In focus

Why pension funds should consider impact investing

The current market environment poses significant challenges for institutional investors, particularly as they are increasingly looking to include environmental, social and governance (ESG) factors into their investments while achieving a financial return.

For pension funds in particular, the challenge is finding investment opportunities that support their return targets and meet a number of other sustainability requirements.  In addition, they are often looking for ways to diversify away from existing asset classes in their portfolios.

Impact investing can be an attractive way for pension funds to incorporate sustainability requirements into their investments while also providing diversification benefits.

Impact investing enters the mainstream

The trend towards sustainable investing continues to gather momentum, as people seek not just financial returns, but also to make a positive contribution to the world. Often investors look to achieve this with funds that screen out companies that do not meet a certain threshold of sustainability, or by focusing on specific ESG themes. However, it can be hard to know how much of an impact an investment is really making.

This is where impact investing can help. It focuses on delivering measureable impact, while aiming to also provide attractive investment returns. Correlation between impact investing and financial performance has been tested, demonstrating synergies across risk, return and impact metrics. Impact investing is often described as having a ‘triple bottom line’, whereby the social or environmental impact and the financial return have equal importance and reinforce each other.

Diversification benefits for pension funds

While impact investing can cover a wide range of asset classes and themes, the focus tends to be on areas that are traditionally not accessible via public markets. These include private debt, private equity and sustainable infrastructure. This means that there is typically very low correlation with public markets, making impact investing a good tool for diversifying a portfolio, even amongst other ESG investments.

In the face of challenging market conditions and mixed investment performance over the last few years, pension funds have increasingly looked to move some of their assets away from traditional markets. As this trend continues through current challenges, the low correlation between private markets and more traditional asset classes could make impact investing an attractive diversification option. In addition, the industry has now reached a size that means it can absorb large investments, supporting the investment appetite and commitment of pension funds.

Goals focused approach

Besides supporting pension funds in achieving their financial goals, impact investing helps them to meet the growing appetite for integrating sustainability into their portfolios. An increasing number of investors focus on achieving ‘capital with a purpose’, and allocating funds with a specific goal in mind.

In some cases, it is easier for pension funds to steer their portfolio towards new investments instead of influencing the investments in their existing portfolio. For example, it is easier to invest in a new eco-real estate development than shifting existing real estate property portfolios into more energy efficient buildings.

Impact investing has the power to contribute to finding solutions for many of the world’s social and environmental challenges and can help to fast-track the move towards a more sustainable strategy. However, it is also important to ensure that the ‘impact’ is effectively managed and measured in order to reduce concerns around ‘impact washing’.

In order to do this, there needs to be a clearly defined intent and contribution, which makes it easier for pension funds to allocate investments to areas that align most closely with their own goals. Pension funds with a deliberate intent can define the objectives of their contribution, and align their measurement of impact to tailored key-impact indicators as highlighted by the IFC-led Operating Principles for Impact Management.