This report explores the challenges in achieving environmental and social impact through investments in listed equities, and provides guidance and solutions to overcome these challenges.
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Executive Summary
Impact investing has evolved from a niche philanthropic approach to a popular investment choice among mainstream investors. Investors in listed equity impact products, however, often fail to achieve the real-world change they seek. Whereas private equity investors can exert influence through concentrated ownership and direct governance, listed equity investors face dispersed ownership and limited control.
“Impact Investing: Guidance for Designing Listed Equity Strategies That Generate Real-World Outcomes” provides guidance for creating listed equity impact strategies that effectively deliver social and environmental impact. This report is written primarily for asset managers, but its insights and recommendations have relevance for asset owners, consultants, and regulators as well.
In this report, we define impact investing as requiring 1) a credible Theory of Change that links actions to outcomes, and 2) an investor’s active role achieving the targeted environmental or social outcome. Listed equity strategies that simply buy shares in companies whose products or services have positive effects on people or the planet — for example, renewable energy or affordable housing — without additional investor actions to improve outcomes, lead to investment products that lack the rigor necessary to achieve real-world change.
Creating Impact
Shareholder engagement and stewardship activities are the primary mechanisms for creating change through listed equity. To influence one listed company to create one change, asset managers must ensure their engagement proposals are not only socially or environmentally valuable but also financially and strategically viable for the company.
A credible impact investing strategy begins with SMART objectives — Specific, Measurable, Affects people/planet, Realistic, Time-bound. Managers should clearly define baselines, targets, and beneficiaries, while emphasizing “win-win” opportunities that align impact with business value.
A rigorous theory of change that sets out the steps needed to achieve an outcome, tests assumptions, and measures progress is essential. Proposals should be grounded in deep company and sector research, based on credible economic rationales, and delivered by experienced professionals with C-suite level communication skills.
Impact Portfolios
An impact objective is inherently company-specific; scaling impact across a portfolio of holdings introduces additional challenges. Effective engagement for each company requires deep expertise and often requires years of sustained effort. Shallow engagements across many companies rarely deliver meaningful outcomes. Reducing the number of portfolio holdings to allow for deeper engagement can lead to more concentrated portfolios, high idiosyncratic risk, and large deviations from market benchmarks. Portfolio managers may face additional challenges in the form of trade-offs between financial valuation goals and impact goals. Estimating the long-term value of a successful engagement outcome can help managers guide these decisions.
Benchmarking is a critical challenge, as traditional indices are ineffective for measuring the performance of a portfolio with concentrated risks and both financial and non-financial objectives. Alternative benchmarks and measures, such as custom benchmarks, absolute return targets, or the acceptance of high levels of tracking error can better align expectations and reduce short-term performance pressures. Adopting such benchmarks requires investors and clients to prioritize long-term value creation and measurable real-world outcomes over quarterly returns.
The regulatory environment introduces additional risks, such as incurring fines for misrepresentation of a strategy or failing to meet certain criteria for an investment product claiming to have impact. Best practices to mitigate these risks include clearly defining objectives, avoiding exaggeration, and reporting impact efforts and outcomes with transparency and integrity.
Achieving measurable real-world environmental and social change through listed equity requires rethinking conventional investing norms around diversification, benchmarking, and time horizons. Asset managers must balance financial objectives with impact objectives while navigating a demanding regulatory landscape.
Key Takeaways
- Engagement and stewardship are the primary mechanisms for creating real-world outcomes in listed equity impact investing.
- SMART objectives and a credible theory of change link investor actions to measurable outcomes.
- Constructing a portfolio of companies with impact objectives requires substantial resources, including sector expertise and specialized company knowledge.
- Benchmark mismatch can be addressed through custom benchmarks and metrics, such as absolute-return benchmarks or a tolerance for higher tracking error.
- Regulatory risk can be mitigated through alignment between objectives and outcomes and reporting with transparency and integrity.