Impact funds aren’t that impactful
There used to be a clear distinction between ESG investing and impact investing. ESG investing takes into account environmental, social, and governance criteria to assess risks and identify opportunities. Impact investing focuses on the so-called triple ‘bottom line’, and tries to generate benefits for investors, the company making the investment, and the communities in which that investment is made. A classic example is financing a hospital that makes money for the health care services running the hospital, its investors, and the community that benefits from improved medical care.
The problem is that impact investing is such a good slogan that more and more investment firms have adopted it ‘informally’ to mean that their investments are trying to make an impact on the world in general. This creates all kinds of confusion, so it is worthwhile reviewing which ‘impact funds’ really create impact and which ones are merely carrying a marketing label of impact. The Evangelische Bank eG sponsored research to investigate ‘impact funds’ available in Germany and their investment approach. In total, they examined 185 funds investing mostly in publicly listed equities, but also into private equity, private debt, and microfinance.
The approach they used was to classify these funds along four different styles promoted by the G7 Impact Taskforce:
ESG-screened: Investments are screened based on a set of exclusion criteria. This is the old-fashioned approach to ESG investing and has absolutely nothing to do with impact investing.
ESG-managed: In these funds investments are screened plus additional measures are taken to integrate ESG criteria in the investment process. These are essentially what I would call modern ESG investment approaches, but they do not impact investments in my understanding.
Impact-aligned: These are funds that only invest in companies that contribute to the United Nations Sustainable Development Goals (SDG). The problem with this approach is that any company can claim to contribute to a specific SDG without having to substantiate that claim in any meaningful way. In my view, this is also not an impact investment.
Impact-generating: These are funds where the fund manager can demonstrate that and how his actions created an impact. This could be by actively engaging with company management, voting in favour of ESG proposals at AGMs, or showing how the activities financed by the investment improve the environment or the living conditions of communities. This is what I and I presume most people would consider an impact investment.
So where do we stand with funds that claim to have ‘impact’? The chart below shows that among the 185 funds examined, about two thirds are in fact just ESG-managed or ESG-screened. A further 15% are impact-aligned and only 19% are truly impact-generating funds. In other words, only one in five funds that claim to have ‘impact’ truly does something that has ‘impact’. Things get even worse if you look at the new EU regulation that allows funds to classify themselves as so-called Art. 8 or Art. 9 funds. Art. 8 funds, in short, are funds that take ESG considerations into account in their investment process. Art. 9 funds are funds that have sustainable investments or reductions in carbon emissions as their objective. Among funds proclaiming to be aligned with Art. 9 only one in ten is impact-generating while again some two thirds are simply ESG-managed.
It should be clear from these numbers that the term ‘impact’ is nothing more than a marketing term at the moment. Investors who really want to create impact with their investments should look for funds from companies that are members of the Global Impact Investing Network and carefully read the objectives of the fund. That is not guaranteed to give you a list of great impact investments, but it excludes most of the funds marketing themselves as impactful when they are not.
True investment approach of funds claiming to be impact funds
Source: Schaitza et al. (2022)