Whether a private wealth manager, a government agency, an asset manager, or an asset owner, we all have stakeholders demanding we do more. Do more in how we invest our capital to improve the social and environmental fabric that holds not just our local communities together, but also our global communities.

Climate change is not a domestic problem, it’s a global problem. Unemployment, or under-employment, is not just a local problem, it’s a global problem. Affordable housing is not just a local problem, its everyone’s problem, and gender inequality is certainly not ‘the woman next doors problem’, it’s the women next door everywhere problem. COVID was not a local problem, it was, and still is a global problem. To find local solutions, we should embrace global solutions.

Impact investing is not the holy grail, but it comes close as its investments made with the intention to generate positive measurable social and environmental impact alongside delivering market or better-than-market financial return to its stakeholders. It’s driven by intention, its outcomes are measurable, and verifiable and unlike many other forms of sustainably labelled products, it takes account of the negative impact.

There is no such thing as a neutral investment.

Regulators in Europe, the US and now Australia are putting money managers on notice. Get your house in order in respect to what you market as ESG, sustainable, green, net-zero and even impact because if it’s not true-to-label, you will be exposed. Impact investing is not a cottage industry, its growth rate is exponential and the great wealth transfer from Boomers to Millennials over the next two decades, will see the demand for true-to-label ‘impact funds’. A demand that will need to be met by all who manage money, if they want to maintain or grow their market-share.

Advance the journey in impact. BOOK YOUR PLACE

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It may appear absurd, at first glance, to consider proposing a thesis whereby instruments of death and destruction could be classified in the same breath of renewable energy and educational companies but, according to reporting in the New York Times, bankers at Citi believe that “defending the values of liberal democracies and creating a deterrent, which preserves peace and global stability” is indeed a ESG investment.

One thing is very clear from the data – war is profitable.  Weapons company stocks soared on news of a significant war erupting Lockheed Martin (NYSE: LMT) is up around 20% YTD at the time of penning this blog.

Irrespective of financial motivations for investing in weapons of mass destruction (WMDs) or including them into ESG indices, there seems to have been lack of acceptance to embrace the Citi bankers’ suggestion to make WMDs green.

Further reported by the Times, Leslie Samuelrich, president of the Green Century Funds, was clear on her view as a dedicated ESG investor: “Those who argue that weapons belong in a sustainable portfolio are capitalizing on the horrific attack,” she said. “Excluding military and civilian firearms has been a long-held screen by authentic responsible investors.”

With the subject trending, Citywire went further analysing existing ESG funds as to whether those funds were exposed to weapons companies.  The results of their research were shocking.  Citywire journalist Siri Christiansen suggested that a third of Europe’s Article 8 (green) and 9 (dark green) funds have controversial weapons exposure.

Given the express and implied goals of the EU Sustainable Finance Directive, namely to target investment in environmental themes and avoid significant harm, the findings were indeed surprising.  However, like many considerations of ESG investing, the findings were somewhat nuanced by the fact that some data reporting agencies classified some companies as ESG friendly whereas other investors did not.

Companies such as Airbus SE (AIR.PA), Thales (HO.PA) and even champions of energy transition Brookfield (NYSE: BAM) have been earmarked as companies with connections to military and weapons revenues yet were seeming greenlit for ESG investing by certain ESG data providers.  However, investors conducting their own due diligence found that these companies should be captured by a negative screen on weapons companies.

The debate around ESG themes and where the grey areas exist is one that seems likely to continue.  Outside the realm of WMDs and military contracts, debate even exists on whether tobacco companies are ESG investments.

Whilst some such as Tobacco Free Portfolios, the Australia-based pressure group, would never consider tobacco as ESG, ratings agencies such as Dow Jones disagree making Philip Morris (PMI) a “sustainability leader”. Per the press release announcing this triumph for PMI:

“Underpinning PMI’s inclusion in the index, the company scored 84 (out of 100) in the 2021 S&P Global Corporate Sustainability Assessment, reflecting an improvement of 10 points over the prior year and a top decile position in the tobacco industry.1 Importantly, PMI led the tobacco industry in 10 of the 24 criteria assessed1, including Innovation Management, which evaluates companies’ research and development spending, product innovations, and portfolio of tobacco alternatives and smoke-free products”.

There’s no reason to doubt the factual accuracy of the above quote, however where ESG investing differs from impact is also the consideration of negative impacts.  For example, both weapons and tobacco companies can be seen to detract from multiple UN sustainable development goals (SGDs). For example, tobacco negatively contributes to SDG1 (No Poverty) as poor people spend money on cigarettes and both tobacco and weapons negatively contribute to health as both, well, kill people.  We could go on…

Investors seeking genuine positive contributions are increasingly focussed on impact investing rather than ESG on its own.  ESG often provides a solid risk screen to avoid the worst harm but even weapons and tobacco companies could be found in an ESG portfolio.

Whilst impact managers screen for negative ESG risks, they also must account for negative impact from company activities. For example, the negative impact caused by cigarette filters that take up to 1000 years to decompose or how education or healthcare is set back when a bomb destroys a school in Yemen or a hospital in the Ukraine.

ESG provides an important screening process however for investors that are seeking value alignment with overwhelmingly positive impact on the world and across SDGs impact investing is the way forward.  Increasingly investors are seeking out this alignment to steer portfolios towards an overwhelmingly positive impact on the environment and society with the need for smokes or bombs.

