Your Questions Answered: a quarterly Q&A series featuring the top 10 questions that clients and prospective clients ask our investment teams.
What is the difference between impact and ESG investing? How big is the investable universe? These are just a couple of the most commonly asked questions about our Impact Opportunities capability. We recently sat down with the team to tackle some of these most pressing questions.
- What is the difference between impact and environmental, social and governance (ESG) investing?
ESG investing considers financially material environmental, social and governance factors alongside traditional financial metrics in investment analysis and investment decisions.
Impact investing can be defined as identifying companies which can generate positive social or environmental outcomes in addition to financial gains. Impact investors typically use the UN Sustainable Development Goals (SDGs) as the framework for targeting investments. The three key concepts which distinguish impact investing from conventional investing are:
- Intentionality: an investor's intention to have a positive social or environmental impact through their investments;
- Additionality: fulfilling a good cause beyond the provision of private capital; and
- Measurable impact: being accountable and transparent in reporting on the financial, social and environmental performance of investments.
- How big is the investable universe?
Our benchmark, the MSCI ACWI Investable Market Index (IMI) is broad, with 8,768 constituents across 23 developed-market and 26 emerging-market countries.
The first - and simplest - stage of our process is to filter out companies which don't meet our liquidity criteria (that is, $5m+ per day). Subsequently, we eliminate the stock opportunities which do not meet one of our nine impact themes. These nine themes are: water, food security, health & wellbeing, education, financial inclusion, future mobility, impact enablers, energy transition and the circular economy. We believe that there may be as many as 1,000 companies within the investment universe which have some link to our themes. However, when we check for relatively material exposure and assess for some degree of intentionality, the number of stocks narrows to about 200 names. Assessing broadly for measurability (ability to quantify impact) brings us to around 100 stocks. Of that group about 10 companies are fully researched and closely monitored. We are then ready to add one of these fully researched stocks to our portfolio when they fall to a certain price level, or when there is more upside than one of our existing holdings. The remaining 90 companies are also followed, with new impactful companies coming onto our radar at regular intervals.
- How impactful can you be in public markets?
As recently as the early 2010's, impact investing was considered the preserve of philanthropy and private markets. While that is still a big factor today, the sheer scale of public equity markets allows for genuine impact. The market capitalisation of global public equity markets is about $60tn[1] - and the estimated funding gap for achieving the SDGs is between $25-30tn[2]. As such, it is essential that public-market capital is directed towards solving the structural, underserved needs of society.
Figure 1. Directing public-market capital to society's underserved needs is an imperative
Source: The UN
Equity markets also provide investors with the opportunity to invest in impactful companies in a liquid, scalable and accessible way. As public equity impact funds grow, and as capital is channelled towards impactful companies, it helps to reduce the cost of capital for these companies.
In addition, investors can also be impactful in public markets by promoting change and accelerating impact through active and sustained engagement. Our Impact Opportunities Fund has active, best practice stewardship at its core. We engage, alongside our stewardship team, EOS at Federated Hermes, to help businesses become more impactful for the wider benefit of the society and the environment.
- What makes the Impact Opportunities Fund stand out from its peers?
By pioneering sustainability and investment since our 1983 inception, the international business of Federated Hermes has been working to deliver long-term portfolio returns from purposeful companies and positive outcomes for decades. Our Impact Opportunities Fund was a natural extension of our longstanding commitment to deliver Sustainable Wealth Creation that enriches investors, society and the environment - for current generations and those to come. Our vast experience in sustainability and investment ensures we are pioneer in the impact investing space.
As the world faces a myriad of challenges from climate change and biodiversity loss to health pandemics, we believe it is essential to mobilise capital to address the underserved needs of society and deliver strong long-term investment returns. As a pure impact fund, we therefore invest solely in measurable, sustainable impact. Through a combination of thematic and impact investing, we seek to capture opportunities created by megatrends - and our robust process considers a company's impact metrics alongside its financial metrics.
Meanwhile, our rigorous impact assessment quantifies the positive impact of each of our holdings. As such, we can demonstrate to investors how their capital allocation has made a contribution to the attainment of the SDG targets.
We believe that integrated and collaborative engagement with companies is necessary to deliver impact, and we are fortunate to have in-house expertise from EOS at Federated Hermes, a global leader in stewardship.
What's more, we define ourselves as patient capital investors because we aim to outperform the broad global equity market by investing in what we deem to be best-in-class companies that seek to create positive, sustainable impacts over the long term. In this way, we aim to invest in future leaders today and capture the growth opportunities of tomorrow.
To find out more about our Impact Opportunities capability and for a deeper dive into the teams' nine impact themes, read the full Your Questions Answered here.
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[1] Source: UNCTAD World Investment Report, 2014.
[2] Source: Bloomberg - referencing the market cap of the MSCI ACWI Investable Market Index.
