I recently moderated a panel at Pension for Purpose’s excellent conference and also participated in an afternoon tea with The Good Economy to discuss the challenges around place-based investment. I’m fully supportive of the desirability of focusing pension fund money on investments which will make a difference in solving the planet’s problems. However, I wonder whether the industry bandwagon is taking over and over-complicating it for investors.
We spend a lot of time trying to distinguish the many terms used in this area: ESG, responsible, sustainable, impact, local, and the latest, place-based. I offer the hypothesis that for pension funds all of this actually comes under the heading of being responsible investors. In other words, investors should invest in sustainable business models and act as good stewards of their capital by being engaged with their investments. For any serious long-term investor, I would call that a no-brainer.
Impact investments point investors in the direction of where capital is needed to solve growing problems. Two obvious areas today are climate change and the need to address social inequalities which appear in many guises. They provide a welcome and useful service in doing so; but is it necessary to distinguish impact from other kinds of investments?
A pension fund making any investment including impact must seek a financial return which in some way assists it to achieve (or at least is not detrimental to) its target return; otherwise in law they could not invest. There are undoubtedly opportunities to be addressed in what is now pigeon-holed as ‘impact’, and adequate or in some cases superior returns to be harvested by doing so. In order to maximise the risk-adjusted return in the long-term, it is necessary to consider sustainability and engagement issues. So far, no different from any other investment. Impact investments may present issues such as scalability or a greater need to engage and partner, but they can still be fitted into the standard taxonomy of investing.
It becomes more interesting where an impact investment struggles to meet the return hurdle. I suggest that these are further to the right of the spectrum of capital pioneered by Pensions for Purpose. If they are unable to contribute by way of risk diversification to the overall portfolio return, they tip over into the category of philanthropy, and pension funds cannot invest. Other investors such as endowments and family offices who are not investing other people’s funds to match liabilities may be able to, but not pension funds.
The difficult question is of course deciding exactly where the tipping-point lies. Does government backing and involvement increase or reduce the risk? I am instinctively against investments which depend on government subsidies or support; it is easy for a future government to withdraw it at the stroke of a pen. However, as with core infrastructure, a solid and sustainable customer such as the government must lower the risk of investing. Social housing is a good example.
And what about local investment? Is that a part of impact investment, or different? I suggest it is simply a subset and should be treated similarly. It is claimed that in the poorer parts of Britain it is more difficult to generate an adequate financial return because of lack of underlying demand. In theory it should be cheaper to do business there, which should lead to some market arbitrage, but we know that in practice lack of infrastructure or simple distance can stop that happening.
Perhaps the difference with local investment is that it does require alignment and perhaps partnership with government, even if not explicit financial support. But here too I would suggest that for pension funds there is a clear dividing line between local investments which do contribute to the return objective in some form and those which don’t. They need to act as responsible stewards of capital of the former, but don’t have a remit to act philanthropically in the latter. I’d suggest that the great majority of local or place-based investments in fact fit into the former category.
Let me once again state that I am not arguing against impact investments at all. The impact industry does us a service in pointing out the opportunities for pension fund investors. However, I challenge the view that they or local (place-based) investments should be categorised separately or treated differently from any other investment.
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