Alex Wise is the Chief Operating Officer at WON Impact Asset Management

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Within traditional portfolio management, methods for portfolio optimisation are used to determine where the trade-off between risk and return are best optimised. However, these traditional portfolio management methods are not designed to add the third factor: Impact. As a result, investors have used the traditional portfolio allocation rules and strategies to allocate mandates to impact funds. The most simplistic approach is view impact assets in the same light as traditional assets and carve out a percentage of their assets to dedicate to impact investing. [1]

Defining Impact Investing & Misconceptions

Defining impact is important. According to the Global Impact Investing Network (The GIIN), impact investments are defined as: “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.

Expected financial, social, and environmental returns from impact funds vary. However there lies a general misconception that Impact Investing targets below market rate returns, which is false, and academia even argue that impact investing can add financial value. However, some impact funds that lean greater toward philanthropy invest in areas which one cannot expect market returns, and some investors will trade lower returns for greater impact.

However, many investors are still curious of the concept, yet question if achieving measurable positive impact can coexist with strong financial returns or if there is sacrifice for these earnings for contributing to good.

This balance is complex and has many different factors to consider. Concluding on an answer must be backed by historical research and a foundation of knowledge for the various aspects of impact investing.

Portfolio Optimisation: In an Impact Context

For Investors and Portfolio managers who learnt under the Modern Portfolio Theory (“MPT”), the concept of the trade-off between risk and return is an industry consensus in building a portfolio. The essential principle of MPT is that for higher risk assets, investors will demand higher returns and vice versa for lower risk assets. When applying MPT in carving out a portfolio, it is agreed on that by grouping assets together in a way where we can deliver the best financial return within a given level risk. Upon plotting all these portfolios beside each by risk and return, we develop the efficient frontier. However, for the case of Impact Funds, this does not demonstrate information regarding optimising the social or environmental returns a portfolio may deliver.

A white paper published by Athena Capital’s Vice President Jeff Finkelman integrates MPT with impact investing, demonstrating a new frontier where Impact is an independent factor that moves along the new efficient frontier like the 2 pre-existing factors. [2]

The perspectives of the market on Impact Investing

There exist several views on impact investing. Sceptics call impact investing an investment that provides lower adjusted returns for the same risk as a traditional investment, consequently declaring impact not suitable for portfolio optimisation.

However, WONA believe that impact investments do not always require an investor to accept lower returns for the benefit of impact. Jeff Finkelman’s white paper describes a neutral view of impact investing, demonstrating an investment sweet spot. Within this region, investors can contribute to demonstrable impact whilst not sacrificing risk adjusted returns.

Finkelman states that this point of the curve is where investors can access ‘free’ impact, without increasing risk or sacrificing returns. Nevertheless, impact investing still contains risks alike traditional investments, with risks such as lack of track record and unproven investment strategies as some of the risks that impact managers face.

For Finkelman’s thesis to be correct, it would mean that it is possible to map the effect of where impact starts to take over the effectiveness of financial returns. Based on this curve, financial first investors will either seek to generate greater financial returns without considering the social return of an investment or maximise the optimising financial returns while achieving some impact objectives. On the contrary, there may exist impact first investors who take impact priority over financial returns and impact only which wish to maximise social and environmental returns. [1]

Applying Finkleman’s thesis: Achieving Risk Adjusted Returns while Including Impact

By simply carving out a section of a portfolio for impact can be argued as inefficient allocation method. Forward thinking impact investors will consider the dimension of impact when allocating to an impact investing manager.

A study conducted by Arvella investments demonstrated a methodology to integrate impact funds into a mainstream portfolio while considering the impact of the portfolio. Arvella designed a portfolio optimiser that brought together: risk, return and impact. The study found that the impact funds that were used in portfolio construction had low correlations to traditional asset returns, assisted in developing portfolio diversification and enabled the achievement of greater impact all without harming risk-adjusted returns. By adding impact funds, the optimiser demonstrated that the portfolio could increase allocations to impact funds up to 18% without sacrificing risk adjusted returns.

The study assessed across the asset classes of Equity, Bonds, Private Equity and Private Debt. A range of mean variance optimal portfolios were constructed in mind for investors with different risk limits. This resulted in portfolios demonstrating characteristics of high volatility, selected by risk inclined investors comprising of only public equities and private equities and lower variance, which comprised of bonds and private debt.

The study then constructed new portfolios with impact funds now into the equation. In this study, impact funds were allocated 10% of the portfolio. In this example, the proportion of impact funds were divided into 25% private debt and 75% private equity, reflective of the impact investing universe as of the GIIN’s 2020 impact investing report. In the final allocation, the study looked to maximise impact allocations, without financial sacrifice. The study demonstrates over the standard volatility range, 5% to 15% the proposed optimisation strategy delivered a noticeable increase in impact fund allocation, +10% to retain expected return and volatility consistency and +18% to maintain portfolio utility. Additionally, the study also demonstrated that increasing allocation from 10 to 11.8% (1/5 increase) will have no effect on risk adjusted returns. [3]

Impact allocations from second stage optimisation

Maximised impact allocations with utility preserved

Uncorrelated Returns and Diversification

An additional effect of allocating to Impact Funds is the benefits from diversification and subsequently low correlation to broader debt and equity markets. The attractiveness of Impact Funds, especially debt strategies is that they provide balanced returns, and low correlation with traditional asset classes. The nature of this asset class benefits in maximising impact whilst keeping expected return and volatility.

End Remarks

From the studies overview, impact funds with proven strategies and achieve at-market and above market returns are suitable allocations when considering constructing a portfolio. Progressing the sustainable development goals through impact investing managers, is necessarily correlated with sacrificing risk-adjusted-returns and portfolio utility. Over the universe of impact investing, financial first impact investors and investment managers will understand that generating impact overlaps in producing in risk adjusted returns.

