The Rise of ESG and Impact Investing

When it comes to predicting trends in the alternative investments space, wealth managers, financial reporters, and consumers use the same data to form differing opinions about certain sectors’ likelihood of success. In recent studies, however, one sentiment is seemingly shared: confidence in the futures of ESG and impact investing.

Though similar, the two differ slightly: ESG investing centers on allocating assets toward companies based on both traditional financial factors and a scoring system that takes into account environmental, social, and governance-related factors. ESG ratings providers quantify these factors and offer comprehensive ratings to supplement the investment decision-making process. By incorporating ESG factors in the investment decision-making process, investors are rewarding corporations who have adopted views consistent with an inclusive and sustainable future.

Impact investing involves investors taking a more active role in setting benchmarks for these factors, and providing more oversight and guidance toward reaching them. Oftentimes the goal for impact investing is more so ensuring the social rather than financial returns.

With the recent dismantling of federal environmental regulations and programs, coupled with the increase in millennials in the investor base and workforce, commentators shared a largely positive outlook for ESG and impact investing. Counting on the social consciences of the investor pool, trend-watchers speculated that investors would compensate by allocating assets to private companies with green and/or sustainable practices that align with their values.

Investing has traditionally been a single bottom-line paradigm with the Baby Boomer and Gen X workforce, but Millennials now make up nearly 30% of the investor base. Seeing as 95% of Millennial investors prefer to make environmentally and socially conscious investments, the industry is seeing an increase in ESG and impact investing.

Regardless of your firm’s stance on ESG and impact investing, the numbers speak for themselves: A 2018 study by Fidelity Charitable found that 77% of Millennial investors and 72% of Gen X investors have made some type of impact investment. As of 2016, assets tied to ESG and socially responsible investing made up for one-fifth of all assets under management in the United States (up 33% from 2014), totaling US$8.72 trillion, per the 2016 US SIF report.

With European countries leading the charge toward sustainable investing, global rates of sustainably invested funds are even higher. According to the 2018 Morgan Stanley Sustainable Signals report, US$22.8 trillion in funds are invested sustainably, accounting for nearly 25% of professionally managed funds. Of these funds, institutional investors own nearly 75%.

Notably, investors have not suffered diminished profits in this area: In the GIIN (Global Impact Investor Network) 2018 Annual Impact Investor Survey, 76% of investors reported financial performance in line with market expectations, and 15% of investors reported their portfolios were outperforming the market expectations, with just 9% reporting under-performance.

What is forcing this change? The internet provides a wealth of information to those who know how to access it. Social sites like Twitter allow consumers to communicate directly with heads of companies, and it is relatively easy to obtain a company’s financial filings from the SEC. These technological advancements have led to an increased demand for transparency from big corporations from not just consumers, but investors as well. Investing in companies with high ESG scores is a way to effectively mitigate risk, as companies operating environmentally and socially sound business practices are less likely to be involved in financially damaging scandals.

Historically, it has been enough to follow exclusionary screening methods, and exclude or divest from companies who don’t adhere to investors’ social, environmental, governance, or other values. Now, however, many investors want to drill down into underlying securities to ensure adherence throughout their full portfolios. In an article for ThinkAdvisor, CEO and Founder of Align Impact, Jennifer Kenning says, “When an advisor says you don’t own Keystone pipeline,’ investors want to know if they own banks that are loaning funds to TransCanada, which is building the pipeline.”

One way to conduct profitable and effective impact- and ESG-based investment strategies is to implement multi-asset class portfolio monitoring software. Dynamo Software, a cloud-based CRM and asset management system, has just acquired Preqin Solutions, a subsidiary of Preqin Limited. Preqin Solutions offers an ESG and Impact Investing Module, which allows investors to build and manage impact-based portfolios. With Preqin Solutions, investors can define KPIs, benchmark performance against UN Sustainable Development Goals (SDGs), and report on portfolio performance to key stakeholders. For LPs who are considering or are already utilizing these ratings within your investment decision-making framework, Dynamo can act as a further repository for storing and utilizing these ratings. Dynamo also offers advanced relationship tracking, allowing you to chart ownership hierarchies, and relate ESG scores and other relevant factors and documents to investments and investment ideas.