As the fabled investor Charlie Munger once remarked, “show me the incentive, and I will show you the outcome”.
Recently, DWS found itself facing a big bill to settle allegations of greenwashing. My decades in impact investing, during which I’ve engaged with over a hundred fund managers waving the ‘impact’ banner, have convinced me that incidents like DWS’s penalty or the unsettling Home Reit debacle aren’t mere blips. These are red flags, showing increasing concern from asset owners and regulators.
Due to a unique twist in the risk-return dynamics of impact investing, asset owners have grown especially vigilant. Picture a £50m stake in a sofa factory. If everything goes according to plan, it might balloon into £75m.
If the wheels come off, the financial blow could be a loss of the entire £50m. Seems straightforward, doesn’t it? But consider the same investment amount poured into a vehicle manufacturer.
A successful venture might yield the same £75m return.
If the manufacturer ends up producing more fossil fuel vehicles than electric vehicles or produces the electric vehicles in such a carbon-intensive manner that the overall impact is negative and fails to measure, manage, or report this; once discovered the repercussions may extend beyond the initial £50m, with adverse media headlines and lawsuits from investors who were told their investment was improving the environment.
This in turn could result in a drop in the share price of the asset owners who invested in it or cause a private bank to lose some of its customers, with losses that may dwarf the £50m loss.
In spite of this concern there appears to be an ever-increasing investor appetite for commercial impact investments.
Why is commercial impact investing such a compelling investment proposition? Consider the fund manager investing in quality, affordable low-income housing versus one investing in renovating homes for the upper-middle class; the biotech manager investing into costly cosmetic procedures versus the one investing in affordable cancer treatments.
When faced with comparable returns, which investor would not choose to get the same risk-adjusted return and make a real difference in the world? Amplify this with the burgeoning appetite for investments driving the energy transition, the difficult fundraising environment, the hazy definitions of impact, and the temptation for fund managers to don the ‘impact’ label becomes irresistibly strong.
So how do investors distinguish between fund managers expediently putting on a veneer of impact from the genuine article? A few straightforward questions to fund managers will reveal a lot. A key question is whether the investment product actively generates a positive impact. An ESG fund manager avoids investment that pollute the river, an impact fund manager invests in cleaning the river.
Real impact? It’s in the causality. Flashy “100 thousand jobs” badges with SDG emblems are rampant. But asking how their funds directly resulted in such achievements? That filters out the genuine from the merely opportunistic.