1. Botha, F., 2021. Does Impact Investing Always Come At A Price?. [Blog] Forbes. Available at: <https://www.forbes.com/sites/francoisbotha/2020/04/14/does-impact-investing-always-come-at-a-price/?sh=3e6df57d192e>
2. Finkelman, J., 2017. Building Impact Portfolios. [White Paper] Athena Capital Advisors, Available at: <https://www.philanthropy-impact.org/report/building-impact-portfolios> .
3. The Journal of Impact and ESG Investing, 2021. Integrating Impact Funds into Mainstream Portfolios. Summer 2021(1 (4), pp.103-119. Available at: <https://doi.org/10.3905/jesg.2021.1.020>.

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Where do investors ‘really’ want to invest?

People are increasingly becoming conscious of the daily sustainable choices they face, from where they purchase their food, to how they travel. Although their everyday habits might be reflective of their personal beliefs, the question is do their sustainable principles carry over into their investment decisions.

BHP in Australia recently announced plans to demerge its oil and gas subsidiary, despite concerns from some investors that the company will be exposed to higher risk from the lower level of business diversification. However, on the other hand, BHP has also been criticised in respect to its slow pace of advancing towards net zero emissions by 2050. While the decision to demerge has been welcomed by other investors as a step forward, the mixed reception to BHP’s demerger highlights conflicts in the business community around ethical investments, and heightened community concern about corporate social responsibility towards the environment and mitigating climate change.

What is Sustainable Investing? Sustainable investing directs investment capital to companies that seek to combat climate change and environmental destruction, while promoting corporate responsibility.

Global trends

Calls for sustainable investing from individual investors have grown globally. According to the Schroders 2020 global sustainability survey of 23,000 investors across 32 locations, 25% of individual investors “always” ask about the sustainable aspects of investment products when they inquire about investment opportunities with financial advisors, and 40% “sometimes” ask about these aspects[1].

Figure1: Frequency that people ask for information on sustainable investing 

In the Schroders 2019 sustainability survey, responses varied for each generation, in response to the question, “Will you consider sustainability factors as the first or the second priority?”, 27% of Millennials (18-37), 23% of Generation X (38-50), 19% of Baby boomers (51-70) and 14% of older respondents (71+) answered “yes”[2].

Millennials and Generation X were the age groups that agreed the most with exercising social and environmental responsibility with investments. As Millennials and Generation X may be more likely to choose investment products and actively investigate different superannuation funds more than other age groups. Therefore, to attract Millennials and Generation X, investment managers and super funds need to consider increasing their offering in respect to sustainable investment products, and in particular, in impact investments

Figure 2: Ideas about sustainable investments for each generation

Where do Australians want to invest?

Similar to the case with BHP, most Australian companies and institutional investors now face social and environmental obligations demanded not just by the public, but by the government that represents them This has largely been driven by recent devastating weather events in Australia over the last few years from raging floods to devastating fires and biblical droughts across the nation, where at one point, all events taking place simultaneously across different states. The 2020 investment survey “charting consumer expectations and demand for responsible investing in Australia”, conducted by the Responsible Investment Association Australia (RIAA), found that from a group of 1135 respondents randomly selected from the general Australian population older than 18 years of age, 69% want to avoid investing in companies which negatively affect the environment. While 63% will not invest in animal testing-related companies, 61% want to avoid investing in tobacco and alcohol companies[3].

Considering that the majority of Australians wish to avoid investing in companies related to these industries, wholesale institutions, banks, and asset consultants continue to review their investment strategies. The RIAA also noted that 9 out of 10 (89%) Australians feel it’s important that their financial institutions invest responsibly and ethically across the board. Three-quarters of Australians would consider moving their banking and superannuation or other investments to other providers if they found out their current provider was investing in companies that are not aligned with their values. Additionally, 67% of Australians who do not currently invest in ethical companies, funds, or superannuation are likely to do so in the next 5 years with 32% saying they would consider doing so in the next year.

At a glance, there is an increasing impetus demanding sustainable investing on all fronts. With

80% stated that environmental issues are an important factor to consider, and 64% agreed that social problems should be considered when it comes to investing. The top themes are renewable energy (55%), sustainable water management and use (48%), healthcare and medical products (48%), healthy rivers and ocean ecosystems (45%), sustainable land and agriculture management (43%), and education (42%) respectively[4].

Considering that consumers increasingly want to determine their investment products or choose their superannuation funds, institutional investors now should take heed of these consumer preferences when deciding on investment strategies  A caveat to all those managing money on behalf of the ‘conscious generation’, ensure your sustainable products deliver measurable social and environment impact.

The Market is Adapting

In response to public demand, the proportion of sustainable investment in the financial market has been growing. In Australia, responsible investments in assets under management (AUM) have been increasing from AUD 980 billion in 2018 to AUD 1,281 billion in 2020. In terms of proportion of market AUM, 31% was in responsible investments in 2019, jumping to 40% in 2020[5].

Figure 3: Responsible Investment AUM compared to the remainder of the market in Australia 2018–2020 ($ billions) 

Companies are also facing up to the challenge and increasingly focusing. According to KPMG, about 98% of ASX100 companies now provide sustainability reports to the public. Globally, 100 companies with the greatest revenue across 52 countries (N100), and the largest 250 companies internationally (G250), have emphasised sustainable reporting[6]. These growing trajectories of sustainable investment reporting can be considered a reflection of high demand from investors, and some financial markets adapting to its needs.

