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Impact investing is driving a global re-allocation of capital

26 March 2020 Benedict Mongalo, Chief Investment Officer at Novare Investments
Benedict Mongalo, Chief Investment Officer at Novare Investments

Benedict Mongalo, Chief Investment Officer at Novare Investments

As global warming and climate change accelerate, the need to ensure that human development is environmentally sustainable is an accepted imperative requiring fundamental change to the way we live - including how and what we consume, how we earn an income to fund our consumption and how we invest for the future.

The United Nations warned in its biennial assessment report last year that increasingly complex risks from global warming to pollution, epidemics and climate change threaten human survival if left to escalate. It noted that the past can no longer be relied on as a guide to the future, with new risks emerging in ways not anticipated.

Against this background, individual and institutional investors increasingly want to invest in a way that has a positive effect on the world. Surprisingly perhaps, they have found that investing with environmental, social and governance (ESG) considerations in mind can also produce superior returns.

Whereas historically financial markets where dominated by the profit maximisation approach, there is growing support for consideration of ESG factors in investment decisions - hence the prevalence of words like social return, impact investing, triple bottom line, and sustainable development goals.

Market-driven efforts to invest in assets that have a positive impact are supported by initiatives led by multilateral organisations like the United Nations and, in some countries, including South Africa, by legislation.

The United Nations enacted the UN Principles for Responsible Investment (PRI) which are a set of six principles providing global standards for responsible investing as it relates to ESG. Most big investment managers are signatories to these principles, while in South Africa, Regulation 28 of the Pension Funds Act (as amended) compels funds and boards of trustees to consider factors which may materially affect the sustainable long-term performance of assets, including but not limited to those of an ESG nature.

These factors have resulted in impact investing becoming a global trend across asset classes.

This investment wave is causing fundamental economic shifts, affecting many companies, industries and economies – either detrimentally or beneficially, depending on their environmental footprint and investor appetite for investments with a positive social impact. For example, as investors shift away from heavy industry in favour of cleaner sectors, mining companies and fossil fuels companies are losing significant amounts in investments, raising the cost of capital and placing projects in jeopardy.

There’s finally an understanding that environmentally friendly companies, as well as socially impactful and well governed businesses enjoy enhanced access to capital.

Because sustainability concerns have a growing influence over the allocation of capital, companies need to adhere to sound ESG principles to maintain institutional investor interest. The Global Sustainable Investment Alliance estimates that approximately US$30.7 trillion in global assets were allocated to sustainable investing at the start of 2018, which represents growth of 34% in two years.

The World Economic Forum’s Global Risks Report 2020 presents the major risks the world is likely to face in the coming year. For the first time, environmental issues account for the top five risks by likelihood - and the top three by impact.

It’s encouraging that fund managers and investors are responding to this worrying state of affairs.

Numerous institutional investors have divested from environmentally unfriendly projects, while banks have opted to not fund fossil fuel projects like coal fired power stations. Investors are increasingly interested in financing bankable ‘green’ projects. Activists and investors are also demanding more transparency from companies about their ESG and climate-related risks.

Institutional investors who are signatories to UNPRI are increasingly ESG activists as they require, more than ever before, their investee companies to disclose environmental impact and various inputs required for UNPRI reporting.

Indicative that pressure is mounting on corporate SA to take environmental issues more seriously is that AGMs have become a platform for lobbyists to call companies to account. At Standard Bank’s AGM in May last year, shareholders tabled and voted on a resolution relating to climate risk for the first time. The bank’s board recommended shareholders vote against the resolution.

In the end, shareholders voted down the resolution that would have required Standard to report climate risk in its activities, although it received support from 38% of shareholders. A number of institutional investors backed the proposal, including Old Mutual Investment Management and Mergence Investment Managers.

In contrast Sasol, the reported worst emitter of greenhouse gases after Eskom, refused to table resolutions on the climate crisis, denying shareholders the opportunity to vote on the issue at its AGM in late November. This despite the resolutions being backed by some of South Africa’s biggest investors.

Net inflows into sustainable investment funds in the United States almost quadrupled in 2019 to US$20.6bn, according to Morningstar. Not surprisingly, fund managers are capitalising on the demand for investments that align profits with social goals.

Bank of America, for example, announced it would invest $300 billion over the next decade in sustainable business projects. BlackRock said sustainability would be the centre of the firm’s investment approach, stating that climate change will lead to a fundamental reshaping of finance. Capital reallocation will happen quicker than expected as clients prioritise climate change.

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