The Most Important Trends in Impact Investing for 2021

Mercer David Fanger

Capitalism is one of humanity's greatest inventions. It's an unparalleled source of individual freedom, prosperity, and innovation. And yet this is a difficult time. We continue to burn fossil fuels as if there's no tomorrow. In many places, social mobility has declined dramatically. In the face of such monumental challenges, what can we as concerned individuals do to make a difference? Thankfully, the ways are many: by making personal decisions like conserving energy, by donating to nonprofits like World War Zero, by voting for political leaders aligned with our values, and by purchasing from companies committed to creating social impact. And, perhaps most powerfully, by becoming an impact investor, explained in greater detail below.

Mercer, the world's largest investment consultant with over US $15 trillion assets under advisement, defines Responsible Investment (RI) as "the integration of Environmental Social Governance factors into investment management processes and ownership practices in the belief that these factors can have a material impact on financial performance." Investors take many different approaches to RI and each of these approaches is typified by the use of certain investment methods. Key approaches include:

  • Socially Responsible Investment (SRI): SRI investors typically desire to align their portfolios with their values. Some also wish to use their investment dollars to promote social change. The investment methods most often used to achieve these aims are negative screening (a.k.a. divestment) and active ownership (e.g. the filing of shareholder resolutions).
  • Environmental Social Governance Investment (ESG): ESG investors are typically looking to add value through the integration of ESG factors into their investment processes. Increasingly, ESG investors will also employ other techniques to harness this value, including positive screening, thematic investing, and active ownership.
  • Impact Investment: Impact investors strive to achieve positive environmental and social impacts with their dollars, alongside a financial return. Most often impact investors target a sustainability theme(s) to generate their ideas.

Mercer established an RI team in 2004, which develops and delivers intellectual capital, advice, tools, and solutions to facilitate the incorporation of ESG factors in client investment policies, processes, and portfolios. Today, Mercer's US RI business is led by David Fanger. We caught up with Fanger and posed a few questions about the biggest investment opportunities that both make a difference and have the potential to turn a profit.

WW0: What originally got you interested in impact investing?

David Fanger: My interest has been values-driven since childhood. Growing up with type 1 diabetes in a low-income household made it financially difficult for my mother to afford the necessary prescriptions. This fostered a purpose-driven mindset at a young age and also drove empathy as I realized others, too, may have similar experiences. Then, as an adult working in financial services, I began to see this pattern that employees want to work for purpose-driven companies and consumers want to purchase purpose-driven products and services. I shifted my investment career towards impact investing after realizing the lack of options there are for people who want to invest with impact.

WW0: What do you hear from investors about why they want to be part of impact investing?

David Fanger: Investors wanting to be a part of impact investing often are values-driven, purpose-driven or mission-driven. They seek to make a social and environmental impact alongside a competitive risk-adjusted financial return. It is common for investors to measure their impact tied to the United Nations 17 Sustainable Development Goals, which are social and environmental goals that represent the world's to-do list from now through 2030.

Mercer was the original consultant to the UN in the development of the Principles for Responsible Investment (PRI) and a founding PRI signatory. As a signatory to the PRI, Mercer recognizes that ESG issues can be material to investment performance, and has made a commitment to providing services that support the implementation of these Principles. My role on Mercer's global RI team is leading the US RI business.

WW0: What role do you think the private sector will play in the fight against climate change?

David Fanger: The private sector portfolio allocation for institutional clients is material. Access to climate data in private markets is in demand by institutional clients looking to align their portfolio with climate transition goals. Currently, there are limited data providers for private markets' climate data. I expect that to improve as we continue to experience demand for both climate data and climate-related financial disclosure.

WW0: When someone makes a social impact investment, should they expect to see lower returns?

David Fanger: Sustainability-themed investing can provide investors with access to new opportunities not otherwise captured by traditional investment approaches. Early evidence shows that investing for impact does not necessarily entail a return sacrifice.

A 2015 study by the Morgan Stanley Institute for Sustainable Investing compared the performance of actively managed sustainable mutual funds and sustainable separately managed accounts (SMAs) in the US to their traditional peers in the same asset class over a seven-year period. The findings revealed that both equity and fixed income sustainable mutual funds displayed returns in line with, or above, the median returns of comparable traditional funds over time, both on an absolute and risk-adjusted basis. Sustainable equity SMAs performed in line with their traditional peers on a risk-adjusted basis but returns slightly lagged their peers on an absolute basis. The study concluded that "sustainable investments often exhibit favorable return and risk characteristics compared to their traditional peers."

WW0: When researching impact investment opportunities, what do you personally look for?

David Fanger: Recommendation of an impact investing strategy for a client partly relies upon Mercer's Global Investment Manager Database, which provides both outperformance ratings and ESG ratings. Specifically, with impact investing we also aim to align with the Operating Principles for Impact Management, which address intentionality, additionality, and measurability by mapping to widely accepted sustainable goals, e.g. the UN Sustainable Development Goals, sustainable measurement frameworks, e.g. the Impact Management Project, and measurement of social and environmental performance of an investment, e.g. IRIS catalog of metrics.

