The fiduciary responsibilities of retirement fund institutional investors have expanded significantly over the past decade to consider and embrace sustainable investing and investing for impact.

While sustainable investing both mitigates risk (protecting value) and adopts progressive environmental, social and governance practices (enhancing value), impact investing addresses societal challenges while generating competitive financial returns for fund members. These propositions are now part and parcel of delivering sound risk-adjusted returns, while building a better world for members to retire in.

However, some scepticism remains about their ability to beat traditional asset management approaches regarding investment performance. We have no doubt that they — specifically in the form of impact investing through unlisted investments — hold the key to better risk-adjusted outcomes for retirement fund members. And the body of evidence supporting this view is growing.

In September 2015, 193 countries signed and adopted the 2030 UN Agenda for Sustainable Development, with the UN estimating that the global gap to implement the 17 sustainable goals ranges from $3-trillion to $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 SA, and in 2012 by subsequent changes to the regulation governing SA 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.

It is precisely the societal goals of the impact investor — diversity and inclusion, environmental sustainability and responsible governance — that increasingly generate the above-market returns sought by the market as a whole
The Carlyle Group

Sustainable and impact 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, which is chasing returns without considering the economic, social and environmental by-products of a particular investment strategy. Using and embedding these approaches requires a purpose-driven approach in how one targets specific outcomes and aligns with the UN’s 17 sustainable development goals.

Impact investing traditionally entails private (unlisted) investments made into companies or real assets to make a significant social and environmental impact alongside strong financial returns. This type of investment falls 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. Impact investing can and has generated market-beating returns.

Investors who have not yet allocated to these approaches sometimes hold the view that they sacrifice returns in the name of the “do no harm” and “do good” factors. 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. 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 and 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 helping to consistently build better businesses.

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.

Reinforce credibility

More evidence that impact investments do not have to stand back regarding 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 more than a dozen studies produced by a wide range of organisations on the returns of the three asset classes commonly used for impact investing: private equity, private debt, and real assets.

From the data in the GIIN report, the following insights emerge that reinforce the credibility of impact investing:

  • Market-like returns are indeed achievable in impact investing, with returns from impact investments comparable to those of similar conventional investments.
  • Small funds do not necessarily underperform relative to their larger peers.
  • The impact investment market includes opportunities for investors with varied risk appetites, investment strategies and target returns.

As institutional investors 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.

It’s encouraging that institutional investors are already thinking beyond traditional approaches to asset class returns, and considering new approaches. Institutional investors 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.

• Shanmugam is CEO: Alternatives at Sanlam Investments.

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