Integrating AI and technology is pivotal to strengthening the case for impact investment, but portfolio managers must first learn to better communicate benefits of their strategies.
A major concern for private clients is potential risk and return of ‘impact’ investments. Portfolio managers can address this by highlighting financial performance and resilience of impact funds. Recent research from Nuoa has shown impact funds often demonstrate less market risk exposure compared to traditional venture capital (VC) funds. Impact funds had a lower market beta, indicating less cyclical performance and greater downside protection during economic downturns like the Covid-19 pandemic.
Higher ESG scores were associated with lower stock-specific drawdown risk and slightly better earnings growth and stock performance. This growing body of evidence supports the argument that impact investments can provide competitive financial returns while achieving positive social and environmental outcomes.
ESG success stories
Portfolio managers should leverage success stories and market trends in dialogue with investors. For example, the adoption of sustainability-linked bonds (SLBs) has gained momentum, with AI playing a crucial role in setting and verifying sustainability targets. SLBs link financial performance to specific sustainability goals, such as reducing carbon emissions, and impose financial penalties for failing to meet targets. This mechanism ensures accountability and helps mitigate ‘greenwashing’. Notable examples, like Enel's 25 basis points step-up for not meeting emissions targets in 2023, demonstrate financial implications of failing to achieve sustainability goals.
Additionally, outperformance of ESG-integrated investments during economic downturns reinforces financial viability of impact investing. Institutional investors reported higher returns on ESG investments compared to non-ESG investments within three years. This rapid return on investment is a compelling argument for integrating impact strategies into investment portfolios.
The concept of ‘impact alpha’, which suggests pursuing positive social and environmental impacts alongside financial returns, can enhance investment performance, is another powerful tool for portfolio managers. Factors such as attracting and retaining talent, enhancing brand reputation, and driving innovation contribute to this alpha. Although isolating the specific financial contribution of impact alpha is challenging, its existence supports the rationale for allocating resources to impact strategies.
Portfolio managers should engage in tailored discussions with investors, focusing on specific aspects of impact investing that align with their passions and desired outcomes. By addressing concerns about decarbonisation, good governance, conservation, or gender equality, managers can highlight how impact investments can meet individual investment expectations while contributing to broader social and environmental goals.
Being on the right rise of history
Opportunities are evolving as the themes of the ‘just transition’ and green transition take hold. Investing in low-carbon portfolios misses the point. Investors miss out on opportunities to help transition high polluters to low polluters, investing in critical new infrastructure and processes that ultimately improve operating margins and profits. It is exactly these companies in the real economy that need to transition if the world is to meet the Paris Agreement goals.
‘Powershoring’ is a concept taking hold among investors – moving factories to countries with clean, cheap energy. This benefits companies and the environment, creating green jobs, upskilling, and offering stable growth for businesses by reducing energy costs and risks. Brazil is a prime example: Powershoring could bring $395bn in green exports and $351bn in investments by 2032.
A productive transformation that incorporates climate resilience improves ability of vulnerable communities – and workers – to withstand or adapt to climate change and improve their attractiveness for investors. Energy-intensive industries are at risk – installations, which need to decarbonise, but manage costs to ensure energy security for their constituents, and re-skill workers whose jobs are changing. The crisis in the South Pacific territory of New Caledonia for companies like Glencore and Trafigura makes this issue obvious – Glencore is putting a transition financing strategy in place.
Education also plays a crucial role in convincing investors to adopt impact investing. Portfolio managers should provide comprehensive evidence of financial and impact performance of these investments. This includes highlighting studies that demonstrate resilience and competitive returns of impact funds, as well as sharing success stories of companies and funds that have successfully integrated ESG criteria.
Leveraging AI for transparency
AI and technology are revolutionising sustainable finance, making it easier to track and measure true impact of investments. AI’s ability to analyse vast amounts of data enables it to uncover hidden sustainability information and provide accurate assessments of a company's performance in areas such as diversity, equity, and inclusion (DEI).
By scrutinising hiring patterns, turnover rates, salary information, and employee feedback, AI can identify biases and flag underperforming departments. Additionally, AI can track public sentiment on social media regarding a company’s DEI efforts, providing insights into public perception and areas for improvement. But implementation is still at an early stage. Applications such as Fireflies unarguably save time and improve efficiency, when it comes to transcribing minutes and note-taking, but are unlikely to give companies a competitive edge. Companies like Schneider, on the other hand, are using AI to track energy use, identify efficiency gains, optimise electricity loads, and predict maintenance needs.
For investors concerned about risk profiles of their investments, AI offers a solution by cross-referencing public sources to detect discrepancies between a company's sustainability claims and its actual performance. This detailed analysis helps investors make informed decisions, reducing risk of greenwashing and aligning investments with their values.
Generative AI is often hyped but direct competitive implications for businesses are not yet clear – besides constructing better chat bots. These may be essential for travel agent, not so much for asset managers.
Leveraging AI and technology to provide transparency and accurate performance measurement, demonstrating financial viability and reduced risk of impact investments, and focusing on the concept of impact alpha would help portfolio managers to build a compelling case for impact investing. Tailored discussions and comprehensive education further strengthen this case, ultimately encouraging investors to embrace a highly transformative approach to finance.
Tenke Zoltani, founder, Better Finance
