Private Debt – Scaling Up Impact Investments

    by Richard Sherry, M&G Investments

    Richard Sherry,
    Director, Alternative Credit
    M&G Investments

    Investment is required on a huge scale to address the world’s biggest challenges, such as climate change, poverty and inequality. The UN Sustainable Development Goals (UN SDGs) and the series of targets underpinning the goals, have provided a powerful global framework for all public and private stakeholders, including governments, regulators, civil society (the ‘third sector’) and the private sector, for tackling social and environmental issues.

    With an estimated funding gap of up to US$6 trillion annually needed to meet SDG targets, more needs to be done to mobilise capital on the scale required.
    Whether investing to fund the construction of a solar park or wind farm, or new affordable housing, impact investing has a clear role in supporting the aims of the SDGs by putting capital to work in investments and projects with positive real-world impact. The Global Impact Investment Network’s (GIIN) 2018 Survey suggests there are $228 billion of impact investing assets under management1 – a figure the GIIN notes serves as the latest best-available ‘floor’ for the size of the impact investing market.

    Impact funds are often small and concentrated, such as microfinance funds, and in many cases focus primarily on the impact of the investments, with financial returns a secondary consideration i.e. ‘impact first’. Although surveys signal a diverse and dynamic impact investing market, there is still some way to go before it reaches critical mass. So, how can impact investing be scaled up so that it makes a real difference?

    Increase access to impact investing opportunities

    The ‘use of proceeds’ bond format has been the result of innovation in traditional fixed income markets and there has been a strong take up from institutional investors. The market for green bonds is fast growing albeit still in the early stages of development – the global green bond universe is estimated at around $389 billion2 and is forecast to reach $1 trillion of annual issuance by 2020 – but arguably offers an imperfect ‘solution’ for impact investors.

    The breadth and depth of the market currently does not easily allow the construction of a well-diversified, institutional-scale portfolio, while the lack of global green bond standards which issuers must adhere to, has led to some concerns about ‘greenwashing’. This places the onus on investors to perform the due diligence needed to ensure the most impactful projects receive the necessary financing. New thematic bonds are starting to appear in the market, including social bonds, sustainability bonds, ESG-bonds and SDG-bonds, and even ‘blue bonds’, but issuance volume remains a fraction of the overall bond market.
    Impact investing typically does not take place in large-cap public markets as there tends to be less ‘pure-play’ impact opportunities available. However, as the GIIN 2018 survey finds, an allocation of 14% of capital through public equity demonstrates a growing practice (and acceptance) of impact investing through publicly-listed equities. By adding a third dimension – ‘impact’ – to traditional risk-return analysis, it is possible to invest in companies that will have some positive impact, particularly compared to peers.

    Catalyse collective action

    Together with the UN’s call to action with the SDGs, there are several key global and public-sector sustainable finance initiatives that look set to promote the growth and development of the impact investment market, including:
    The PRI’s Sustainable Development Goals (SDGs) agenda:
    The UN-supported Principles for Responsible Investment (PRI) have included the SDGs and impact investing as part of their aim to bring responsible investors together over the next 10 years to work towards sustainable markets that contribute to a more prosperous world for all. This includes setting out steps and developing tools for investors to align their investment activities with the SDGs and introducing the SDGs into the PRI Reporting Framework.

    The Global Impact Investing Network (GIIN):

    There is positive momentum behind impact investment, yet impact investing is still a relatively small, niche area of broader investment practice. In its report, “The Roadmap for the Future of Impact Investing: Reshaping Financial Markets”, published in March 2018, the GIIN presents a vision for more inclusive and sustainable financial markets and articulates a plan for impact investing to lead progress toward this future.

    European Commission’s Action Plan on Financing Sustainable Growth:

    The High-Level Expert Group (HLEG) on sustainable finance appointed by the European Commission (EC) to help develop an overarching and comprehensive EU roadmap on sustainable finance, is one public sector initiative that is helping to steer private and public capital towards sustainable and impact investments. The Commission adopted a package of measures in May as a follow-up to the recommendations announced in its Action Plan, with all actions, including the development of an EU taxonomy on sustainable finance, set to be rolled out by Q2 2019.

    A multi-theme approach

    As policymakers, regulators and international organisations continue to push the sustainable finance agenda forward and look for ways to mobilise private capital on the scale required, the current impact investment market offers a ready supply of diverse and viable opportunities that can help to tackle the world’s most pressing social and environmental issues.

    Pension funds, insurance companies and other institutional investors can already put their capital to work in multi-theme private debt impact strategies that target positive impact and offer attractive returns in excess of public markets for equivalent risk – often referred to as an illiquidity premium.

    Private debt investments that generate clear environmental or social impact can be across a range of maturities and different asset types, for example this could be in the form of a private loan to finance the construction of a solar park or wind farm, or new affordable housing, hospitals or university facilities.

    Why private debt for impact investing?

    • More ‘pure-play’ impact investment opportunities than public market
    • Ability to directly negotiate covenants and other investor protections
    • Potential for attractive returns given relative illiquidity and complexity
    • Close dialogue with borrowers that could help:
      • ensure the investment delivers a positive impact and preserves capital
      • foster engagement to address ESG issues, improve impact reporting and mitigate risks

    Having access to a broad range of asset types from which to source opportunities is essential to be able to build diversified portfolios and remain selective about which assets make it into a portfolio. Investing in sustainable private assets also requires detailed knowledge of environmental and social standards, as well as the resources and expertise in asset sourcing that an experienced active manager can help deliver. Bespoke private assets are often held to maturity, so they require careful analysis, documentation and monitoring to ensure high credit quality and positive impact generation throughout the life of the investment.

    We assess an impact asset as we would any other asset in the private debt universe, with rigorous and detailed credit analysis and making investment decisions on a relative value basis. The only difference is that we carry out an impact assessment at the same time, using criteria we have developed in conjunction with a leading sustainability advisor. Impact can be measured through tangible outcomes such as the megawatt-hours of electricity a solar park generates or the reduction in carbon dioxide emissions as a result of the construction of a new renewable energy project. Assessing and quantifying impacts such as these are integral to our analysis and due diligence prior to making an investment.

    Read this article and about 5 other Sustainable Fixed Income strategies, and more in this NordSIP Handbook.

    Image © Shutterstock


    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

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