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Why impact investing is important in Canada

Jennifer Vieno, CFA

CFA Society Toronto hosted a panel of impact investing professionals to discuss this rapidly evolving subset of capital markets. The forum, moderated by Lindsay Wallace, Senior Vice President, Strategy and Impact at MEDA, consisted of Catherine Marshall, CFA, Principal at RealAlts; Eric Wetlaufer, CFA, Managing Partner at TwinRiver Capital; and Narinder Dhami, Managing Partner at Marigold Capital and Co-Founder of New Power Labs. This article summarizes some key highlights from this engaging discussion. 

What differentiates impact investing from ESG investing?

Intentionality is the main differentiator in impact investing. In impact investing, investments are made to generate social and environmental impacts alongside financial returns. The focus also differs, with environmental, social, and governance (ESG) investing focusing on the ESG footprint of a company and how it operates its business, and impact investing targeting the company’s output: the products and services they create and their net result. 

An investment example in practice: Coca-Cola

An ESG investor might determine that Coca-Cola is managing its ESG risks with appropriate policies, committees, and commitments to reduce water and electricity use. Meanwhile, an impact investor examining the company’s significant outputs, sugar and plastic, might have a more negative view due to the impact of these outputs on society.

The evolution toward the focus on outcomes

At first, companies looked to leverage the  Sustainable Development Goals (SDGs) and other similar criteria to show they were doing better than other companies and deserved investor capital. However, this led to investors becoming jaded, given the lack of consistency in claims with no comparability or transparency. Next came the advent of organizations such as  IRIS SASB, and the  PRI to bring consistency, transparency, and comparability to this information; this fostered an obsession with processes and left some wondering about the outcomes of their investments. 

Private markets are somewhat more advanced in their focus on reporting outcomes, with the Global Real Estate Sustainability Benchmark (GRESB) that requires participants to track data, including emissions, water, and waste, in a consistent and reportable way. Companies must measure and compare these data points on a year-over-year basis, which is scored and rated against their peer group and serves as a meaningful benchmark.

Measuring the impact

Overall, much more needs to be done to reach alignment on what to measure and how to measure, build better benchmarks, and encourage the industry to be much more consistent regarding impact transparency. Conversations about impact are not possible without measurement. There are many tools and systems used to calculate impact elements, including quantifying who experiences the impact and by how much. There is an opportunity to use software that can provide precise measurements related to other ESG issues such as climate change, which is flexible enough to use for other data such as impact. The value of measurement could be supported by embedding the processes that are correlated with impact outcomes in a systematic way. Investors could then measure the process used and the desired outcomes and continually enhance the investment process to get closer to the desired outcome. 

What is the state of play in Canadian impact investing?

The Canada Forum for Impact Investment and Development (CAFIID) published its  2021 State of the Sector report reviewing private Canadian impact investing in emerging and developing countries. There is a strong alignment with the SDGs, with some governments viewing impact investing as a way to achieve selected SDGs. The report also found that gender lens investing was a significant focus, with almost two-thirds of impact investors utilizing this approach. 

CAFIID’s report highlighted three recommendations to increase impact investing: 
1) Catalyze impact investing in developing economies by growing the ecosystem
2) Investigate how to advance Canada’s leadership role in gender investing in the world 
3) Find ways to increase transparency and comparability of measurement 

To see the current state of impact investing in Canada, refer to the Table of Impact Investment Practitioners’ (TIIP) inaugural report, Impatient Readiness: The State of Social Finance in Canada, which provides an overview by province and issue base.

Canadian retail investors tend to be left out of the space completely, with no available retail impact investing products; this contrasts with Europe, where there are many options available. One potential explanation for this absence is the concentration of retail assets in a small number of financial institutions in Canada. These institutions tend to move slowly, are not particularly innovative, and often wait for a first mover.

A second explanation is that trustees, such as pensions and insurance companies, are not allowed to consider non-financial criteria unless they can be proven to enhance the investment. However, institutional investors outside of Canada invest in SDG funds and conduct impact investing while also operating under the same fiduciary duty requirements. A notable legal opinion by Randy Bauslaugh, Climate Change: Legal Implications for Canadian Pension Plan Fiduciaries and Policy-Makers, published by McCarthy Tetrault, concluded that pension fund trustees have obligations to consider climate change as part of their fiduciary duty, which allowed pension funds to very quickly change the way they were investing and incorporate climate change risks. A legal opinion of similar weight may be necessary to show how impact factors can create a financial benefit. Some pension funds in northern Europe have made the case that investing purely for economic reasons would provide retirees with a nice income in a world that is non-livable. 

Challenges for impact investors 

One main challenge in the finance industry is that the managers’ evaluations focus on their ability to generate returns, particularly active returns. Allocators have difficulty adding evaluation of impact as a second and equally, if not more, critical screen of returns compared to financial criteria, as the current machinery defaults to metrics such as alpha, up and down capture rates, and benchmarks.

In conclusion: Don’t let perfection be the enemy of the good

Measurements are getting more useful as an increasing number of companies and projects are producing measurements. Without increased standardization and transparency in impact reporting, there is the risk of “impact washing.” However, there is as much danger in letting perfection be the enemy of the good; if you wait for the perfect measurement scheme, you’ll never invest a dollar for good. The time to begin impact investing is now. CFA_Toronto_RGB Milly

Jennifer Vieno, CFA, is ESG Research Manager, Technology, Media and Telecommunications at Sustainalyics, as well as the Co-Vice Chair of the CFA Society Toronto Member Communication Committee.

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