How impact can enhance the risk-return equation

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Impact investing is a rapidly growing segment within sustainable investing. It aims to channel money toward the companies that have a positive impact on the world in which they operate – and to deliver outperformance for investors in the process.

Eric Rice, Head of Impact Investing within BlackRock Fundamental Equities and Portfolio Manager of the BlackRock Global Impact Fund, hosted a virtual sit-down with Sir Ronald Cohen, the highly regarded “Father of Impact Investing” and author of the new book Impact: Reshaping Capitalism to Drive Real Change. The conversation, available here, covered the forces driving impact and how this style of investing is upending the traditional risk/return equation.

The new math

A major shift is underway as companies are increasingly measured not only on how much money they make, but also on the societal impact they are having. Rather than judging by risk and return alone, investors are looking at risk, return and impact. Two examples: measuring companies by the impact they are having towards the achievement of the 17 United Nations Sustainable Development Goals, and measuring the impact they have on the progress towards the Paris Climate Agreement to limit global warming to well below 2 degrees Celsius. Mr. Rice says an extra $5 trillion of investment is needed to achieve these two goals – and that public market participation will be critical in achieving it.

The myth of lower returns

One narrative that never seems to die – according to Mr. Rice – is that this is a philanthropic mode of investing that neglects the fiduciary obligation to maximise returns. “This myth is now being exploded,” says Sir Ronald, noting that some electric vehicle companies are attracting lofty valuations, while some big oil companies have lost significant value over the past few years. “There are a lot of reasons why risk/return/impact should deliver better returns than just risk/return optimization.” For example, a company with a great product that does environmental harm, or uses child labour, could face consumer boycotts and sterner regulations, weighing on profitability.

Bringing measurement to ESG … is turning ESG into impact investing.

Sir Ronald Cohen

Three forces driving change

Sir Ronald, who is also featured in BlackRock’s Global Impact Annual Report, has been an impact investor for decades. But now, he says, there are three forces driving rapid change. These are:

  • The shifting values of consumers
  • Technological innovation such as machine learning
  • The ability to harness computing power to analyse vast data sets and measure the impact of companies.

“When you put these three things together,” he says, “you can see that this is going to have a huge disruptive effect on the business models of companies and on the portfolios of investors.”

Many companies are embracing this change in a “race to the top.” And where there is some resistance, investors can engage with companies to drive change.

“I think investors are certainly the ones driving companies now to look carefully at their impacts and judge whether their impact performance is likely to affect their future profitability,” says Sir Ronald. Mr Rice agrees: “I think impact engagement ― real engagement with those public companies to make sure they know what's going to be required of them ― is an important new stage for us.”

The future of impact investing

Sir Ronald sees this now-voluntary company embrace of impact measurement becoming mandatory over the next three to five years. Bringing impact transparency to public equities would be a game changer, he says, as companies are required to show the impact they are having on the environment, diversity, gender equality and other social problems. Companies may have to publish transition plans or risk losing investors. They may also struggle to attract customers and talent, as BlackRock CEO Larry Fink emphasised in his annual letter.

This impact revolution is going to be as widespread and as deep as the tech revolution which has preceded it.

Sir Ronald Cohen

The two believe this has significant implications for the nature of portfolios – and it can already be seen with the rotation towards clean energy. Investors may expect a further shift toward companies delivering both profit and positive impact.

Visit BlackRock Fundamental Equities’ Expert to Expert video portal for all three parts of “Impact investing and the future of capitalism.”

See the videos