The financial sector is undergoing a long overdue renewal. Sustainable investments are on the rise and are increasingly in demand from private and professional investors. Some traditional financial players are still sceptical, as they fear lower returns. However, this fear is unfounded, as various studies show impact investing and returns are not mutually exclusive.
Impact investing is the term used to describe investments in companies, organisations or funds with the aim of generating a positive financial return as well as a positive effect on the environment or society. This social or ecological effect is an integral part of the investment strategy and is measured - like financial success. More on this below.
Impact investing thus includes a whole range of investments that focus either on social or environmental aspects or on compliance with responsible corporate governance. The latter includes the observance of labour rights, the fight against corruption and respect for human rights, while the former impact investments focus on ecological aspects such as reducing CO2 emissions, promoting renewable energies or reforestation projects.
For a long time, the motto for financial customers was to invest in the products that their bank or financial advisors recommend and which promise the highest chance of being financially secure in old age. These were often funds that invested their capital in products that customers did not know about and did not want to know about. However, more and more customers are becoming aware of their power to coordinate with their wallets, as they have been doing for some time now in car dealerships and supermarkets.
Initially, the trend was limited solely to excluding negative influences. This means, for example, that the customer of a bank did not want his money to go to developing countries in business with weapons, fossil fuels or exploitation of cheap labour. This trend catapulted, for example, GLS Bank from Bochum out of a niche into the top 20 cooperative banks in the country (website in German) - even though bank customers there pay comparatively high fees for their accounts.
From the initial negative selection, the desire of private investors, but also institutional investors such as family offices and asset managers, to actively promote certain areas is now growing. Thus, financial investments are now sprouting up from the ground that have quite consciously committed themselves to a goal, such as complying with the UN climate targets by promoting renewable energies, preserving biodiversity by supporting reforestation projects or a rapid turnaround in traffic by supporting e-mobility.
“The growth in the market for sustainable investments is driven primarily by institutional investors. But private investors are also making significant gains. Many of them feel a responsibility to leave a world worth living in and a sustainable future for coming generations. This is why they are paying more and more attention to what their money is being used for when selecting their investments.” Volker Weber, Chairman of the Forum for Sustainable Investments (FNG)
Sustainable investments are rightly at the top of the agenda for many investors," says Volker Weber, Chairman of the Forum for Sustainable Investments (FNG). According to the latest FNG industry report, the volume of sustainable financial products worldwide rose from around 171 billion euros in 2017 to more than 219 billion euros in 2018, an increase of around 28 percent.
These are "funds that are managed in accordance with environmental, social and responsible corporate governance criteria," writes Weber, in the WELT supplement Personal Finance: Analysis (website in German). The growth is even stronger in sustainable investment funds, which increased by 48 percent in the same period. The FNG assumes that this trend will continue. The boom in sustainable investments is driven on the one hand by increasing demand from customers and on the other hand by the politically determined course.
The European Union, for example, has committed itself to becoming climate neutral by 2050 in order to comply with the decisions of the Paris Agreement. In addition, the EU Commission has approved the world's first "green" classification system for sustainable economic activities (taxonomy). The Taxonomy Regulation creates a general framework for the step-by-step development of an EU-wide classification system for environmentally sustainable economic activities.
With the help of this taxonomy, climate goals are to be achieved and customers are to be protected from "green labeling fraud" (greenwashing). The EU decisions have far-reaching implications for the financial market, which is striving to achieve these provisions by increasing the supply of sustainable investments. Institutional investors, in particular, are therefore attaching increasing importance to including sustainable investments in their portfolios or to setting up corresponding funds.
Many private and institutional investors interested in impact investing often have doubts as to whether a sustainable investment is compatible with a normal market return. These doubts prevent them from investing more in sustainable investments. According to this view, impact investing would be in a grey area somewhere between philanthropy and classic, return-oriented investing. But does impact investing really always come at a price that translates into a lower return?
Most investors compile their portfolios according to modern portfolio theory. According to this theory, there is always a relationship between risk and return between all financial investments. The riskier an investment, the higher the return and vice versa. In theory, there is always a composition among all investments that perfectly balances a portfolio (depending on the risk aversion of the investor).
