Quantifying the social and environmental benefits of companies and funds has long been problematic, with double standards common.
People who invest in socially responsible funds can easily find out how their portfolios have performed financially, but historically it has been very hard for investors to get clear information on the social and environmental benefits of their funds’ holdings. That is changing with the growth of ‘impact investing’, which aims to generate measurable societal benefits as well as financial returns.
To help people assess whether companies have good environmental, social and governance (ESG) practices, organisations such as Morningstar have created new sustainability ratings for companies and the funds investing them. But these often have a major flaw: they tend to favour larger companies that have the scale to publish the data necessary for inclusion. Thus oil and gas company Royal Dutch Shell, which produces extensive data on its operational practices, has ended up ranking higher than electric car manufacturer Tesla. In contrast, small renewable energy businesses are often excluded because they don’t produce enough data about themselves.
Focus on fundamentals
In addition, ESG ratings can in some cases favour those companies that are most likely to have a negative impact on society. That’s because companies with the biggest ‘negative impact challenges’ often try to balance them out by having good ESG practices in other parts of their business. Tobacco companies, for example, tend to have extremely well-developed policies on how they manage their workforce, so are likely to score well. It seems that ratings can be misleading if they ignore the fundamental nature of a company.
‘The focus should be on the impact of products and services on the environment and society, rather than on company operations,’ says Tanya Pein, an independent financial adviser at In2 Planning and a specialist in responsible investment. She highlights Impax Environmental Markets and FP WHEB Sustainability as good examples of funds investing specifically in companies that reduce water waste, improve energy efficiency, and develop clean and sustainable transport services.
However, Pein points out that both these funds have been awarded below-average ESG ratings by Morningstar. She adds: ‘The Virgin Climate Change fund has the highest score for investing in companies with lighter-than-average environmental footprints.’ But this fund invests ‘far beyond the environmental sector, and holds companies such as UBS Group, a Swiss bank fined for tax evasion – hardly an investment making positive contributions to society or the environment’.
So how can you tell if the impact of an investment is captured properly? Companies and funds can ‘map their outcomes against a widely acknowledged benchmark, such as the United Nations’ set of 17 sustainable development goals,’ says Matthew Coppin, manager of financial advice at ethical IFA Castlefield.
In 2015 the UN created these goals for governments and the private sector. They range from ending poverty and hunger to providing quality education, gender equality, and clean water and sanitation. Each goal comes with a timeline and specifications, such as achieving universal access to safe and affordable drinking water for all by 2030. However, says Coppin, ‘a company might say its objective is to overcome poverty, but how is it getting down into it?’
In the environmental sphere, the FP WHEB Sustainability fund is trailblazing the measurement of its investments’ impacts in clear terms. Its 2016 Impact Report outlines a clear methodology for mapping and calculating that impact. It shows, for example, how much renewable energy was generated for every £1 million invested. ‘The fund was one of the first listed equity funds to be recognised by the Global Impact Investing Network on the ImpactBase [a database for impact funds],’ says George Latham, chief investment officer at WHEB.
The WHEB report captures seven broad categories covering water, emissions (specifically greenhouse gas emissions) and solid waste. It found that during 2016 every £1 million invested in the fund generated 1,200 MWh of renewable energy, equivalent to the total energy use of 60 average UK households. That same investment avoided 1,600 tonnes of carbon dioxide emissions, which is equivalent to taking 333 cars off the road for a year. It also treated 1.6 million litres of waste water, provided 40 million litres of drinking water and recycled 140 tonnes of waste.
WHEB is candid about the fact that while 80 per cent of fund revenues come from businesses that have a positive impact, several holdings also operate other businesses. For example, its JB Hunt holding derives about 80 per cent of its revenues from a business that utilises efficient, low-carbon rail services instead of road haulage, reducing carbon emissions by 50 per cent for any amount of freight making the journey. However, JB Hunt also operates a trucking business, which accounts for about 5 per cent of its revenues and which is not considered to have a positive impact by WHEB.
WHEB recently launched an impact calculator on its website that allows people to enter the exact amount they have invested in the fund and see the impact their investment has had. (The environmental impact of a £20,000 investment is shown on the following page.) Coppin adds that when talking to clients, he finds the impact calculator ‘makes it sit with their actual experience’.