Figure 4: Growth in global sustainability reporting rates since 1993: N100 and G250

Are Institutional investors adapting fast enough and what should we do? 

Financial markets are changing as a growing majority of investors now seek sustainability in their investments, and the market has been adapting to fulfill some of the needs of clients, yet are the investment options keeping up with the actual demand for them?

With 77% of people would not willing to invest against their personal beliefs, the investment industry could be doing more to satisfy investor appetite for sustainable investments by also having financial advisors pro-actively providing their clients with sustainable investment options and information as 45% of people say they only receive information on sustainable investing if they prompt their financial advisor[7].

Figure 5. “The investment industry could be doing more to satisfy investors’ appetite for sustainable investments. 

Money is fluid and humans move in herds, there is more action being taken from Gen X’s to Millennials to the recently entering Gen Z’s they have made their investment intensions clear and are demanding   that their investments are driven by intentionality towards sustainable and ethical investing practices that also have the ability to provide a good financial return. These cohorts are willing to shift their investments towards sustainable impact investing and 67% are most likely to do so in the next 5 years (RIAA)[8].

Investing in positive impact could in fact lift Australian savings rates with 53% saying that they would be motivated to invest and save more money if they knew their savings or investment made a positive difference in the world[9].

To finish, a quote from Adam Smith should be headed, as after all he did not only write Wealth of Nations for which he best known for, he also wrote a classic, ‘The Theory of Moral Sentiment’

“A nation is not made wealthy by the childish accumulation of shiny metals, but is enriched by the economic prosperity of its people”

Adam Smith

Wholesale institutional investors, banks, and asset consultants or all financial services must look to actively incorporate the impact investing needs of clients and not merely at ESG or SRI level which are risk mitigation tools or outdated aspects of positive impact measurements tools respectively. To better serve current and future generational client’s, superannuation’s and banks must seek to communicate the impact (positive/negative) to their consumers and disclose and be transparent in how the companies that are invested in aligning to their personal beliefs and the needs of the wider social and environmental demand of the country and the world. As in the end, “IMPACT” is never a local issue, it is a global one.

References:

[1] Schroders, Sustainability survey, 2020, https://www.schroders.com/en/insights/global-investor-study/2020-findings/sustainability/

[2] Schroders, Sustainability survey, 2019, https://www.schroders.com/en/au/advisers/insights/global-investor-study/2019-findings/sustainability/

[3] Responsible Investment Association Australia, Charting consumer expectations and demand for responsible investing in Australia, 2020, https://responsibleinvestment.org/wp-content/uploads/2020/03/From-Values-to-Riches-2020-full-report.pdf

[4] Responsible Investment Association Australia, Charting consumer expectations and demand for responsible investing in Australia, 2020, https://responsibleinvestment.org/wp-content/uploads/2020/03/From-Values-to-Riches-2020-full-report.pdf

[5] Responsible Investment Benchmark Report Australia, Responsible Investment Association Australia, 2021,

https://responsibleinvestment.org/resources/benchmark-report/

[6] KPMG, Survey of Sustainability Reporting, 2020, https://home.kpmg/xx/en/home/insights/2020/11/the-time-has-come-survey-of-sustainability-reporting.html

[7] BlackRock, Global Sustainable Investing Survey, 2020,

https://www.blackrock.com/corporate/about-us/blackrock-sustainability-survey

[1] Schroders, Sustainability survey, 2020, https://www.schroders.com/en/insights/global-investor-study/2020-findings/sustainability/

[2] Schroders, Sustainability survey, 2019, https://www.schroders.com/en/au/advisers/insights/global-investor-study/2019-findings/sustainability/

[3] Responsible Investment Association Australia, Charting consumer expectations and demand for responsible investing in Australia, 2020, https://responsibleinvestment.org/wp-content/uploads/2020/03/From-Values-to-Riches-2020-full-report.pdf

[4] Responsible Investment Association Australia, “Charting consumer expectations and demand for responsible investing in Australia”, 2020, https://responsibleinvestment.org/wp-content/uploads/2020/03/From-Values-to-Riches-2020-full-report.pdf

[5] Responsible Investment Benchmark Report Australia, Responsible Investment Association Australia, 2021, https://responsibleinvestment.org/resources/benchmark-report/

[6] KPMG, Survey of Sustainability Reporting, 2020, https://home.kpmg/xx/en/home/insights/2020/11/the-time-has-come-survey-of-sustainability-reporting.html

[7] Schroders, Sustainability survey, 2020, https://www.schroders.com/en/insights/global-investor-study/2020-findings/sustainability/

[8] https://responsibleinvestment.org/wp-content/uploads/2020/03/From-Values-to-Riches-2020-full-report.pdf

[9] Same as above[/vc_column_text][/vc_column][/vc_row]

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The most extreme example of where Australia’s water resources have been affects by environmental shifts and human activity is the Murray-Darling Basin. As a water system it reaches all corners of Australia. Thus, it’s impact on Australia’s society and environment is profound. With 77,000 km of rivers, it is Australia’s largest and most complex river system. Which makes it one of the most important water systems in Australia. It holds roughly 34,000 GL of water, which contributes to the hydration of fauna, flora and dependent communities throughout South Australia, Victoria, New South Whales and Queensland. The basin is of significant environmental, cultural and economic value to Australia. It’s home to 16 international significant wetlands, of which holds 35 endangered species and 98 difference species of waterbirds. More than 2.2 million people live along the Basin, including 40 different communities of Indigenous Australians. On an Annual basis the Basin attracts visitors from around the world, with tourism earning around $8 billion each year. Along with 40% of Australia’s agricultural produce comes from the basin, including 100% of our rice, 80% of our grapes and 28% of our dairy.

