feedback loop. We expect that the proliferation of impact investing strategies and related engagements focused on public companies will be an important signal to issuers that impact measurement data is valued.

Regarding the complexity argument, public companies are undoubtedly intricate entities, which makes determining the net impact of an entire company a major challenge. Given ongoing debates around defining impact and how to measure it, a single, standardized approach is unlikely to emerge anytime soon. Nevertheless, impact investing strategies can tackle this challenge by using both positive and negative signals of ESG performance to more holistically understand impact performance. Revenue from sustainable products can be considered alongside traditional product involvement data (e.g., tobacco) and controversy insights to obtain a balanced view on positive and negative impacts. For example, a company offering renewable power solutions, while also operating coal power plants may not be a desirable inclusion in an impact-focused fund.

Tips on navigating the tensions

Imperfect company disclosure, and a flourishing debate around the true meaning of impact should not be a deterrent to developing meaningful impact-focused strategies for public equities. To increase credibility and potentially avoid the risk of an “impact washing” label:

• Be deliberate about your impact intentions: Start by determining your impact intention, being as specific as possible. For example, choose one or more themes or one or more SDGs, and/or identify a targeted geography or stakeholder group. Communicate the “theory of change” – the logic connecting company activities to expected outcomes.
• Adopt a holistic approach to impact: Develop an approach that reflects the complexity of public equities and captures both the positive and negative impacts they create. This may include the use of involvement in problematic product areas and controversy ratings alongside sustainable product research.
• Be radically transparent: Communicate your research methodology and measurement approach. Don’t hesitate to be clear about current limitations and assumptions, and situations where the established impact goals were not met. Using company-specific case studies can complement impact metrics and foster valuable conversations with prospective and current clients.

Looking Forward

Investing for the explicit pursuit of environmental and social impact is inherently subjective as the impact goals of individuals and organizations can vary. This complicates reaching a consensus on what qualifies as genuine impact investing. However, the urgency of global environmental and social issues requires leveraging all mechanisms and asset classes available to pursue solutions. If executed well, public equity impact strategies can advance the debate on defining and measuring impact, encourage greater disclosure from companies, and make impact-focused solutions available to a broader audience. The potential to generate meaningful positive changes by applying an impact lens to public equity investments should not be overlooked.

To learn how Sustainalytics can support your impact investment strategies, read about our Sustainable Products Research, our Controversies Research or contact us.