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Impact investing in public equities

Our research shows that impact investing in public equities can help yield outperformance and provide a differentiated source of alpha versus global equities. We extend the concept of breadth and illustrate how impact investments can enhance a portfolio’s structure through diversification.

Overview

Our research shows that impact investing in public equities can help accomplish two crucial investment objectives: generate financial outperformance and provide a differentiated source of alpha versus global equities. Inspired by the foundational framework in Grinold and Kahn’s “Fundamental Law of Active Management,”1 we extend the concept of breadth to analyze the opportunity for alpha in impact investing in public equities. We also illustrate how impact investments can work to enhance a whole portfolio’s structure by improving diversification, increasing the potential for financial performance while mitigating risk.

What to expect

01

What is the impact universe?

The impact universe is made up of companies whose core products or services help solve the world’s great social and environmental challenges. To qualify for the universe, companies must meet the criteria of “materiality” and “additionality.”

02

Applying the concept of “breadth”

Market inefficiencies in public equities impact investing reflect breadth and potential opportunities. With more variance in returns comes a wider set of risks and opportunities that can be exploited in seeking to generate alpha (see chart below). Impact entities are also neglected by sell-side analysts* and have low overlap with major indices.**

03

Complementary roles in asset allocation structure

Impact investing in public equities can serve five important roles in a portfolio’s strategic asset allocation structure: a structural growth engine; exposure to growth at a reasonable price; diversification benefits; provides a liquid complement to private market impact investing; serves as a complement to other sustainability vehicles.

What is the impact universe?

The impact universe is made up of companies whose core products or services help solve the world’s great social and environmental challenges. Consisting of approximately 600 publicly traded companies as of March 31, 2020, the universe has been built by BlackRock based on proprietary, fundamental research. To qualify for the universe, companies must meet the criteria of “materiality” and “additionality.” The materiality requirement insists that greater than 50% of a company’s revenues or business activity must come from products or services helping to solve major social or environmental problems (such as those represented by the United Nations Sustainable Development Goals (SDGs) and targets2). Additionality requires that a company’s products or services must address a need that is unlikely to be fulfilled by others (such as competitors or governments).

Applying the concept of “breadth”

Differentiated market inefficiencies in public equities impact investing reflect breadth and the potential opportunity for capturing alpha. Impact companies have higher standard deviation of returns versus global equities, leading to a wider set of risks and opportunities that can be exploited in seeking to generate alpha. Impact companies demonstrate a higher and more frequent dispersion of returns versus global equities, representing another market inefficiency (see chart below). Next, impact companies have lower coverage by sell-side analysts, which we see as an opportunity.3 Notably, the impact opportunity set has low overlap in names with major indices, adding to breadth and the opportunity to generate alpha.4 Finally, impact companies cannot be systematically identified5, and therefore are often misclassified or misunderstood, offering significant opportunity.

Rolling 12-month standard deviation of daily returns

Five-year ending March 2020

Rolling 12-month standard deviation of daily returns.

Source: BlackRock, with data from Bloomberg ending March 2020. Defined as average standard deviation of daily returns trailing 12 months across underlying holdings (BlackRock’s proprietary Impact Universe and MSCI Indices); 5-year period ending March 2020. Indices are unmanaged. It is not possible to invest directly in an index.

Complementary roles in a portfolio asset allocation structure

Impact investing in public equities has characteristics that can serve important roles in a portfolio’s strategic asset allocation structure. Investing in impact companies provides exposure to structural growth. Additionally, with lower valuations across standard equity metrics such as Price/Earnings, Price/Cash Flow, and more, many companies in our impact universe are less expensive than global equities.6 As previously noted, because impact companies are (i) more neglected by analysts, (ii) have low overlap in names compared to traditional equity indices, (iii) are often misclassified by industry frameworks, (iv) cannot be identified by systematic screening and (v) have business models that can be driven by megatrends, impact companies can offer exposure to these segments of the market and enhance portfolio diversification. In a portfolio that already has private market impact investments, public equities impact investing provides exposure to companies that are typically at a different stage of growth in their business lifecycle as they scale their business models. Finally, impact investing in public equities serves as a complement to other sustainability vehicles.

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Impact companies in our universe have had twice the sales growth compared with companies in global equities over three years.7

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Download the full Impact investing in public equities report
Our research shows that impact investing in public equities can help generate outperformance and provide a differentiated source of alpha versus global equities. We extend the concept of breadth and illustrate how impact investments can enhance a portfolio’s structure through diversification.
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Quyen Tran
Director of Impact Investing
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Eric Rice
Head of Active Equities Impact Investing
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Jae Sung, CFA
Associate Core Portfolio Manager