More than 2.2 million people live along the Basin, including 40 different communities of Indigenous Australians. Which makes it one of the most important water systems in Australia.

Although due to pressures put on the basin ecosystem many travesties have befallen it. Draught, blue-green algae leading to fish kills in the millions. These have cased ecological problems on top of the now endangered list of aquatic life. The desertification of the basin has also led to a higher likelihood of bushfires. The devastating bushfire season has been the worst Australia has ever seen with more than 40% of the bush burned with an estimated 3.14m hectares within national parks. The bushfire season in 2019-2020 is estimated to have released 830m tonnes of carbon dioxide into the atmosphere. Not to mention the roughly 1 billion animals that were killed during the fires and 2,439 homes were destroyed. Desertification can be a devastating thing, and it is all a result of draught, gleyed soil and low infiltration rates causing limited natural water supply.

This lack of water, let alone clean drinking and washing water, has impacted the overall health of the bush. This unclean nature of the water has meant that parents in communities surrounding the basin have been forced to wash their clothing, water their plants and even wash their children in donated bottles of water as the state of the darling has left it unusable without consequences. An ABC report shows how simply watering one’s plants with the water from the basin will kill them. Due to these conditions the scope of opportunity in Australia is large. Agricultural and Indigenous communities in need of clean water would benefit greatly from the ability to access clean water. Through the pandemic it has been advised that people’s hands be washed more frequently, yet 3 billion people, 40% of the world’s population, lack access to basic hand-washing facilities in their homes. This is also evident in the communities that surround the Murray-Darling Basin.

This is another reason why Wealth of Nations Advisor’s “Impact Investing Portfolio (IIP)” have looked to expand its initial Alternatives Portfolio 3 years ago to include Impact Investing. As a firm we have come to believe and resonate with the concept that there cannot be jobs or financial return on a dead planet. A slogan fortified by the International Trade Union Confederation. This is why we look to invest and promote companies such as WaterEquity in Australia and New Zealand, whose mission is to build a global capital market that accelerates universal access to water and sanitation. Its aim to serve two constituencies: low-income communities who needs access to water and sanitation, and investors who want to deliver impact and earn returns. This model and vision was embedded as COVID-19 spread in 2020, which made both parties realise that water access is a crucial front-line defence against the virus as well as other diseases.

In the process of finding a solution we can see that Impact investing has come to the front of providing measurable social and environmental change in the world.  It has grown both in its influence and its innovation. Many high-net-worth individuals (HNWI+) and Superannuation funds have pledged their capital to go towards investing with intention. By doing this they will have a quantifiable ability to create lasting social and environmental change. Their investments will often go towards Impact investment funds. Who will reinvest that capital into opportunities that align with their appropriate United Nations Sustainable Development Goals’. As a company we at Wealth of Nations Advisors focus our attention on finding managers that create unique and necessary solutions to social and environmental problems alongside a financial return. By growing our Impact Managers knowledge of water and sanitation investment opportunities in emerging markets to drive sustainable change and understanding their methodology is something we believe Australia could adopt and utilise to better serve the communities surrounding the Murray-Darling Basin. In turn, boosting the economy through assisting agriculture and also helping to benefit the health and wellbeing of the communities in need.

Reference:

• Analysis & Policy Observatory. (2019). Murray-Darling Basin Royal Commission report. https://apo.org.au/node/217606
• Cheshire, B. (2019, May 6). The Darling of Menindee. ABC New. https://www.abc.net.au/news/2019-05-06/menindee-four-months-on-from-mass-fish-kill/10998562?nw=0
• Chan, G. (2017, August 4). NSW minister gives himself power to approve illegal water works in Murray-Darling Basin. The Guardian. https://www.theguardian.com/australia-news/2017/aug/04/nsw-minister-gives-himself-power-to-approve-illegal-water-works-in-murray-darling-basin
• Chan, G. (2017, July 25). Murray-Darling basin: allegations of water theft spark calls for judicial inquiry. The Guardian. https://www.theguardian.com/australia-news/2017/jul/25/murray-darling-basin-allegations-of-water-theft-spark-calls-for-judicial-inquiry
• Davies, A. (2021, March 17). $13m mistake: valuer says $80m water buyback price was not in line with its advice. The Guardian. https://www.theguardian.com/australia-news/2021/mar/17/valuer-tells-auditor-general-water-buyback-price-was-not-in-line-with-its-advice
• Department of Agriculture, Water and the Environment. (2020). Sustainable Diversion Limit (SDL) adjustment mechanism and its implementation. https://www.agriculture.gov.au/water/mdb/policy/sdl-adjustment-mechanism
• Department of Agriculture, Water and the Environment. (2020). Australian Government Response to the final report of the Independent Assessment of the 2018-19 Deaths in the Lower Darling the Vertessy Report). https://www.awe.gov.au/about/reporting/obligations/government-responses/vertessy-report
• Department of Agriculture, Water and the Environment. (2020). Murray-Darling Basin policy. https://www.agriculture.gov.au/water/mdb/policy
• Hasham, N. (2019, April 24). What are water buybacks and how did we get here?. The Sydney Morning Herald. https://www.smh.com.au/politics/federal/what-are-water-buybacks-and-how-did-we-get-here-20190423-p51gla.html
• Kirby, M., Bark, R., Connor, J., Ejaz Qureshi, M., Keyworth, S. (2014). Sustainable irrigation: How did irrigated agriculture in Australia’s Murray-Darling Basin adapt in the Millennium Drought? Agriculture Water Management, 145(1), 154-162. https://doi.org/10.1016/j.agwat.2014.02.013
• McSweeney, R. (2019). Explainer: ‘Desertification’ and the role of climate change. CarbonBrief. https://www.carbonbrief.org/explainer-desertification-and-the-role-of-climate-change
• Morton, A. (2020, April 21). Summer’s bushfires released more carbon dioxide than Australia does in a year. The Guardian. https://www.theguardian.com/australia-news/2020/apr/21/summers-bushfires-released-more-carbon-dioxide-than-australia-does-in-a-year
• Murray-Darling Basin Authority. (2020). A plan for the Murray-Darling Basin. https://www.mdba.gov.au/basin-plan/plan-murray-darling-basin
• Murray-Darling Basin Authority. (2020). Governance of water management in the Murray-Darling Basin. https://www.mdba.gov.au/about-us/governance-water-management-murray-darling-basin
• Murray-Darling Basin Authority. (2019). Prerequisite policy measures. https://www.mdba.gov.au/publications/mdba-reports/prerequisite-policy-measures
• New South Whales State Government. (2017). Floodplain Management Plan for the Barwon-Darling Valley Floodplain 2017. https://legislation.nsw.gov.au/view/pdf/asmade/sl-2017-328
• Ombudsman NSW. (2018). Water: compliance and enforcement. https://www.ombo.nsw.gov.au/__data/assets/pdf_file/0006/57903/Water-compliance-and-enforcement-a-special-report.pdf
• Parliament of Australia. (2018). Murray-Darling Basin management. https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook44p/MurryDarlingBasin
• Quiggin, J. (2019, July 9). The Murray-Darling Basin scandal: economists have seen it coming for decades. The Conversation. https://theconversation.com/the-murray-darling-basin-scandal-economists-have-seen-it-coming-for-decades-119989
• Reese, A. (2001). What’s Behind Desertification?. PRB. https://www.prb.org/whatsbehinddesertification/
• Thackray, L., Condon, M. (2021, April 22). New report finds two-thirds of irrigators non-compliant with new water law. ABC News. https://www.abc.net.au/news/rural/2021-04-22/irrigator-compliance-concerns/100086068
• The Australian Institute. (2019). PM blames drought, but there’s been over 100 cases of maladministration in Murray Darling in less than one year. https://australiainstitute.org.au/post/pm-blames-drought-but-theres-been-over-100-cases-of-maladministration-in-murray-darling-in-less-than-one-year/
• United Nations. (1990). Policy Issues in Irrigated Agriculture. http://www.fao.org/3/t0800e/t0800e0d.htm
• United Nations. (2006). Policy Highlights Irrigation and Water Management. http://www.fao.org/3/am365e/am365e.pdf
• Water Equity 2020 Annual Report.

https://waterequity.org/wp-content/uploads/2021/06/2020-Annual-Report.pdf

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The Global Impact Investing Network defined Impact Investments as investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return[1]. With the turn of the decade, the Coronavirus pandemic elucidated systemic shortcomings of the standard operating model of governments and financial systems, while at the same time the increasing trend of ESG regulations are further highlighting that the investing world will be required to not only measure the return on the dollar invested against the risk taken to achieve it but will also need to move a significant step further, in actually quantifying the measurable impact that dollar has had on society and the environment.

Fortunately, the field of impact investing has never been better positioned to address this challenge and capitalise on the opportunities this presents.

What we and the market as a whole is looking to address is the ‘Impact Monetisation’, which refers to the monetary valuation process of the positive impact created by an investment[2]. Monetising impact is a potential tool that investors can use to evaluate the impact an investment generates over the lifetime of the investment or the current impact value. This consequently will enable the ranking between impact investments that produce greater social or environmental impact versus another investment.

The need for Impact Monetisation can be considered as part of the natural progression of the assessment process for Impact Investors. It fits in the investment due diligence process where Impact Investors will compare the impact an investment creates in the same manner of the risk and return of a traditional investment.

The research surrounding impact monetisation is growing and at Wealth of Nation Advisors (WoNA), we are aiming to lead the way in Australia by expanding upon our research into measuring and monetising impact by the transferrable economic value an investment creates. We apply this monetisation technique to impact fund managers we represent and look at the impact monetisation at the fund level and/or company level. This tool allows WoNA to compare different funds and individual companies in terms of the holistic impact they provide. WoNA is working on an impact multiple, which considers the capital deployed by a fund or investment divided by our calculation of the social and/or environmental impact that an investment generates.

Let us consider an example:

At a company level let us imagine a company called Project Smallholder. Project Smallholder is a company based in South Asia whose operations are in the export and sale of fresh dairy products. The ‘Impact Monetisation’ that was used, to value the impact created, were based on the income uplift smallholder farmers gained who were part of the projects supply chain. Smallholder farmers have small scale productions (>1 hectare land under cultivation), and usually sell their goods in open markets to inconsistent and non-market rate incomes. However, farmers in Project Smallholder were able to intervene, enabling smallholder farmers to gain access to consistent income by enabling supply chain linkages through sale contracts[3].

The impact monetisation for this impact investment was the income uplift the smallholder farmers obtained prior to the sale contract and after.

For illustrative purposes, let’s visualise Project Smallholder to have completed raising $25mn US. The calculation below is how the positive impact was derived.

