INVESTORS should be aware of the impact their investments could have, both to be able to align with their values and preferences and to help make better judgements of the likely future performance of the company.
To do this requires two key considerations: how the company operates and the goods and services it provides.
Highlighting and separating these two aspects reveals a common confusion for many investors interested in impact investing.
Investors can negatively view companies whose goods and services produce harmful effects on people or the planet, but these companies can be seen positively by ratings agencies whose assessment is based primarily on how they operate.
However, it’s important that these two aspects are distinct.
With the rise of the UN Principles for Responsible Investing, signatories commit to take into account companies’ operating practices in their investment decisions.
These considerations split into three general categories: environmental, social or governance, which are generally abbreviated as ESG.
The core premise is that by considering these ESG factors an investor will take in a broader set of data and be able to make a better judgement about the financial performance and longer-term health of a company.
In essence, considering these factors helps identify where a company can be at risk or have an advantage relative to its peers.
To support these assessments, data firms and ratings agencies now collect and report on ESG data.
However, only considering this aspect of a company’s impact highlights one of the key confusions, that ESG is the same as impact.
It is part of it but ESG focuses primarily on how a company operates while impact includes how a company operates as well as what that company produces.
The goods and services a company produces can go on to have a negative or positive effect on society and the environment. It is up to investors to decide whether and how to factor this impact into their investment process.
On the one hand, companies can make products that pollute the environment or are harmful to people. Some investors avoid these companies for ethical reasons. But considering their impact, and therefore likely longevity, can be useful even where personal or moral considerations are not as signi?cant.
On the other hand, companies are creating business opportunities by solving social or environmental challenges. Some are bene?ting from societal trends that generate demand for new products – such as ageing populations seeking healthy lifestyles – and others have set out speci?cally to address larger challenges, such as climate change.
Even companies with negative impact are seeking to transition to ones that have longer-term viability.
Even though there is new potential value in the companies tackling urgent societal challenges, most companies provide goods and services that, on their own, are not necessarily doing that. This is why we would encourage investors to seek companies considering both negative and positive outcomes of their products.
Considering the impact of the company in terms of both its operations and outputs is at the core of impact investing. If investors want their portfolios to be invested for impact, they should hold listed stock or bonds in companies that address social and/or environmental challenges and trends, which can be identi?ed through revenue generated by their goods and services, and companies with strong governance, risk management culture and sustainable practices, which can be identi?ed through ESG data.
It is possible and desirable to include impact considerations when investing into listed securities. It is important to remember that investing with impact in mind can be catalytic, as it encourages behavioural change among businesses driving them to think about their overall outcomes beyond the immediate bottom line.
In the end, all companies generate an impact both from their outputs and how they operate. To consider both exempli?es our view of impact investing - generating ?nancial returns and societal impact to protect and grow assets while making a positive contribution to the world.
John Godfrey is director at Barclays Wealth & Investments, Scotland.
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