In April, I attended the Ecosperity Conference in Singapore where participants in the impact investing roundtable were asked to deliberate on the state of impact investing.
Among the various questions raised, the one which gathered an overwhelming consensus was: “Are we at the inflection point of impact investing?” I disagreed and was relieved to find more than three-quarters of the room shared my sentiment; To fix a problem, the first step is to acknowledge it.
In the world of investment, the term ‘inflection point’ signifies a pivotal moment when a significant change occurs, potentially leading to a period of dramatic growth. However, when it comes to impact investing, the anticipation of reaching this critical juncture seems perpetually on the horizon.
Despite the growing awareness and interest in socially responsible and sustainable investments, the core considerations for investors remain rooted in profitability and competitiveness. There are three key reasons why this is the case, and why we need to fundamentally challenge the notion of how investments are evaluated.
Profitability and competitiveness
First, impact investments continue to be perceived as yielding lower returns compared to traditional investments. This myth has been frequently debunked. For example, McKinsey studied the returns of 48 different impact investments and found an average internal rate of return (IRR) of 10 per cent and also found that a third of the investments had an average IRR of 34 per cent.
Second, investments that prioritise social or environmental outcomes can sometimes lag in traditional measures of success such as early financial performance or market share. This makes them less attractive to investors who are looking to beat the market.
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While the interest in impact investing continues to grow, the transition towards it being a dominant force in the investment world is gradual.
Third, the social and environmental outcomes resulting from an impact investment can be tricky to measure or quantify, unlike financial returns which are clear-cut. A lack of clear metrics makes it challenging for impact investments to demonstrate their value proposition in the short term, further hindering their appeal to mainstream investors.
The need for a paradigm shift
For impact investing to reach an ‘inflection point’, there needs to be a paradigm shift in how investments are evaluated, and it all comes down to capturing the right data. The traditional metrics of profitability and competitiveness must be expanded to include social and environmental impact. This requires the development of robust and standardised impact measurement tools that can provide investors with the data they need to make informed decisions.
Another suggested approach can be a gradual incorporation of an ESG risk premium into corporate loan rates and (more) taxes to signal in a material way that doing business unsustainably will be increasingly more costly, such as Singapore’s carbon tax, which is implemented gradually, starting with a modest rate and a focus on major emitters.
It cannot be ‘business as usual’ for very much longer. Over time this will help erode the inertia, drive a transition towards more sustainable practices and tip the commercial competitiveness scale (i.e. potential for higher yield) towards more sustainable and profitable enterprises.
Additionally, investors should assess the strategies the funding recipient has in place to effectively scale their impact solution in an allotted period. For example, we at Nandina REM produce circular carbon fibre and aluminium materials which have been reclaimed from retired aircraft and reprocessed back into aviation-grade specifications. We recognise that just as important as creating the product is embedding it into global supply chains and the market.
As such, we have led the formation of the Aviation Circularity Consortium alongside Qantas, Jamco America and other key aviation stakeholders to chart the certification pathway that gets circular materials back to aeroplanes. At the same time, we are engaging with financial institutions to create fit-for-purpose financial products that will enable multiple tiers of suppliers to embed the certified materials into their processes and transition as a collective towards more sustainable supply chains.
While the interest in impact investing continues to grow, the transition towards it being a dominant force in the investment world is gradual. The main investment considerations of profitability and competitiveness remain paramount, and until impact can be measured with the same rigour as financial returns, we are unlikely to see a significant shift.
However, innovative approaches are taking shape that can drive change. And as society and businesses become more conscious of global challenges and as measurement methodologies improve, we may eventually witness impact investing taking its rightful place at the forefront of investment strategies.