WW0: What are the various ways that individual investors can invest in Impact?

David Fanger: Although Mercer typically advises institutional clients, individual investors can access impact investing solutions via various vehicles, including mutual funds, Exchange Traded Funds (ETFs), or separately managed accounts. Some are available through online retail financial technology platforms. The Rockefeller Foundation published a relevant report titled The Individual Imperative: Retail Impact Investing Uncovered.

WW0: Mercer released a new tool that relates to impact investing and climate change. Please tell us how it works and why you have created it.

David Fanger: We've already had over a 1°C increase in average global temperatures on pre-industrial averages. According to current science, in as few as 30 years, we could soon be facing a 2°C increase -- a climate humans have never experienced and one that hasn't occurred on earth for millions of years. This is described by the Central Banks and Supervisors Network for Greening the Financial System (NGFS) as a society living in a "hothouse world." This crisis puts the need to address transition squarely on today's to-do-list alongside a 1.5°C global climate ambition and supporting the UN's "decade of delivery."

Mercer's Analytics for Climate Transition (ACT) tool enables investors to assess and rank emissions intensity, transition capacity, and green revenues in the portfolio. Central to this assessment is portfolio-wide consideration of the transition capacity to align to a 1.5°C global warming target. Mercer's ACT assessment draws on multiple data providers and metrics to assess portfolios across a spectrum from gray to green investments.

The Mercer analysis is designed to provide investors with a portfolio-wide view of the emissions reduction needed to meet a net-zero target and to plan the changes required to the portfolio in order to transition. The results are intended to guide investors to assess where emissions reductions could come from, compare different strategies, engage with asset managers, and plan for making portfolio changes to reduce emissions. The goal is to reduce the greys in a portfolio where there is potentially high-stranded asset risk, grow the green solutions that will help facilitate a low-carbon transition, and finally steward the assets that are "in-between."

Mercer can advise on a transition action plan as a natural next step for investors that have undertaken climate change scenario analysis. Mercer's decade-long investment experience with climate change scenario analysis and modeling, along with its collaboration with climate-change leaders globally -- clients we call "Future Makers" -- is documented in Investing in a Time of Climate Change — The Sequel and Investing in a Time of Climate Change.

WW0: What do you think will be the most important trends in impact investing for 2021?

David Fanger: Mercer's annual themes and opportunities paper, entitled The Great Acceleration, addresses one key theme in 2021 related to impact investing expressed as "position for transition."

Investors looking to mitigate risk should position for transition by developing a total portfolio climate-transition plan, which reviews their portfolio holistically to assess its ability to weather the move to a sustainable future. They can then develop a path to a more robust alternative portfolio, one that manages the "gray" transition risks, targets more "green" investments, and stewards the "in between."

Though the UN Sustainable Development Goals (SDGs) have a broader purpose than informing investment decisions, they are a useful framework for health-checking investments in the decade of delivery. We suggest investors consider SDG-aware investing, with a particular focus on SDG 7 as developments aimed at reducing the cost of production and storage of renewable energy accelerate, fueling the energy transition. We are seeing investor flows accelerating into sustainable funds (money talks, markets listen), marking a turning point in overall investor sentiment toward sustainability.

WW0: During the Trump Administration, many turned to impact investing as a way to contribute to the things the government wasn’t doing. What did you hear from investors? Did anything surprise you?

David Fanger: There is a growing focus on impact investing as an investment strategy, as evidenced by the size of the impact investing market, which has grown from US$ 60 billion in 2014 to US$ 715 billion in 2019, according to the Global Impact Investment Network.

Not only have US sustainable funds already set a calendar-year record for the fifth consecutive year, but they are also on track to double their 2019 flows.

According to the US SIF Foundation's 2020 Report on US Sustainable and Impact Investing Trends, sustainable investing in the United States continues to expand at a robust pace. Total US-domiciled assets under management (AUM) using environmental, social, and governance (ESG) strategies grew from $12 trillion at the start of 2018 to $17.1 trillion at the start of 2020, a 42% increase. This represents 33% -- or 1 in 3 dollars -- of the total US assets under professional management.

WW0: Some Exchange Traded Funds (ETFs) have outperformed the market in the last year, do you think there’s still enough upside to investing today?

David Fanger: As the UN has stated, we are in the decade of action and delivery. So many are setting social and environmental pledges and regulations, including net-zero emissions goals. Some estimate that achieving the UN Sustainable Development Goals could open up US $12 trillion of market opportunities, and action on climate change would result in savings of about US $26 trillion by 2030. (Business and Sustainable Development Commission, 2017; Better Business Better World; and, Report of the Global Commission on the Economy and Climate, 2018).

To achieve the ambitions of the Paris Agreement and the Sustainable Development Goals, new infrastructure must be sustainable, low-carbon, and climate-resilient. The New Climate Economy estimates that from 2015 to 2030, the global requirement for new infrastructure assets will be US $90 trillion, more than the value of the world's existing infrastructure stock. Current infrastructure spending of US $2.5 trillion to US $3.5 trillion per year across both the public and private sectors is only about half the amount needed to meet the estimated US $6 trillion annual infrastructure demand.