Positive change through impact investing

There is an ongoing debate in the world of sustainable investing: can public equity investors invest with impact? We believe they can and, indeed, should.

The traditional view is that meaningful impact can only come through investing in private markets.

Impact investing dates back to the 1970s, and originally came in the form of private investors directing capital to specific ecological or socially-responsible projects. The approach has twin benefits: to generate financial returns and to deliver positive environmental and social change.

The idea that private equity is the best and most efficient way to achieve a positive impact is inextricably linked to the notion that private investors have much more control over how the capital is used.

After all, most of the investment that takes place in public equity markets (aside from the initial public offering process and secondary equity offerings) does not involve raising new funds and therefore does not direct capital in any real sense. The argument therefore follows that a minority owner of a public company can only hope to have a limited impact in comparison to a significant stakeholder or majority owner in private markets.

In some cases that might be true. However, given the scale of public markets globally, listed companies have a massive impact on the world and their shareholders have the opportunity to influence and change their behaviour for the better. Even minority shareholders can play their part, including by establishing a dialogue and taking joint action.

This is the approach we use in our Positive Change strategy, which invests not only in companies which already have a strong social or environmental footprint, but also in those which can improve their ESG credentials. We believe that companies which align themselves with UN’s Sustainable Development Goals will benefit from superior returns over time – and that we, as investors, have a part to play in encouraging them to pursue that alignment.

Let’s consider what impact investing actually is. It is defined by its objectives, not by asset type.

According to the Global Impact Investment Network (GIIN), "the primary aim of impact investing is to deliver a positive, measurable social and environmental impact alongside a financial return".

There has to be intent and it has to be measurable. This objective of impact investing is certainly possible through both private and public market investing.

GIIN further explains that an investment’s impact is a function of two things:

• The impact of the underlying asset(s)/enterprise(s) that the investment supports – described as “company impact”.
• The contribution that the investor makes to enable the enterprise(s) to achieve that impact – described as “investor impact”.

Both “company impact” and “investor impact” clearly apply to public markets as well as private investments .

Company impact

There is no clear agreement on what constitutes company impact and how this should be measured. The Chartered Financial Analysts Institute has recently weighed into the debate summarising a number of impact models into three categories:

• Impact-centred – Companies which generate revenue from activities or goods that have a direct positive impact on society and/or planet. The model relies on continued need for that product or service.
• Impact through operations – Positive impact is created from the delivery of goods & services and the operations of the company – e.g. providing employment where it’s most needed or choosing environmentally-friendly supply options. This positive impact is likely to carry an additional cost for the company.
• Cross-subsidy – Companies whose main revenue-generating activities enable them to support a sideline in a no or low revenue-generating activity, which has a positive impact.

Working with this framework, there are plenty of opportunities to invest in companies that are delivering one of more of the three types of company impact in both public and private markets.

Another area of contention is how to measure and demonstrate company impact – the efficacy of the investment.

Because private equity investors get more of a direct say in how the investee company spends its money, it may be simpler for them to prove a positive impact – for example if they instigate a specific product or service. However, private markets also tend to have much lower levels of disclosure than public ones, and less available data. So, as a private market investor, one may have more control at directing the capital but struggle to measure its impact.

With publicly-listed companies, there are still measurement challenges, but there tends to be more transparency, greater disclosure and often better tools in place to measure impact. Industry best practices are being defined and frameworks established.

For example, in 2023, some 23,000 companies disclosed environmental performance data to the non-profit environmental platform the Climate Disclosure Project, up from 9,526 in 2020. Together, they represent USD67 trillion in market capitalisation. Of those, 38 per cent provided environmental performance information on nature-based issues beyond climate. Additionally, 97 of the largest 100 companies in the world committed to reporting in line with the guidance set by the Taskforce on Climate Related Disclosures (TCFD).

Public companies attract greater scrutiny from non-government organisations and activists, and therefore from public opinion, heightening the need for transparency and robust reporting.

In our Positive Change strategy, we select three to five material and relevant key performance indicators (KPIs) of impact for each of our companies to track the change in their company impact, basing these on SDGs and on the Sustainability Accounting Standards Board’s materiality framework. That could include recycling rates for a semiconductor manufacturer, share of loans to low income groups for a bank, or reduction in plastic packaging for a supermarket.