Project Smallholder Impact Multiple

Annual Income (w/out Project Smallholder)                           $500 USD

Annual Income uplift (from Project Smallholder)                   100%

Annual Income (from Project Smallholder)                            $1,000 USD

Income Uplift (from Project Smallholder)                               $500 USD

# Of smallholder farmers under contract                                250,000

Total Annual Income Uplift (from Project Smallholder)          $125,000,000 USD

Divided by: Total Equity Investments                                     $25,000,000 USD

Project Smallholder Impact Multiple                                       5.0x

As another example let us look at an infrastructure fund that focuses on energy and sustainability.

For illustrative purposes, let’s call the Fund, Renewable Energy Fund I (REFI). The underlying assets in the fund are primarily solar and wind energy infrastructure assets which over its lifetime generates power from photovoltaic modules (solar) that convert light directly to electricity and turbines that spin from wind that converts the spinning of a magnetic inside a coil into electrical energy[4]. In contrast to the common coal fire energy stations which produce carbon dioxide emissions from a combustion reaction, the solar and wind farm project produces no carbon dioxide emissions. The impact monetisation created from the project can be deduced to be from the aversion of the social costs of carbon dioxide. The social cost of carbon is a measure of the economic harm from those impacts, expressed as the dollar value of the total damages from emitting one ton of carbon dioxide into the atmosphere[5].

Renewable Energy Fund Impact Multiple

CO₂ Emissions Avoided (Metric Tons/Year)                         2,000,000

(x) Social Cost of Carbon (per ton)                                        $125 USD

Total Social Cost of Carbon dioxide (Avoided 2021)             $250,000,000 USD

Divided by: Capital Deployed                                                 $100,000,000 USD

Renewable Energy Fund Impact Multiple                              2.5x

Whilst there has been increased research and improvement in the monetisation of impact, it is still a work in progress. Select impact investments may create various impacts from the operations of a business. In certain cases, this should be considered when configuring the impact monetisation of an entity. Additionally, studies comparable to the listed case studies have been conducted in context where data sources are validated and readily available. Addressing impact multiple of money calculations in companies, funds and bonds in markets and companies where data is limited (e.g., emerging & frontier markets, new technologies, lack of research) will limit the accuracy of the monetisation of impact. We believe the impact multiple realistically should be used as a guide to show the measurable impact an investment has across asset classes, risk/return profiles and impact thematic and WONA like many, will continue to work on improving the calculation of impact monetisation which we are sure, will continue to be assisted with the advances in data collection through technology, especially in emerging markets.

It’s clear that impact monetisation is a journey.

In a world still heavily weighted on ‘trading impact’ or ‘impact by proxy’, investors and regulators for that matter – like Europe with Article 9 funds – are starting to realise that there is a difference between leveraging the concept of ‘trading impact’ versus delivering impact.

We work with the best-in-class global as well as local impact managers, along with progressive institutional investors across Australia and New Zealand, who invest with the intention of delivering positive measurable and quantifiable social and/or environmental impact, while at the same time delivering market-equivalent risk-adjusted returns.

Impact Monetisation is about a journey in following the money. As an investor ask yourself the question, what true impact is my dollar having – am I trading impact or creating it? Check out the impact managers we represent via the website or the IIP APP, it’s how you start to follow the money.

1. https://thegiin.org/impact-investing/need-to-know/#what-is-impact-investing
2. https://yanalytics.org/research-insights/monetizing-impact
3. https://digitalnative.substack.com/p/will-impact-investing-come-to-venture
4. https://www.edf.org/sites/default/files/expertconsensusreport.pdf
5. https://www.epa.gov/energy/greenhouse-gas-equivalencies-calculator

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Don’t be fooled:

There is a difference between Impact Investing and ESG

The Definitions and Differences

Many people and companies believe that if one is to be conscious of the environmental and social implications of their investments or screen out any negative effects and put in place some level of basic governance to their capital investments that they are Impact Investors. This customary view does not level up to what “Impact Investing” really is.

The GIIN (Global impact Investing Network) defines impact investing as “investments with the intention to generate positive, measurable social and environmental impacts alongside a financial return”[1]. The key factor in this definition is the INTENTION of the Investor or Enterprise that wishes to part with their capital, as they intend to advance a positive ethical outcome alongside a favourable financial return.

In the case of ESG, Investopedia defines this area as an “environmental, social and governance practice of an investment, that may have material impact on the performance of that venture”[2]. Although this shows a social and environmental conscience, the main objective of ESG valuation pertains to the investment’s financial performance. Therefore, this adherence to ESG is mostly a risk mitigating factor for practical purposes beyond an ethical concern, since many organisations wish to follow ESG criteria for brand promotion, to avoid negative PR and/or to signal their companies that they could be at risk similar to the VW emission scandal or the 2010 BP oil spill debacle that plummeted the company’s stock prices and resulted in billion-dollar payouts and negative public relations[3]. In short ESG is driven by a commercial opportunity over an intentional positive outcome to society and the environment.

Another factor to note is that ‘Socially Responsible Investing’ (SRI), which is similar to ESG, yet goes one step further by actively eliminating or selecting investments that follow certain ethical guidelines. For example, SRI’s will seek to avoid investing in companies that deal with alcohol, tobacco, firearms production, human rights and labour violations and environmental damages etc[4]. SRI still values profit but it seeks to balance its yield against its core principles, i.e., to generate return without violating one’s social conscience[5].

Why Impact Investing?

Impact investing allows an investor, whether it be a Fund Manager, an Individual Investor, a Pension Fund, Religious Institution, an Insurance Company, a DFI or Bank to provide capital to address the world’s most pressing challenges in the world. Whether it be equality, sustainable agriculture, renewable energy, conservation, micro finance, climate impacts and/or accessibility to basic services such as housing, healthcare, education and food for all people.