Unfortunately, modern portfolio theory focuses only on financial returns and makes no statements about social or environmental aspects. Classic, yield-oriented investors view impact investing with scepticism because they are convinced that a shift away from a classic risk/return ratio by definition increases the financial risk of the portfolio. In other words, the investor takes a higher risk without receiving the usual market return in return. But is this assumption correct?
"In impact investment today, we are experiencing a phase in which we experiment and provide proof of concept. I have no doubt that we will be successful, just as I had no doubt that we would be successful with venture capital. But this time for the sake of impact: It's about good business and good deeds at the same time." Sir Ronald Cohen, British businessman who is considered both the "father of venture capital" and the "father of social investment"
An analysis by Forbes magazine comes to the conclusion that it is often a misconception that financial market players believe that impact-oriented investing can only be achieved by cutting back on returns. Forbes quotes from two exciting studies that have taken a closer look at impact investing.
The first is by Jeff Finkelman, vice president at Athena Capital and is called building impact portfolios. Finkelman concludes that there is an area of the financial market where investors can find investment opportunities that have a social or environmental impact while providing a financial return that is in line with the market. Here, investors could find impact-oriented investments "free of charge" without sacrificing returns.
The second study by researcher Rachel Browning is an investor survey in the Scandinavian countries from 2019, which covered 83 professional investors, including business angels, family offices, venture capital companies and institutional investment funds. The result astounded even the researchers: the vast majority (83 percent) of these professional investors expected their impact investments to yield financial returns in line with or even above the market average. The investment focus of the investors surveyed was on healthcare, the promotion of renewable energies, industrial innovations and sustainable solutions for urban areas (smart cities).
"In impact investment today we are experiencing a phase where we experiment and provide proof of concept," Sir Ronald Cohen, the British businessman who is referred to as both the "father of venture capital" and the "father of social investment", is quoted in a PHINEO report (website in German). "I have no doubt that we will succeed, just as I had no doubt that we would succeed with venture capital." The question was how to inspire the millennial generation to repeat what they have already achieved in the technological revolution: "But this time for the sake of impact: It's about good business and good deeds all at once."
But how do you measure these good deeds? How do you measure the social or environmental return of an impact investment? The Sustainable Development Goals of the United Nations (SDGs) provide a framework of orientation by means of which the world has agreed on fields of activity to which a high normative urgency is attributed. Although this framework does not claim to be exhaustive, it does provide a helpful starting point. It also offers investors a range of methods and tools with which they can demonstrate the positive impact of an investment. These include the Impact Management Project, the Social Return on Investment (SROI) method, the IRIS catalogue or the Social Reporting Standard.
In any case, two aspects must be clarified before any impact investment is made. First: Can the investment object (company, fund or organisation) achieve the ethically desired effect at all? And secondly: Does the investment really achieve the intended ethical effect? Especially in order to measure the social or environmental impact of the investment, clearly defined goals must be set in advance. These goals vary depending on the desired effect on society.
An example: If an afforestation project is concerned with the preservation of a plant species threatened with extinction, the impact would be measured in the number of trees planted. If, on the other hand, the same project was about CO2 reduction, it would have to be determined in advance how much carbon dioxide this tree species can bind. In the end, however, the number of trees planted rather than the amount of bound CO2 would be the indicator for the success of the impact investment.
A second example: If an investment involves the promotion of renewable energies, the ecological return could be measured, for example, by how many kilowatt hours of electricity were generated by the projects implemented. After all, with every solar power plant and every wind turbine, the share of renewable energies in the total electricity generation of an economy increases.
The Vereinte Energiegenossenschaft eG (VEG) from Hamburg, founded in 2013, is committed to the expansion of renewable energies and is also involved in the areas of energy efficiency and energy storage possibilities. To this end, VEG, together with its already more than 450 members, operates and finances block-type thermal power stations, solar and wind energy plants and relies above all on a decentralised energy supply, which means that energy is generated where it is to be consumed without placing unnecessary strain on the networks.
VEG also ensures savings potential in terms of electricity and emissions by converting existing systems - for example, by replacing conventional lighting systems with LEDs. VEG has realised more than 40 projects in recent years. The cooperative now operates 24 efficient combined heat and power plants, three photovoltaic systems, one wind power plant and two LED projects. The cooperative from Hamburg also offers end consumers a green electricity tariff.
