ESG investing has come a long way over the past few decades. In the early stages, it was largely an exercise in exclusion, as investors constructed portfolios that avoided industries like tobacco, firearms and alcohol. The next wave was about integration and materiality—focused on questions of whether ESG factors were relevant to a company’s financial risk and return.
The third wave—a wave that is currently cresting—redirected our focus from firm to community and ecosystem, namely addressing the question of what impact a company is having on people and the world. Having moved from the fringe to mainstream, as the number of investment offerings branded as sustainable or impactful grows, so too does our general dissatisfaction with the metrics of impact and claims of materiality—topics which now increasingly take center stage. In this way, we’ve moved from values to generating value to impact, with investors asking questions, such as “how and where does my capital show up in the world?” And “am I creating not only economic value, but also the change I seek in the world?”
Impact investing is increasingly focused upon the creation of net positive impact, considering all externalities, both positive and negative. And it will now bring increasing focus on outcomes and understanding how much meaningful change we are truly creating.
In short, our investing will evolve from what we now think of as ESG to an exploration of how those approaches create change in the world. And there will be other distinctions as well:
- Impact capital will increasingly be structured as patient capital, taking the long view. Transformation doesn’t happen overnight and investors seeking to make a difference need to be mindful of that. In some cases, this will require a different mindset from how money is managed today, with investors moving from a focus on liquidity and quarterly performance to long-term holding company and fund structures. Triodos Organic Growth Fund, an evergreen fund financing organic agriculture, is just one of a growing number of such strategies.
- Measurement practices will continue to evolve and improve, integrating reporting on financial and extra-financial data. At COP26 in Glasgow, there was a concerted push by the financial community to create uniform and transparent standards for ESG measurement. That is a step in the right direction. But ultimately, science-based assessments will be needed to measure risk, return and impact in a way that will give investors an accurate picture of how their capital is being deployed and how its total performance (risk, return and impact) is assessed. The impact-weighted accounts work from Harvard Business School’s George Serafeim and colleagues, the training and certification work of Social Value International and the practices promoted by the Value Reporting Foundation are all examples of how financial and extra-financial data are being integrated to redefine our understanding of portfolio performance.
- A global perspective will be essential. A recent G7 taskforce on impact investing identified emerging markets as the biggest opportunity for impact investors. As the report’s summary put it: “The reality is that 4 billion people in emerging economies are rising out of poverty, and it is crucial they leapfrog to decarbonized technologies.” Again, for some this will represent a new way of looking at investments, presenting a generational investment opportunity from both an impact and a returns perspective.
Ultimately, all investing will—and increasingly does—consider ESG elements, as investors move to open their aperture of analysis to include a broader consideration of factors effecting total performance. As such, our investing approaches will be additive, not restrictive. They will start with fundamental investment practices and then integrate considerations of social and environmental impact. ESG Investing will build on what works with traditional investing, as augmented by greater consideration of “off balance sheet” risk and opportunity.
At its core, investing with impact—whether considered within public securities, private markets or direct equity and credit investing—will all be done with consideration of any investment approaches’ possible impact outcomes. In recognition of the fact that all capital and all companies create impact, the question is whether one manages that impact with intentionality to create net positive impact. While one can engage in direct impact investing as a specific investment approach, in this context, impact investing becomes a lens for looking at the world—not a separate asset class or “sleeve” of a particular type of investment strategy.
In a world that is drowning while on fire, the future of ESG investing will demand accountability and the capacity to make a direct connection between the investment of our capital and the creation of a material change in our communities and ecosystems. This shift will transform not only the future of ESG and impact investing, but mainstream investing and—by extension—global capital markets. Only then may our investing practices fulfill their promise to transform the world itself.
Jed Emerson is the global lead of impact investing at Tiedemann Advisors.
