Why impact investing matters now more than ever

Hari Balkrishna April 25, 2023 10:08

In the past few years, investors have seen the coronavirus pandemic enveloped the world, prompting widespread upheaval to established patterns of conducting business, communication, travel, and the daily lives of people and communities.

Amid this crisis, we saw the tipping of pressure points around social inequality, elevating issues like diversity, health care, education, and equality higher up the political and business agenda. Meanwhile, the world witnessed more worrying manifestations of rising pressures on the environment created by human activity.

Why does this matter now, when the world has already emerged from the pandemic? We believe extreme events of since 2020 represent catalysts that will drive a new era of accelerated action by policymakers, businesses, and society alike. For all investors, understanding the implications is more important than ever. Indeed, many investors are seeking to make a more active and conscious choice to favour companies that show clear leadership in sustainability, environmental, and social issues.

With momentum building, companies are moving to actively shift investments and policies to address distinct regulatory changes and environmental and societal pressure points. Either through compulsion or a desire to influence positive change, these trends are rapidly shaping the way companies behave, invest, and innovate.

Public markets key to change

Ambitious international and local goals are being set on environmental and social initiatives to directly address risks and promote change. Among them are the UN Sustainable Development Goals (SDG). On its own, it is estimated that approximately US$2.5trn of capital will be needed annually until 2030 to achieve the SDG objectives.

If we aspire to accelerate these and other initiatives targeting social and environmental transitions, it is essential to fund them at scale and in a liquid manner – so public equity markets will be critical to the effort. The enormity of issues like clean energy transition will not be possible without the backing of large and well-funded publicly listed firms.

Excitingly, the opportunity to own businesses that create a positive environmental or social impact is greater than ever before in public equity markets, as companies should shift investment to address environmental and societal pressure points. Striving to be on the right side of this likely societal and environmental change creates a real opportunity to select stocks that convey a positive impact profile, and with it, the added return potential that this can bring.

Influence through active ownership

Impact investing’s modus operandi is to try to generate positive, measurable social, and environmental impact, alongside an excess financial return when compared with recognised global equity indices. This style goes beyond other categories of responsible investing, such as ESG integration or ESG screening. Impact investing directly aligns and measures investments according to their ability to contribute to particular social and environmental outcomes.

One way of targeting these types of impacts is to align and anchor investments according to the UN SDGs, as this provides a framework to identify pressure points and target the companies whose activities are working to address them. The potential investment opportunity set that the UN SDG opens is, however, vast and complex. This means an active, high-conviction, and forward-looking perspective is essential to screen, identify, and capture desired positive impacts and to target the financial returns they can generate.

The potential for enhancing the quality and quantity of the impact a company generates can be enhanced through active ownership. We are also resolute that it is an investment manager’s role to influence change through corporate governance monitoring and engagement. But the journey to change takes time, making a long‑term investment horizon essential.

Moving to the mainstream

Like every nascent asset class, impact investing faces a hurdle of recognition as well as the need to work with companies and clients to ensure robust and transparent measurement of impact over time. Rather than wait for norms to be established, which can only happen when businesses adapt their disclosures, these challenges can be addressed through engagement with companies and through investment in our own capabilities.

As asset managers proactively invest in capability to move the sustainability debate forward, we believe impact investing will move into the mainstream of equity markets to ultimately sit alongside many other established styles and approaches.

Importantly, the move toward impact investing is being backed by an explicit choice of a growing population of investors who want to be part of global and sustainable solutions. Asset managers now have a unique opportunity to play a key role in helping deliver positive environmental and social outcomes that the world is increasingly seeking – aligning clients, investors, and business interests in the process.

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Hari Balkrishna

Portfolio manager of T. Rowe Price’s Global Impact Equity strategy