Trend Impact Investing: Investing Money and Doing Good

Sustainability as a principle according to which no more can be consumed than can be made available again in the future creates a new awareness in many areas: Starting with nutrition and opting for organic food, through environmentally friendly mobility solutions, resource-saving construction and regenerative circular economy to investment. Die Sustainability Strategy of the German Federal Government has defined “intergenerational equality, quality of life, social cohesion and international responsibility” as guidelines. The fact that sustainable investments are a growth market is also confirmed by FNG Market Report 2020 (Forum for Sustainable Investments). According to this, “green” investments recorded growth of 23% in 2020 compared to the previous year and amounted to 269.3 billion euros. Private investments in sustainable funds rose by 96% in 2019.

Responsible investing is attractive but not always effective. It is therefore important to differentiate between two approaches: impact investing and investments based on ESG criteria. In general, sustainable investments focus not only on returns, but also on social and environmental factors and a company's control processes. Investments follow this approach in accordance with the three ESG criteria (environmental, social, governance). They stand for action in harmony with the environment, society and corporate social responsibility. However, it is often impossible to measure the concrete benefits of ESG investment forms. That's where impact investing comes in. But how do ESG and impact investing differ from each other?

ESG investments: Acting responsibly is more than just a trend

There are roughly two approaches to the ESG investment process: Exclusion or divestment on the one hand, and targeted investment on the other. In the first approach, the companies concerned are usually first screened according to the three ESG criteria environmental, social and corporate governance (negative screening). This excludes problem sectors, such as the arms or tobacco industries.

The “best in class” approach involves filtering out the companies that stand out positively in relevant areas (positive screening). These include, for example, special benefits in the area of employee management or a low CO2 footprint. The next step is to select the highest-yielding investments from the remaining investment universe.

More transparency through ESG disclosure requirements

In order to separate the wheat from the chaff in sustainable investments, investors can check, for example, whether the investment company or the asset manager is supported by the United Nations Principles for Responsible Investment (PRI) signed.

Furthermore, on March 10, 2021, the new ESG Disclosure Regulation (Level 1) in force, which is intended to make sustainability criteria more transparent. Financial institutions, funds or insurance companies must then disclose, for example, whether and how ESG criteria are taken into account in investment decisions. Or what negative effects an investment decision has on sustainability factors. In addition, the Disclosure Ordinance regulates further transparency obligations at product level in sales brochures, on the website and in regular reports.

Impact Investing: Earning money with a clear conscience?

So-called impact investing is also one of the sustainable investments. Financial market participants and investors want to achieve a positive impact with their investment. In contrast to traditional ESG investments, this is not just about avoiding critical content, but rather about achieving a concrete, measurable, positive added value from the investment. For example, in areas such as environmental protection, access to education or poverty reduction. Impact investors want to initiate social, health or ecological change with their capital investment. They define an impact target and impact logic and integrate them into the entire investment process.

Especially for millennials, investments and impact are now firmly linked. Around 95 percent of investors born between the 1980s and the late 1990s are interested, according to a Study by Morgan Stanley generally for sustainable investing. Around 67 percent already have one or more such investments. For young investors, measurability is a decisive criterion: 91 percent expect comprehensive reports on the social and/or ecological impact of their investments.

But: Sustainability is a broad field that is being explored by many investment companies and asset managers who speculate that, for example, “green” always sells — regardless of what is actually behind the alleged eco-label. Due to a lack of transparency, valid ESG criteria and definitions, there is no guarantee that companies will not simply name their financial products sustainably for marketing reasons without meeting appropriate criteria or review processes.

Since the topic of sustainability is very easy to reach customers emotionally these days, there is also plenty of scope for misuse here. For example, an investment project may well support a good cause — but this investment can still be risky and structured with a short-term return target. Customers should not be blinded by the pure promise of sustainability, but pay close attention to a balanced interplay of all factors that influence risk and return.

Sustainable product portfolio for a sustainable society

The trend towards sustainable investments could even pick up steam in the coming years due to the corona pandemic, because the crisis is causing a change in consciousness among some people. Both for corporations and investors: Companies that see social and ecological change as a challenge rather than a hurdle have the best prospects of long-term success. In turn, investors benefit from this, who can both do good with impact investing and achieve market-compliant returns.

The decisive factor will be the extent to which companies, on the one hand, long-term focus on risk minimization and, on the other hand, be able to reconcile the continuous development of the portfolio with regard to sustainable projects, so that everyone ultimately benefits: investors through continuous, stable returns and society through innovative, sustainable solutions.