Impact investing is not a welfare scheme or charity. Many impact enterprises and investors seek to intentionally invest in projects or research that will provide a future positive social and environmental impact (more so under 1 or more of the 17 stated UNSDG’s)[6], they also expect to generate a financial return on capital at market value, with a few exceptions at concessionary return in the short term.

We as individuals and team members in organisations each have the ability to positively change the trajectory our forefathers deteriorated over decades of industrialisation and over consumption. The opportunity to be a part of the future solution, one that is no longer decades away, but a present circumstance and action that falls upon our shoulders to push forward so our children and the future generations can enjoy the pleasures of natural beauty, humanity and kindness to all things around us that we were lucky to experience and have a glimpse of when we were young.

Comparison of ESG versus Impact Investing in a typical investment process

Gaining greater clarity in the difference of Impact Investing over ESG can be determined by the actions taken at each stage of a typical investment process. The 4 key stages are: Originate, Deployment of capital, Managing the investment project and Exit[7].

Measuring Impact

In the past many of the concerns in ‘Impact Investing’ has been due to the lack of standardised measurements. Yet with improved and more robust screening tools being developed over the past couple of years such as IRIS+ (under GIIN), IFC’s Environment and Performance Standards, Operating Principles for Impact Management (with good guidance on responsible exits), UN Principles of Responsible Investments (PRI), Sustainable Accounting Standard Board, Alinus SPI4 etc. greater ability and capacity is being presented frequently to assist in validating the returns and positive impact that these investments are bringing not only to the investor but to the overall community and planet.

Although many questions may exist in these screening processes and they may vary according to the asset class or industry the measurement pertains too, one of the key questions asked by many is how an enterprise/investor can monetise impact?

Y Analytics provides a simplified measure to assess impact and help organisations define impact by incorporating 4 metrics[8].

Although no unified best practice has emerged for impact investing as yet, the pace at which impact investing is gaining traction gives hope that more refined, streamlined methodologies will emerge in the near future. Until that time, multiple frameworks are used in combination (on average a combination of three tools, frameworks, standards and rating systems[9]), along with some customised elements to fit an investor’s strategy[10].

To understand these frameworks and their roles in impact management, Franklin Templeton and Tideline classified the frameworks into five broad categories.

Ultimately each investor must decide on a combination and level of customisation required for proper impact management system. As this is an emerging area, a dynamic process is required to continuously improve and capture all impact variables.

That is why here at #WoNA, we make it our mission to assist each investor find the right IMPACT Fund Manager that sets a combination of realistic, evidence-based targets for what our investments can achieve, that value the importance of monitoring and evaluating actual achievements using appropriate data to ascertain whether the investment made provides material positive changes to society and the environment and avoids harm along the way.

Therefor in summary, despite the commonalities in ESG and Impact Investing and the fact that many advisors lump these two areas together into an umbrella term such as ‘sustainable investments’, there are 3 important distinctions that can help investors ensure their investment are impact investments. They are,

1. Select assets with the INTENT of impact,
2. Contribution to the impact of the INVESTEE FIRM,
3. OBJECTIVE MEASUREMENT of the impact investment.

[1] GIIN – What you need to know about Impact Investing – (https://thegiin.org/impact-investing/need-to-know/) accessed on 9^th April 2021

[2] Investopedia – ESG, SRI and Impact Investing: What’s the Difference – (https://www.investopedia.com/financial-advisor/esg-sri-impact-investing-explaining-difference-clients/) accessed 7^th April 2021

[3] Investopedia – ESG Criteria – (https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp) accessed 11^th April 2021

[4] [Same as ref. 2 above]

[5] SRI – (https://www.investopedia.com/financial-advisor/esg-sri-impact-investing-explaining-difference-clients/) accessed on 7^th April 2021

[6] UN Sustainable Development Goals – (https://sdgs.un.org/goals) accessed 12^th April 2021

[7] IFC – The difference between ESG and Impact Investing and why it matters (https://ifc-org.medium.com/the-difference-between-esg-and-impact-investing-and-why-it-matters-8bf459b3ccb6)

[8] Evidence based Impact, Y analytics (https://yanalytics.org/research-insights/evidence-based-impact ) assessed 15th April 2021

[9] GIIN: The state of impact Measurement and Management Practice, December 2017 – accessed 15^th April 2021

[10] Franklin Templeton: Five Building Blocks for Impact Management – (https://www.ftinstitutionalemea.com/content-common/topic-paper/en_GB/five-building-blocks-for-impact-management-tideline-0319.pdf) assessed 12^th April 2021

Image Credits: Markus Spiske from Pexel

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More and more investors are putting their dollars into impact investments. Kevin Peterson of the New Hampshire Charitable Foundation talks about how this trend is helping save the environment, boost local economies and build childcare centres – and how you can be part of it. From New Hampshire Charitable Foundation’s Upper Valley office in Hanover, Kevin co-leads design and implementation of the Impact Investing Program. He also manages four grant programs: a state-wide environment portfolio; the Wellborn Ecology Fund; the Upper Connecticut River Mitigation and Enhancement Fund; and regional grants/non-profit/donor relations in the Upper Valley.

Insight: Kevin Peterson’s nine-minute TEDx Talk delves briefly into the benefits and importance of impact investing as a practice and provides some useful tips for the those who are unaware of impact investing and socially focused investments.

Changing the world by helping those that can. Raising $10 billion for impact investing across social and environmental opportunities.

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