Unlocking Public Equity Key to Scaling Impact Investments

Seb Beloe, Partner, Head of Research, WHEB Asset Management

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Unlocking Public Equity Key to Scaling Impact Investments

Seb Beloe, Partner, Head of Research, WHEB Asset Management

 

Traditional Private Equity Dominance

Given its philanthropic roots, much of the survey data around capital allocation to impact investing was reported to be largely achieved through private equity. In a GIIN/JP Morgan annual impact investment survey in 2011, public debt and equity together accounted for just 3 out of 2,213 investments.

By 2019, public equity and debt, also known as listed equity (i.e publicly traded stocks and shares), accounted for around one-third of impact investments, becoming two of the fastest growing asset classes for purpose-led investors.

A traditional view of impact investing holds that the investor must prove a positive outcome as a direct result of the invested capital. Known as ‘additionality’, this concept appears to protect against bad-faith actors making false claims or ‘impact washing’.

However, attributing causality for a positive change in cost of capital, to a single investor is impossible when there are multiple parties willing to inject capital. The only applicable circumstance is one where the investor is the only actual or potential capital provider. This necessarily restricts impact investing to philanthropy or capital allocations to markets with very poor liquidity and therefore excludes all markets that seek a market rate of return on the basis that there will almost always be other investors willing to make that investment.

Interpreting impact investing this way leaves the practice in a small cul-de-sac of highly illiquid and philanthropic markets. In order to have big global impacts, you need big global companies, matched with big global markets. As Sir Ronald Cohen put it ‘There is no other way to cope with the scale and severity of social and environmental issues other than to attract investment capital from the $200 trillion of investable assets in our financial system’.

Without means to allocate purpose-led capital to the largest – public – markets, impact investors will fail to deliver the scale of global solutions our communities and planet require.

 

Public (Listed) Equity Benefits

Public equity markets remain a dominant part of the financial ecosystem, with a value almost ten times the $5.8trillion of private equity markets (in 2020). Public, listed markets offer scale, liquidity and enhanced transparency. They are also accessible to small and large investors alike. Impact investing in these markets can attract more – and more widespread – support than private markets which remain the preserve of large private investors.

A traditional view that investing via listed equities fails to prove additionality because buying and selling stock has little impact on the cost of capital or anything else is, we believe, false. It ignores the systemic nature of finance and the economic system. It is right that individual transactions have less effect on the cost of capital as the market becomes larger and more liquid. But this is quite different from saying that those transactions have no impact. Clearly every participant has some say on where prices are set.

By maintaining or even increasing equity prices and thus lowering the cost of capital for the investee company, trading in listed shares supports businesses in other ways too. For example, higher equity prices support the company in tangible ways such as by underpinning employee incentive structures that rely on equity prices. Companies may also be better able to undertake acquisitions by using their equity to finance deals. In addition, as holders of the company’s equity, shareholders get a say on the company’s strategy and its capital allocation policies. Encouraging management teams to reinvest profits in further growth is a key pillar in accelerating the positive impact of the enterprise as a whole.

Ultimately by supporting or even increasing market value, investors enable businesses to leverage their equity in pursuing more activity, in turn enabling the company to scale more quickly and deliver greater positive impact. In our view, affecting the cost of capital for a business in this way constitutes a form of investor impact. And it is certainly not exclusive to private markets.

Secondary markets – whether private or public – support the functioning of primary investments. A primary contribution with no value realisation mechanism is a donation rather than an investment. The prospect of secondary markets is what encourages impact entrepreneurs to create impactful business models. This, in turn, is what leads them to recycle their capital and do it all over again. The impact ecosystem does not work with primary investments alone.

 

Tackling ‘Impact Washing’

The rapid expansion of impact investing has been met with concern by some early practitioners. Some consider ‘impact washing’ the greatest threat facing the market, and worry that investing in listed equities represents a contradiction in terms.

A significant benefit of impact investing through public markets is right there on the label – they’re public. Listed companies are subject to disclosure regulations and governance requirements that far exceed those in private markets. This means they face public scrutiny and access by small and large investors alike, with far greater oversight, access to corporate information, and mechanisms for shareholder stewardship such as voting rights and opportunities to influence.

We believe in a ‘holistic’ approach that focuses on investments as part of the financial system, emphasising the interdependencies between different asset classes. This view holds that investor impact is founded in the investor’s intention to deliver positive impact. This needs to be evidenced through a clearly articulated ‘theory of change’ connecting the investment and the underlying holding with the problem that is being tackled. The ultimate impact also needs to be described and measured to further underpin the impact claim.

 

Conclusion

Establishing demanding but pragmatic standards that require clarity in investment intentions, and evidence of related impact, is essential if impact investment is to retain its potency – free from bad-faith actors and ‘impact washing’ – and its potential to bridge the $2.5 trillion annual deficit for meeting current UN Sustainable Development Goal commitments.

These standards would enable impact investors to harness the full potential of capital markets in order to drive scalable positive impacts that are urgently needed by our communities.

It would be a travesty for impact investing to remain niche, inevitably failing to deliver positive impact at the scale that is required. By unlocking public equity and debt markets and investing with intentionality and evidenced rigour, impact investors can access listed markets that are more transparent, offer higher liquidity and can attract more – and more widespread – support than private markets alone.