With the Amazon on fire and Iceland melting, even the most Gordon Gekko of investors might struggle to continue with business as usual.
In the last ten years, the global spotlight has fixed on a number of critical social and environmental issues. These have prompted international conversations with significant and far-reaching ramifications: just consider #MeToo, which went from a Twitter hashtag to the driving force behind sweeping public and private sector reforms.
Whether it’s the onset of climate change, resource scarcity or populist politics, corporations and consumers alike have been paying attention. As a result, so have investors.
Global diversification, global opportunity, global citizen
‘Impact investing’ wasn’t a term that appeared in many investment outlooks, presentations or conferences ten years ago. A decade later, you can’t escape it. Defined as “investments made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return,”  the market is estimated at $502 billion and growing. Fast.
There are broadly three incentives to invest with impact.
1. The global diversification premium (or, in non-jargon terms, risk): Evidence suggests impact investments are uncorrelated to market movements, given they tend to follow themes which aren’t subject to the same booms and busts. As a result, they can protect portfolios from market downturns.
There are other ways that integrating environmental, social and governance (ESG) factors into investment analysis mitigates risk. Of course, it makes sense that the long-term viability of a company rests, at least in part, on how it treats employees (Sports Direct), handles corporate scandals (Volkswagen), monitors supply chains (Tesco), and otherwise engages with its stakeholders.
Investing for environmental and social impact goes a step further, however, by taking into consideration factors outside a company’s control. Climate change in particular poses three significant risks to the financial system, as outlined by Bank of England Governor Mark Carney in 2015: physical risks (i.e. asset depreciation and insurance losses); liability risks, (i.e. the ripple effects of compensation claims); and transition risks (i.e. stranded assets, or the value that will evaporate in the shift to a low-carbon economy).
But transition risk has a flip side…
2. The global opportunity premium (or, in non-jargon terms, reward): If ESG integration is primarily about managing risk, impact investing builds on it by uncovering investment opportunities. A frequently cited example is renewable energy, with the value of wind and solar energy companies expected to rise in the transition to a low-carbon economy. Just as increased regulation and lower consumer demand will negatively effect ‘old-economy’ companies and lead to stranded assets, it will also see sectors that cater to new demands (like clean water, social and economic equality and renewables) thrive.
That’s the opportunity from a performance point of view. For asset managers, impact investing yields another upshot: clients.
We’re on the precipice of an unprecedented generational wealth transfer between two broad investing cohorts with very different values. Over the next 30 years, Baby Boomers are expected to transfer $30 trillion to Generation X and Millennials. Research data vary, but it’s clear an overwhelming majority of Millennials want to invest in line with their values and towards positive environmental and social outcomes. As a result, the demand for ESG and impact investment products is only on the rise. It seems likely that the next generation of investing comes of age at the same time as the next generation of investors.
Which leads us to the final incentive: simply doing the right thing.
3. The global citizen premium (or, in non-jargon terms, doing the right thing): Call it the feel-good factor. Or, if you’re a cynic, just call it good reputation. Whatever your motive, advancing positive social and environmental outcomes is increasingly expected of financial institutions and corporations.
And ultimately, investors have the power and impetus to direct capital towards a more sustainable future. When it comes to climate change in particular, we’re at a critical juncture: ignoring it simply isn’t an option anymore. In the words of the recent plaque commemorating melted Icelandic glacier Ok: “we know what is happening and what needs to be done. Only you know whether we did it.”
Which is where ESG integration meets its limits. It’s absolutely critical, so much so that it’s now becoming ubiquitous in investment portfolios. But it’s also the investment equivalent of a financial stress test, flagging the problem rather than rooting it out.
But first, some context.
How did we get here?
The road to the ubiquitification™ of responsible investing has been a long one — hundreds of years long. But ESG investing is really a 21st Century phenomenon, the rapid rise of which builds on the much older socially responsible investment (SRI) movement.
The term ESG was coined in 2005. In 2006, the United Nations launched the six Principles for Responsible Investment: “a voluntary and aspirational set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice.”  The goal was a more sustainable global financial system.
It couldn’t have come too soon. The Global Financial Crisis (GFC) of 2008 almost decimated the financial industry, as well as the societies in which it operates. It was a painful reminder of the delicate balance between economies, stakeholders and markets. Investors and regulators emerged chastened, with a renewed focus on the significance of long-term stewardship and good corporate governance.
Today, the PRI is a network of over 1,700 international investors representing over $70 trillion. ESG investing is estimated at over $30 trillion in AUM, or almost half of the world’s professionally managed assets. A proliferation of national mandates and disclosure regulations, such as the European Commission’s sustainability disclosure rules, have propelled ESG the mainstream.
Investors were initially reluctant to embrace it, arguing their fiduciary responsibility was limited to maximising shareholder value regardless of environmental or social impact or governance concerns. But ESG has since been accepted as a litmus test for company sustainability and so become a key part of financial analysis and fiduciary responsibility.
Fast-forward a decade, and ESG is simply good investing. The problem is, it’s not good enough.
What’s next for sustainable finance?
If corporate governance was a bandage for the problems caused by the GFC, impact investing addresses the suite of global issues now reaching a critical point. These can’t be rectified via good corporate behaviour alone. Realistically, the world is unlikely to reach the Paris Agreement targets or bridge the $5–7 trillion funding gap needed to meet the UN Sustainable Development Goals without a significant shift in capital allocation.
It’s also the sensible thing to do. In the 20th Century, we woke up to the fact that our business has an impact on society and the environment. More recently, we’ve learned that society and the environment have an impact on our business. CPD estimates climate risk will cost the world’s biggest companies $1 trillion, with most of that value lost in the next five years;  other predictions put annual output losses at 1% to 5% depending on how much action is taken and when. 
But impact investing isn’t just urgent and necessary; it’s also hugely exciting.
The shift to a new economy — one where progress doesn’t hinge on resource waste and environmental decline, but instead on new technologies — is arguably one of the greatest investment opportunities since the Industrial Revolution. As corporations move away from quarterly results, what is good for people and planet will coalesce with what’s good for bottom-line returns.
The final frontier of investing
All this may sound like a panacea for investors seeking to align their investments with their values and find a new point of differentiation. Unfortunately, however, the industry still hasn’t cracked impact.
The obstacle is non-financial data. How do you gather it? Measure it? Standardise it?
Measuring financial risk and reward is easy by comparison. It’s not hard, after all, to determine whether or not you made a financial return on an investment; it’s much more difficult to assess its social or environmental return. As with financial returns, non-financial returns can increase or decrease as a result of myriad external factors, be it the stage of the economic cycle, industry disruption or new regulation. But unlike financial returns, which can be measured by a single metric — money — non-financial returns can manifest in almost countless ways.
But when we finally reach consensus on what non-financial returns look like, as well as how to generate them in a way that is automated, scalable and cost-efficient, this niche and nascent sector will make an indelible mark on the financial system.
To paraphrase Adam Tooze: a decade after the world bailed out finance, perhaps it’s time for finance to bail out the world.
 GlobalSustainable Investment Alliance, 2018 Review
 CarbonDisclosure Project, 2018 annual report