"From the very beginning, we have relied exclusively on energy of ecological origin or with a direct link to it - such as natural gas as the bridging technology of the energy turnaround," says VEG co-founder and CEO Marc Banasiak in an interview. "Behind this is our conviction that the world's growing energy needs must be met ecologically and in a way that conserves resources, while at the same time being economical. We are quasi pragmatists with a green soul".
The members of the cooperative as well as the impact investors, who support the project financially, are thus actively shaping the energy revolution in Germany - away from nuclear and fossil fuels and towards renewable energy - and helping Germany to achieve its climate protection goals. In addition, by expanding the use of renewable energies, they ensure that this form of energy will become increasingly economically viable in the future. VEG wants to become independent of large energy suppliers and state subsidies in the future.
What makes VEG an impact-oriented investment? Sustainable can be Sustainable Development Goals (SDGs) used as a yardstick here. The United Nations (UN) has agreed on these 17 development goals. VEG pays directly into five of the 17 goals: affordable and clean energy, innovative and sustainable infrastructure, sustainable communities and cities, responsible production and climate protection.
Sandalwood is one of the oldest hardwoods in the world. It is used for cultural, natural cosmetic and medical purposes. The strong demand for sandalwood has led to illegal exploitation, so that the tree is threatened with extinction. Since 1998 it has been on the red list of the World Conservation Union (ICUN) as an endangered species. For 20 years now, sandalwood has been cultivated in northern Australia by the Australian company Quintis in an environmentally friendly and socially responsible manner.
Quintis has specialised in plantation operations and tree harvesting and is now the world market leader in this field. Through the cultivation and distribution of sandalwood, wild growing trees are protected, as the worldwide demand can be met from a sustainable source and illegal exploitation is thus limited. The Hamburg-based impact investor Jäderberg & Cie. (JC) became the first international plantation investor of Quintis in 2010. Furthermore, only a handful of international institutions have been granted access to this exclusive investment. These include renowned addresses such as the Harvard University Foundation, the largest sovereign wealth fund of the United Arab Emirates (Abu Dhabi Investment Council) and the Church of England.
Jäderberg & Cie. buys parts of the plantations and commissions Quintis to manage and harvest the plantations, to process the trees and finally to market and sell the sandalwood end products such as essential oil, powder and wood in various forms. The JC Group now owns around 700 hectares of sandalwood and over 1,300 investors have already invested in the five JC Sandalwood plantations through various JC Sandalwood investment vehicles. Jäderberg & Cie has twice won the German BeteiligungsPreis (participation award) for this, the last time in 2019.
"At the moment there is a narrow focus on the threat of climate change and CO2 emissions. Further acute ecological and social imbalances are still being neglected in the broad debate. However, a strong increase in demand for sustainable investments can be observed," says Peter Jäderberg, founder and managing director of the Jäderberg & Cie. group, in an interview. "In fact, however, we are seeing a rapid increase in interest in our assets on the part of professional investors, as there have been very few real impact investing projects to date. For almost ten years now, private investors have been consistently investing with JC Sandalwood, probably because the sustainability of our business model is convincing".
What makes this project a real impact investment? The focus is on the preservation of biodiversity by saving this tree species from extinction. In addition, sustainable cultivation methods and the resulting production of medicinal and natural cosmetic products are also important. And finally, the reforestation project contributes directly to climate protection, because the tree plantations bind large amounts of CO2. JC is thus contributing to 5 of the 17 Sustainable Development Goals (SDGs): Health and well-being, responsible consumption and production, rural living, partnership for development goals and climate protection.
The market for sustainable investments and impact investments is becoming increasingly important. This is clearly shown by the figures of recent years with double-digit growth rates. This growth is being driven on the one hand by private investors, who are also paying increasing attention to ethical, social and ecological aspects when it comes to financial investments. But also professional investors such as family offices, asset managers and investment funds are discovering this asset class for themselves. They are keen to offer clients appropriate products and to expand their portfolios through sustainable products.
In addition, various studies dispel the initial fears of professional investors that impact-oriented investing is always associated with a reduction in financial returns. Surveys among professional investors in Scandinavia show that the vast majority of them expect returns for their impact investments that are in line with the market or even above average. In addition, political institutions such as the European Commission or the German government are also focusing more strongly on issues such as climate protection, energy system transformation and CO2 reduction, which is exerting additional pressure on the financial market to develop and offer sustainable products. The current trend towards more impact investing will therefore continue to increase.
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