An example of a company with a clear positive impact is HCA Healthcare, the largest provider of healthcare services in the US, operating over 180 hospitals and 2,000 sites of care.

It served 37 million patients served during 2022 – including many on state-funded programmes – and has a 6 per cent market share in inpatient services. Pictet’s SDG Alignment Indicator shows a strong positive alignment to SDG 3 (Good Health & Wellbeing) while the benefits of healthcare provision on the reduction of poverty and inequality is reflected in secondary positive alignments to SDG 5 (Gender Equality) and SDG 1 (No Poverty).

This impact-centred company can expand the scope of its positive contribution by growing its revenues while using that core business to cross subsidise the provision of beneficial services to underserved communities. KPIs material to the company’s impact include admissions of patients on the US government-funded Medicare programme and charitable care provision alongside total number of patients served.

Investor impact

While investors in publicly-listed companies might not have a seat on the board or direct management control, they do have a voice that can be used and can certainly be heard.

They can have a positive contribution in three ways.

First, equity investors can bring their influence to bear via active ownership, including direct engagement with company management and proxy voting.

Second, through enabling access to and lowering the cost of capital of companies with environmental or societal products or services.

Third, by promoting impact investments and research, investors can disseminate new knowledge and embed the principles of impact investing across the broader financial ecosystem.

Of these three, active ownership can arguably have the greatest impact. Numerous studies have analysed the effects of shareholder engagement by active asset managers. They have found that dedicated investors can be successful in raising concerns on ESG matters with companies. While the rate of success varies widely, depending on a number of factors, academic research has shown that it can be as high as 60 per cent.

Pictet Asset Management’s Positive Change team believes that there is real power in taking time to fully understand a company and then approaching the company with value-accretive objectives to drive the transition, thus accelerating the improving alignment of a company’s products and services to the SDGs or mitigating ESG risk.

Partnering with a company on this level can have a significant positive impact. While investors should avoid claiming that a successful engagement was down to their engagement alone, we should still celebrate when successful change occurs.

To amplify and maximise the impact of an engagement there are multiple options available to public market investors.

These include bilateral collaborations between different investment teams within one asset manager, or between asset managers, as well as third party led collaborations, such as those with Farm Animal Investment Risk and Return (FAIRR) , which often focus on one particular issue or set of issues.

Escalation options are many and varied, including proposing shareholder resolutions at annual general meetings or even the more aggressive approach taken by activist investors.

Selling a shareholding in a company should be seen as a last resort, signalling the failure to drive investor impact rather than actually driving change.

On the Positive Change strategy, we prefer the partnership approach: working in collaboration with our companies in which we engage to encourage and accelerate change.

Examples of successful progress towards our engagement objectives in the short history of the strategy include those with oil services company Baker Hughes, US utility PG&E and auto giant Toyota.

Take Toyota. The auto industry’s transition from internal combustion engines to clean fuels is crucial for the development of sustainable mobility and urban infrastructure. Producing 10.6 millions cars in 2022, Toyota’s scale makes it key to a successful transition.

In our view, the company has lagged its peers in the transition to zero emission vehicles despite historical technological leadership; we also identified some problems with the company's governance structure. Pictet AM established engagement objectives aimed at setting targets and accelerating investment in EV and alternative power solutions alongside others which would enhance board independence. We made our position clear by voting against management on a governance-related proposal at the AGM and communicating our rationale directly to Toyota, making clear our position as supportive shareholders seeking change.

In 2023 Toyota set an ambitious target for EV production of 1.5 million vehicles annually by 2026 alongside technological advances in solid state batteries (see chart). Moves to simplify the cross-shareholdings and the establishment of processes to improve governance also demonstrates positive progress.

Was our engagement or proxy voting the sole catalyst for change? Perhaps not. But combined with the voices of other stakeholders, perhaps we played a role and had a positive investor impact.

Even if we only play a small role in driving positive change, we feel it is our responsibility to do that.

In summary, the established definitions of impact investing certainly do not preclude public market investors from investing with impact.

Moreover, it can be argued that company impact may be even larger in public markets and, while the investor impact may have a more direct link in private investments, there are multiple avenues available to public market investors as well.

Actively engaging with companies to encourage positive change can and does have a measurable impact as well as being potentially value creative for investors.