‘[ WHEB’s] metrics are broadly sensible,’ says Matthew Rooney, energy and environment research fellow at Policy Exchange. He says the ‘cost of carbon dioxide avoided’ is a common metric used in energy and climate change policy discussions, and a good way of comparing different carbon dioxide emission reduction strategies. He adds: ‘Energy efficiency, such as insulation and business energy efficiency, is generally an excellent thing to invest in [if you care about climate change]’. WHEB invested £625 for each tonne of carbon avoided, which Rooney deems an attractive ratio.
Beyond that, returns can be enhanced by considering the social and environmental impact of funds, Pein argues. She says: ‘This approach gives fund managers a rich source of investment opportunities ahead of the mainstream. For example, they monitor what pollution control regulation is being proposed, which strengthens the investment case for investing in certain industries.’ She adds that the Rathbone Ethical Bond and Pictet Timber funds embed environmental, social and governance factors at all levels.
Pein goes on to explain that managers who use impact investing have insights into various countries’ policies to address climate change. ‘Some countries have targets to double the fuel efficiencyof cars by 2020. So manufacturers are under a lot of pressure to increase the efficiency of their models, and fund managers who seek out companies that specialise in research and equipment in this area will generate a return much faster than [those focusing on] the industry as a whole.’
When people express doubt that investing for a social and environmental impact is profitable, Coppin counters: ‘Think about the global movement in the areas of driverless cars or the improving efficiency of transport and healthcare: these are growing areas, so why would you not want to be invested in them?’ Given that the UK government plans to reduce greenhouse gas emissions by 24 per cent by 2020, he adds, investing in technology that goes into environmentally friendlier cars ‘makes a great deal of sense’.
In the social impact space, Coppin picks out the Threadneedle UK Social Bond fund. It holds bond issues by companies such as Motability, a national charity that runs a scheme to lease specially adapted vehicles to people with disabilities. For those looking for a social impact fund, Pein mentions Edentree Amity UK, which is co-managed by Sue Round and Ketan Patel, and RobecoSAM Sustainable Healthy Living, an offshore fund that invests in areas such as preventative healthcare.
Coppin makes the point that while financial performance is always given in numbers, and calculators such as the one from WHEB offer comparable impact figures to go with them, that kind of quantitative assessment has thus far focused on the environmental impact. Social impact, in contrast, is still largely captured in qualitative terms.
However, there is one investment where social impact has been measured in a more quantitative manner: social impact bonds (SIBs). At the end of July, schemes funded by the world’s first SIB, the Peterborough SIB, were shown to cut reoffending rates at HM Prison Peterborough by 9 per cent. It was launched by the non-profit organisation Social Finance in 2010. To sponsor the SIB, 17 impact investors (trusts and foundations) committed £5 million to fund a series of rehabilitative interventions for three cohorts of 1,000 short-sentence male prisoners for a year after their release from prison.
The interventions funded by the SIB were designed to help prisoners with mental health, substance abuse, housing, employment and debt problems. The programme successfully reduced reoffending rates among the cohorts by 9 per cent – thus also saving public money. Thanks to the positive outcomes and savings made, the government returned investors’ capital and paid a 3 per cent return on the investment.
The concept of SIBs was introduced by Social Finance in 2010, and there are now 89 SIBs in 19 countries. More than £300 million is currently invested in tackling social problems such as refugee unemployment, loneliness among the elderly, rehousing and reskilling for homeless young people, and diabetes.
SIBs in the UK are not currently available to retail investors, but this situation is likely to change. A government spokesperson for the Centre for SIBs, part of the Department for Digital, Culture, Media and Sports, says: ‘In 2016 we established an independent advisory group which is looking at how the industry can open up social investment products to more sectors, including retail investors, and they will report back to government later this year.’
Dearth of passive options
When it comes to passive investments, Pein mentions the iShares Global Water Ucits ETF. But she says there are few other options for passive impact investors. ‘New products are sorely needed,’ Pein adds. ‘Vanguard, HSBC, FTSE Russell, MSCI and all, please take note.’
She says the valuation and dividend risks in the traditional oil and gas sector continue to increase sharply as governments and businesses commit to reducing oil consumption and carbon emissions. ‘This leaves the FTSE 100, with its predominance of oil and gas companies, a high-risk option, and again tracker funds for retail investors that exclude this risk are rare.’
At a time when the use of trackers is on the rise – as robo-advisers, investors and IFAs opt for lower-cost investments – demand for passive impact investments continues to increase. Pein says: ‘I expect that a year from now, the market will be much better provided for.’
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