There has been an explosion of interest in sustainable and responsible investing in the past few years. And even though higher interest rates have tempered demand and the share prices of related stocks, the trend towards investors adding ethical slants has not gone away.
However, there are subtle differences between the different types of investing marketed by fund managers and Isa providers. The main one, ESG, which stands for environmental, social and governance, focuses on companies that follow positive ESG principles. It is typically directed at meeting compliance requirements or used as a tool for managing investment risk.
Then there is ethical investing, which excludes stocks based on an investor or a fund manager’s prescriptions, such as not investing in tobacco stocks, or defence companies, even if the investment case is valid. Impact investing embodies an investment philosophy that gives positive, measurable social and environmental impact equivalence to a financial return. In turn, the money is invested to address the world’s most pressing challenges.
All investments have an impact. Some negative and some positive. Impact investing, however, has the dual aim of producing a financial return while making there is a sustainable impact. This means the investment manager must describe how they expect the fund’s investments to contribute to achieving a positive and measurable impact.
For example, a business which collects, manufactures and sells recycled cardboard (a preferable packaging material with lower environmental impacts compared with other materials) can have its positive sustainability impact measured in tonnes of waste recycled and tonnes of CO2 emissions avoided.
Another important impact investing principle is ensuring engagement with a company’s management. Engagement enables investors to influence and improve the company’s social and environmental impact on areas such as biodiversity impacts, carbon reduction targets, community relations and gender diversity.
The potential of impact investing
To have large global impacts, you need large global companies, matched with global markets. As the venture capitalist Sir Ronald Cohen once said: “There is no other way to cope with the scale and severity of social and environmental issues than to attract investment capital from the $200trn of assets in our financial system.” Stocks and debt accounted for around one-third of impact investments in 2023, according to the Global Impact Investing Network, becoming two of the fastest-growing asset classes for purpose-led investors.
A benefit of impact investing in stock markets is it is available to small and larger investors alike and offer scale, liquidity and enhanced transparency. For example, they can be accessed via tax-efficient vehicles such as Isas and personal pensions.
Listed stocks are also public companies so are subject to disclosure regulations and governance requirements including access to corporate information. This can help tackle ‘impact washing’ – where companies make statements around impact or being green but are misleading about their actual aims.
How do I know my money makes an impact?
Last year, the Financial Conduct Authority introduced the ‘Sustainability Disclosure Requirements (SDR)’ designed to ensure financial products marketed as ‘sustainable’ should do as they claim and have the evidence to back it up.
The purpose of SDR is partly to ensure ‘greenwashing’ of funds becomes a thing of the past. SDR also introduces a set of sustainability-related product labels intended to help investors clearly distinguish between products.
One such label is ‘sustainability impact’ where the fund’s sustainability objective must be consistent with the aim of achieving a ‘pre-defined, positive, measurable impact in relation to an environmental or social outcome or both’. Fund managers can use a label for each of their funds from 31 July 2024.
Seb Beloe is head of research at WHEB Asset Management