Impact and Environment, Social & Governance (ESG) Investing
By Marc L. Rinaldi, CPA, Partner
Impact and ESG investing has become a primary focus of many families, institutional investors and our regulators. The pandemic has heightened this focus on climate change, health, social welfare and governance. One byproduct of this emerging sustainability focus is the proliferation of socially responsible direct private and ESG-related investing (collectively, SRI).
Based upon a recent EY survey, SRI has doubled since 2019 and is expected to double again in the next two years. Of those surveyed, 88% of all investors said they expect investment managers to explain and follow their ESG policies when making investment decisions. As to the U.S., 26% of all investors are required to invest in SRIs and another 19% expect to do so in the next year. Europe has a much higher SRI investment percentage than the U.S. with 42% currently invested and an anticipated investment in SRI of another 42% in the next two years.1
The following is a discussion of why these investments are so prolific and how families can move toward a higher level of impact in their investment and philanthropic activities.
Demonstrated Growth in Impact and ESG Investing and Why It Is Happening
Family Investors and investment managers are always interested in the investment themes that effectively attract additional capital to investment projects or funds and must assess the financial and social returns that are expected through these investments.
The primary trend driving this growth in SRI is the increased focus of families and institutional investors on ESG factors in their investment thesis. Unquestionably, millennials are currently inheriting vast amounts of wealth globally and their views matter. In Capgemini’s World Wealth Report 2020, 40% of those with $30 million or more are interested in impact investing and 43% want to invest in businesses actively pursuing ESG policies, which is expected to rise to 46% by 2021.2 This is a stark change from five years ago when families developed certain philanthropic themes, but few had SRI-related investment alternatives. The main reasons for these changes are:
- better understanding and availability of impact and ESG-related investments,
- higher returns than previously thought in ESG investments (Morningstar indicated that 70% of ESG funds generated returns in the top half of their peer group), and a
- new focus on environmental and climate risk, ethical governmental behavior, social responsibility and giving back.3
Impact and ESG Investing
Impact investing is a strategy that aims to generate specific social or environmental effects in addition to financial gain.4 Most family impact investing is based upon various goals and objectives set by the family for specific investment projects or initiatives. An impact investment thesis is in sharp contrast to ESG investing wherein the investment focus is on public corporations and their environmental, social and governance policies and performance.
A family may, however, consider a company’s commitment to corporate social responsibility or its duty to positively serve society as a whole. Such an analysis moves ESG investing closer to an impact investing concept and is much easier to execute. However, the rewards of a well-executed family impact investment plan are sometimes immeasurable for the family. More than 88% of investors indicated that their impact investments met or exceeded their expectations per the Global Impact Investing Network.
How to Best Invest in Impact and ESG Investments
A descriptive list of how to make SRI investments follows, with certain variations for impact vs. ESG investing:
- Goals and Objectives can be developed to define clearly the impact your family or charity wants to achieve through its investing. Start with a set of goals and develop a thesis as to how the family mission is achieved. Utilize risk and return criteria as a policy measurement technique.
- Impact/ESG Investment Sourcing frequently emanates from investment manager programs or via manager self-sponsored ESG funds. A thematic approach will assist the investor in defining investment projects or types of investments that are most appropriate, especially for impact investing. In addition, impact projects or themes of projects can be formulated from new ideas or historic business-oriented philanthropic projects. Morningstar has meaningful research on various ESG funds that invest in public companies as do most investment managers.
- Assessment of Risk and Expected Return is an essential process in SRI investing. The risk of a private equity or direct investment project is higher than an investment in an ESG fund managed by a large investment house. An impact investment may, however, have a much higher measured return from a “greater good” family perspective than an ESG public securities fund investment.
- Project or investment manager due diligence and the annual review process as a risk mitigation tool, includes accounting, audit, tax, investment reporting, operations and management supervising of projects or fund investments.
- ESG investing-sustainability reports have become a very useful tool in assessing investments in public companies, larger private companies and certain impact projects. These reports are based upon global reporting standards such as the UN Sustainability Development Goals (SDGs), Global Reporting Standards (GRI), Sustainability Accounting Reporting Standards Board (SASB) and various Greenhouse Gas Reporting Initiative (GHGI) and International Integrated Reporting Convention (IIRC). The World Economic Forum has attempted to amalgamate these reporting standards using its measuring capitalism methodology published in October 2020.
- Performance Measurement includes the data set of performance information which attempts to measure the impact of a project for a particular type of investment using data performance information. This process will enable the investor to measure success on both a financial and impact level as defined in the goals and objectives setting process.
- Sustainability measurements which are a source for setting data measurement criteria for certain businesses or projects.
- Select performance criteria which are comprehensive of the investment thesis and impact goals and objectives. As to ESG public securities selection, a screening process is utilized. Sources such as IRIS, SASB or other materiality standards are helpful data measurement setting tools.
- Legal Structure, Financial Oversight and Investment Term are very important when investing together with others as a limited partner, as a co-investor or in impact project finance. Manager selection is, of course, key when investing into a fund. The term of the fund is essential to portfolio liquidity management and to impact expectations, especially when investing with others.
Amplifying Investor Return and Impact
In conclusion, investors have moved beyond why they should invest in impact and ESG-related investments. A world with scarce resources and diverse social and economic circumstances requires a deeper analysis by investors in order to maximize the investor’s return and impact.
About the Author
Marc Rinaldi is the Partner-in-Charge of PKF O’Connor Davies, LLP Financial Services; Director of Family Office Investments; and CEO of O’Connor Davies Administration, LLC. He is also Senior Managing Director of PKF Funds and Family Office, which includes PKF member firms in London, Scotland and Dublin. He has over 30 years of industry experience and is a leader in the fields of sustainable investing, alternative investment accounting, reporting and valuation, due diligence and investment and portfolio performance and risk reporting. His clients include family offices, private foundations, endowments, and private equity, hedge, venture capital, infrastructure and real estate funds; and broker-dealers. Marc creatively combines alternative investment, private fund and family office global technology and accounting and reporting solutions and systems to help streamline operations and improve timely and accurate reporting.
Marc’s accounting, trading and risk management experience includes: Goldman Sachs & Co.—New York and London; Merrill Lynch International Bank, Ltd.; Kleinwort Benson, Ltd.; and Bank of America, Ltd.—London. Marc serves on the New York State Society Investment Management and Private Equity Committees and Sustainability Committee. He is a Board Member of Family Wealth Report.
Marc recently presented on the impact of socially responsible investing on family office and private foundation investors at the firm’s annual Private Foundation Symposium and Investor Symposium; at the NYSSCPA FAE’s Sustainability Investment Leadership Conference; and at The Clearview Family Wealth Forum in London.
Marc Rinaldi, CPA
Partner, Financial Services
mrinaldi@pkfod.com | 646.449.6309
———-
1. Alternative Investment Survey 2020
2. Capgemini World Wealth Report 2020
3. Capgemini World Wealth Report 2020
4. Investopedia, Impact Investing Definition