OCTOBER 2018

ESG and Impact Investing: Q3 2018 News Highlights

Category: Impact Investing

By Bill McCalpin, Managing Partner, Impact Investments

ESG

Institutional investor interest in incorporating environmental, social and governance (ESG) factors into investment decision making continues to grow. Callan reported that 43 percent of U.S. institutional investors surveyed in 2018 incorporate ESG information into their decisions, up from 22 percent five years ago.

Some institutional investors are not part of this trend. According to a recent NEPC survey, only a few corporate defined benefit plans have made ESG a priority in manager searches. Also, recent Cerulli Associates research found that less than half of financial advisors are using ESG related products.

More attention is being focused on the quality of ESG data and how data vendors such as MSCI and Sustainalytics use that data to score or rank individual companies. Specifically, there is debate about (a) what is measured; (b) how the rating agencies account for the absence of relevant information in their analyses; and (c) how separate scores for E, S, and G are combined for an overall rating. Different rating methodologies can lead to very different results for the same company. CSRHub, a data provider, calculates that the correlation between MSCI and Sustainalytics for ESG ratings is 0.32.

While there is little standardization in ESG disclosures in regulatory filings, public companies are reporting more information that is relevant to ESG analysis. This, in turn, is attracting interest from quantitative managers that are including the data in their models as potential new sources of investment insight.

Impact Investing

There was much talk in the quarter about impact investing “going mainstream” with news of KKR’s plans to raise a $1+ billion fund for buyout deals targeting impact-oriented middle market and lower middle market companies. TPG also announced plans to raise a second impact fund of $3 billion to follow the $2 billion fund it closed last year, now that the latter is 75 percent committed.

As more capital is mobilized under the impact investing banner, there is widening debate about “impact washing,” prompting several efforts to guard the integrity of the approach. The Global Impact Investing Network (GIIN) is developing a set of principles to guide behavior in the impact investing sector. The International Finance Corporation (IFC) has created a definition of impact investing, and the World Bank announced that it will release 13 principles of impact investing at the IMF-World Bank meeting this month in Indonesia.

There were several developments in the quarter related to measuring, reporting, and benchmarking impact results. KKR announced that it will partner with organizations such as the Environmental Defense Fund and Transparency International to track the results of its new impact investing fund. TPG will continue to use its “impact multiple of money” metric for investments in its second fund (designed with assistance from the Bridgespan Group). And the Impact Management Project, housed at Bridges Fund Management, continues to steer a network of organizations to promote common disclosure standards for impact results in order to facilitate benchmarking and evaluation of different enterprises and investments. The network includes, among others, the GIIN, the IFC, the Global Reporting Initiative, and Principles for Responsible Investment (PRI).

Impact Themes of Interest

In line with their philanthropic missions, the Knight Foundation and the Silicon Valley Community Foundation have been increasing allocations to women- and minority-owned asset management firms, while consultants, including Cambridge, Colonial, and Wilshire, continue to build out their platforms of such managers for institutional clients. Following the practice of other consultants, Marquette Associates pledged to include at least one diverse-owned manager in every equity and fixed income search it performs. Some are referring to this as a “Rooney Rule” for manager searches.

According to new research from Morningstar, firms with the best track record of hiring female portfolio managers are headquartered in California. The report cited in particular Dodge & Cox, Schwab, and Franklin Resources. The CEOs of Dodge & Cox and Schwab are both women. At the end of the quarter, California Governor Jerry Brown signed a bill mandating that all publicly traded companies with headquarters in the state have at least one woman on their boards by the end of 2019. By 2021, companies with at least five directors will need to have two or three female directors, depending on the size of the board.

Finally, opportunity zones attracted a good deal of attention during the quarter. Money has already begun to move even though the Treasury Department’s guidance to implement last year’s Investing in Opportunity Act is not yet final. The Kresge and Rockefeller foundations have committed $25 million to support opportunity fund managers with a combination of grants and investments. Several firms are planning to raise funds ranging from $100 million to $500 million. The Act allows low-income urban and rural census tracks across the country to offer tax-advantaged treatment to private capital investments. Most of the early investments are expected to be in real estate. Community groups have raised concerns over whether the new capital will actually deliver intended benefits to targeted neighborhoods, prompting calls for agreement on data, metrics, and best practices.

A variety of sources were consulted in preparing this update, including The Wall Street Journal, The Financial Times, Barron’s, FUNDfire, and ImpactAlpha.

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