Companies are clearly influenced by the demands of their customers, but so too are they influenced by their investors, and this is being shown strongly in the demands, from both parties, for companies to improve their approach to sustainability.
The growing influence of ‘ESG integration’ has vaulted social and environmental factors up the priority list of corporate boards, and as ESG becomes mainstream, there’s a new group of investors who are going further, to identify companies that are focussed on specific outcomes or impacts. They’re going beyond venture capital and private markets, to find impact companies that are publicly listed on the stock market.
These companies are harder to influence, but the potential impact is huge.
Tim Crockford is head of Equity Impact Solutions at Regnan, a specialty fund manager that launched its Global Equity Impact Solutions Fund in 2020.
The Foundational Philosophy
The fund is somewhat concentrated at only 32 stocks, and across a number of vehicles they’ve grown the FUM to $450 million. The core of the offering is a proprietary analysis model that goes beyond just assessing the financial metrics of risk and return, to also assess the impact a company has.
“It’s a very long-term minded investment process, with the aim of really trying to forge your relationship with the management teams that are running the companies we’re investing in to really try and affect change to the engagement that we do with them.” Tim says.
“The idea is that the broad impact is defined by identifying companies in the public equity space, which is the remit of this strategy, that are able to affect either an environmental outcome or a social outcome against specific SDG targets.”
The UN’s Sustainable Development Goals (SDGs) form a framework to assess each company’s unique outcomes.
“We’re not limiting ourselves to a single Sustainable Development Goal, or to a collection of either environmental outcomes or social outcomes, what we’re actually doing is using the SDGs as a broad lens to uncover where public equity listed companies can generate the biggest difference.” Tim says.
ESG vs Impact
On the spectrum of sustainable investments, ESG is at one end, representing the baseline. While impact investing is at the other, it’s a much involved process. But, to add further complexity, an investment manager doesn’t have to adopt one methodology or the other, they can be layered on top of each other. What’s important is being clear about what you’re measuring, and how.
“Ultimately, the distinction between the two (ESG and Impact) is that when it comes to environmental, social and governance, integration, what we typically mean is the integration of a layer of analysis, be it quantitative or qualitative, within an investment process. Typically pre-existing in an investment process, whereby the manager seeks to understand where the major risks are within the universe that they’re looking at. So historically, at least, the term ESG integration was used to define that additional part of the process.” Tim says.
“Impact investing generally, is a lot more intertwined with the emerging opportunity because ultimately impact investors will look at businesses that are able to drive a specific contribution towards solving some of the major environmental or social challenges that we have. So if you dial back to the global impact investing network definition, sure impact investing is investing with the intention to generate measurable positive impact. But ultimately, that’s a little bit broad.”
As definitions evolve in this space, it’s important for fund avengers to be clear about their labelling. To define the procedures they use, the thresholds, and the company behaviour that they’re looking for, and that which they would rule out.
“So what we specifically mean, in a more practical sense, is building a portfolio exclusively out of companies who have a business strategy that is centred around a specific aim, be it environmental, social, and in the public equity space. Typically, that manifests itself in focusing on companies who have solutions, as the name of the fund suggests products and services specifically, that are able to affect those outcomes.” Tim says.
The Puzzle of ‘Additionality’
Additionality is a word that even my computer’s auto-correct systems fund difficult to manage. It relates to whether a company’s positive impact outcomes would have occurred had it not been for the particular investment of the impact fund.
It’s a high hurdle, and that definition is oft-debated. But what matters is ensuring impact investors are working to identify projects that need funding. This of course is less important in public markets because the shares are listed on a secondary market, there is an abundance of capital, so additionality must come from a different angle, and most often it’s about influence.
“The biggest challenge was asking, how do we take this concept of additionality of capital, and translate it into something that is relevant to a public equity investment space, and it was a challenge that we wanted to meet.” Tim says.
“We can’t invest in any company and just do nothing. That would mean that we are not impact investors. For every investment we make in a listed equity company, we need to show pre-investment, we have a target, we have an objective that we want to achieve during the investment, and, that we are measuring, and ultimately achieving that target. Hopefully, if everything goes well, post-investment we can give an account to our investors of what impact through that period was actually achieved.”
The layers of complexity grow even deeper in terms of the impact an investor has (on a company) and the impact of that company itself.
“What is also changing is the definition of additionality is broadening out to focus not just on the additionality of the capital, but actually now also to take into account the additionality generated by the company, by the corporate. So I think what’s changed as the industry has grown, as the impact investing world has grown, more and more focus is being shown on the company’s impact. And what difference does this particular business make through the mission that it has, through the products and services that it sells.” Tim says.
“There are threads of additionality that run side by side. We’re constantly trying to understand, manage and measure our own additionality, as investors, which is the traditional version of additionality, as it evolved in the private market impact space. Then, alongside that, we’re looking to communicate what impact these companies themselves are actually having.”
Tomra and the Scourge of Plastics
So we’ve set the scene, Tim has outlined his philosophy, he defined his frameworks, and he went deep to explain how he and his team can influence companies through engagement. Now, we get an insight into some of the companies that made the cut. First up, is Tomra.
“Their reverse-vending-machines are able to very quickly identify what material has been deposited, sort that material into the corresponding area, and then figure out and rebate the right financial incentives to that consumer. At the heart of what it sells are sorting and collection solutions to make recycling materials like plastic much easier.” Tim Says.
Tomra has a noble mission, but intention is not enough, a business needs to be able to execute on their plans, and do it profitably.
“There are many different products and services that you can identify, which are trying to contribute towards solving this particular challenge of reducing the flow of plastic into our oceans, what we will then do is try and figure out which one of those solutions which one of those products and services is best positioned for success, and is best able to do so with, if you like the least compromise.” Tim says.
Evoqua and the Value of Water
There’s nothing more valuable to humans that clean drinking water, but sadly we don’t price it that way. It’s abundant for many, but it’s becoming desperately scarce for others. Evoqua has a solution.
“Evoqua is one of the leading companies when it comes to solving how to filter the drinking water supply in the US, of some of the nasty chemicals that have been dumped in their drinking water supply and have some massive health consequences to the people that are drinking this water supply. It’s a very clever business, which has obviously been getting a lot of airtime at the moment, and it started actually with the launch of a Hollywood movie called Dark Waters, which brought this challenge to light.” Tim says.
“They’re able to help clean these aquifers of these so called PFAS or ‘forever chemicals’ which are used and things like flame retardants and non-stick pans, to do good stuff, but then when they’re discarded, and when they flow into the water supply, they do tend to go into aquifers which get drunk by the surrounding communities and there’s been indisputable scientific evidence that consuming these chemicals can lead to all sorts of adverse health effects things like colitis, bowel cancer, a whole range in fact of negative health outcomes.” Tim says.
“This is something which is still very much in its infancy, and we expect it to play out over a 5-10 year period.”
A bit like impact investing really.