Talking Heads – How to have an impact with investments

This is an audio transcript of the Talking Heads – How to have an impact with investments podcast episode

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing impact investing. I’m Daniel Morris, Chief market strategist, and I’m joined today by Bernice Lasfargues, Sustainability Integration Lead. Welcome, Bernice, and thanks for joining me.

Bernice Lasfargues: Happy to be here, Daniel.

DM: When people think about impact investing, we think of microcredit initiatives that started many, many years ago, which is timely given what’s going on in Bangladesh today. The founder of the Grameen Bank has taken over as interim head of government. Clearly, [there have been] a lot of changes, particularly for asset managers as they think about how to go about impact investing. How do you measure the impact of impact investing? What is impact investing?

BL: Impact investments are made with the intention to generate a measurable, positive social and environmental impact alongside earning a financial return. It’s about investing in companies, projects or financial vehicles that have identified a social or environmental problem. You can think about healthcare access, poor housing, biodiversity loss or climate change. [They] are working on addressing that problem. Typically, what an impact investor will do is it would finance these solutions, accelerate the development and enable their scaling.

For an investment to be deemed impact, you need three ingredients: intentionality, additionality, and impact management and measurement. Let’s start with intentionality. Intentionality is about clearly stating the problem that you’re trying to solve and formalising it in the product documentation for investors. Intentionality is central to impact investing because to be an impact investor, impact cannot be an accidental byproduct of your investment. It needs to be a central part of your investment thesis.

Additionality is a second ingredient. Another word for additionality is investor contribution. So, that is what the investor is doing to accompany the impact investment. There are many channels of additionality. For example, financial additionality is a form of additionality. That’s doing concessional financing, patient capital guarantees, etcetera.

There’s something called value additionality. That is engaging with the invested companies to improve the impact that they have on the ground. There’s also something called development additionality, specific targeting of underserved population needs.

The third one is impact management and measurement. And that is the hallmark of impact investing. It’s about the commitment of the investor to monitor and measure and report [on] the social and environmental performance and progress of their investments, thereby ensuring transparency and accountability.

You also asked about the impact investment landscape and market trends. Financial returns range from below market sometimes, what we call concessionary to [the] risk adjusted market rate.

Historically, private equity has been perceived as particularly suited to impact investing because investors can have a strong influence on the target. [They] have access to special essential information. They have also a long-term investment horizon that allows them to drive change. But we need impact investing in all asset classes. What we’re seeing right now in terms of market trends is impact investments more and more outside of private equity.

DM: Berenice, you’ve highlighted some of the framework that you use when you think about impact investing. And that illustrates how this whole area has evolved over the years.
And whereas initially it was just the desire to do good with investing, there was a realisation over time that you need to have some principles, some benchmarks, some way to measure this. As a result of all of that, we now have the operating principles for impact management. BNP Paribas Asset Management was one of the founding signatories. Can you tell us more about what those operating principles are?

BL: Absolutely. What the operating principles for impact management did in 2019 is saying we want to scale up the impact investing market, but we need to do so with integrity. And therefore, we need to have a framework for investors to design, implement their impact management systems to make sure that considerations for investment that are considered impact are integrated throughout the investment life cycle.  Since they [were] launched in 2019, there’s now 184 organisations that are signatories to the operating principles from 40 countries. And if you looked at the total covered assets, this is around USD 500 billion. What are the principles? There are basically nine principles and they’re organised around four categories, which are strategic intent, origination, structuring and portfolio management,  and impact at exit. It’s about defining a strategic impact objective, making sure that you have a process to monitor and manage not only the potential positive impact, but also the negative impact of your investment.

As I mentioned, there are nine principles. Principle 7 is conduct exits, considering the effects on sustained impact. It’s about making sure when you’re disinvesting or exiting an investment, you’re thinking about what does it mean for the impact that you’re trying to have on the ground? Impact needs to be part of the consideration when conducting an exit. It cannot just be financial considerations.

DM: Can you talk about some of the innovations that you’re seeing in impact investing?

BL: We see innovations in terms of asset classes.
So, venturing out of what are perceived as [the] traditional asset classes of impact investing. We also see innovation in terms of themes. If you look at traditional themes of impact investing, a lot has been done on mitigation. We’re hoping to see more on, for example, physical climate risk adaptation, but there’s also innovation in the impact investing structures themselves.

Here, I would like to talk about blended finance, which is a structuring approach that evolves a way of leveraging development funding or funding from philanthropies. There’s a huge funding gap if we think about the 2030 agenda for sustainable development, the Paris Agreement and there’s this recognition that you need to have all forms of capital. An example would be [a] special purpose vehicle. It involves development fund institutions, also private investors.  

You would have different layers of potential investments. You will have junior investor or a first loss layer [and] mezzanine or senior investors that would provide capital at different return levels So, you can see that typically the finance structures are complex, they involve a myriad of stakeholders, and they also ask of asset manager more than just managing the portfolio because they typically will have to support market making and impact management.

DM: Thank you very much, Berenice.

BL: Thank you, Daniel