We need it all: why impact investors should remain open to opportunities in public markets

We need it all: Making a case for impact investing in private AND public markets

Charlie Crossley, Investment Engagement Manager at Friends Provident Foundation, argues that impact investors should also consider opportunities in listed markets.

The impact investing community broadly shares a common purpose: responding to urgent global challenges like the climate crisis and inequality through investment.

Complex challenges require open-mindedness about what works, in terms of solutions.

Over recent years, the argument that private markets impact investing contributes dramatically more impact than public markets has become increasingly strong. This risks narrowing our thinking when we need greater participation and to use every available tool. This article argues that both private and public markets have a vital role to play. The debates around them matter, but they should not become a barrier to investor action.

A few scene setters:

• I use the Global Impact Investing Network (GIIN) definition of impact investment: “investments made with the intention to generate positive, measurable social or environmental impact alongside a financial return”.
• At Friends Provident Foundation, we have both private and public markets impact investments.
• Scepticism about impact claims across asset classes is important. Clear impact objectives, credible theories of change, and reasonable measurement frameworks are always needed. This is certainly the case in public markets where there is a risk of a conflation with more general sustainability-related funds.
• I focus on investment in companies, rather than property or other physical assets
• I focus on equity investment (both public and private) rather than fixed income, bonds, or loans.

Impact is incredibly complex
People who have spent their entire careers thinking about how positive change happens in the world come to diverse conclusions. Contrast, for example, the emphasis on “power and systems” from the renowned book How Change Happens from the international development field, with the quantitative-focused Effective altruism movement. These different views should make us cautious about very strong conclusions about where impact comes from.

The “additionality” argument
The idea that private markets give the opportunity for dramatically more impact largely rests on the “additionality” argument: i.e., when you provide capital to a positively impactful company that could not otherwise access it (which is more common in private markets) you directly enable impact that would not exist without your investment.

Additionality makes lots of sense with earlier-stage companies. For later-stage private companies, things are more complex. Additionality reduces if there is plenty of demand to invest in a company and someone else would invest anyway.

So, while additionality is more possible in private markets, it is a spectrum and not guaranteed. The fact that impact is harder to pin down than 'I gave them money, they grew' doesn't mean it’s not happening. It means we need to be thoughtful about the ways we contribute.

How can public markets impact investors contribute?
Marti and colleagues, in their multidisciplinary review, identify 15 distinct mechanisms through which public markets investors influence company sustainability, across three broad categories: field building, shareholder engagement, and portfolio screening.

True, these mechanisms are available to those who would not describe themselves as impact investors. But I argue impact investors are especially well placed to contribute.

Field building
Marti et al. define "field building" as an “impact strategy whereby shareholders try to make companies more sustainable by influencing the fields in which companies are embedded.” Field building can involve establishing investor expectations or voluntary reporting standards for companies or stigmatising certain business activities. Influencing other investors and regulators is also part of this. You will rarely see a field building effort without an over-representation people affiliated to impact investment firms.

Shareholder engagement
Engagement in public equities is rightly a much-debated topic. A lot of companies primarily fund their activities by keeping some of their profits and reinvesting them. The influence public markets investors have through their rights and relationships is arguably more important than the capital they invest.

There is evidence that engagement can influence companies. Public markets impact investors are well-equipped to engage, for example potentially having longer holding periods and a greater willingness to collaborate with other investors. But further work is needed to:

1. Understand whether impact investors have an outsized engagement effect.
2. Develop impact products that more strongly prioritise engagement as part of their theory of change.

Portfolio screening
It is less clear how impact investors contribute to change through choosing which companies to invest in (or exclude) alone. The effects of this portfolio screening on companies’ cost of capital are theoretically important, but probably require more scale than impact investors currently have. Portfolio screening could though contribute when combined with the other two strategies. The deep analysis involved in screening could help develop a broad investor sentiment towards a company and also inform engagement.

A link between public and private markets impact?
Rather than opposing each other, could public and private markets impact investing be reinforcing?

A working paper identifies that smaller, positively impactful public companies sometimes struggle to find investors during an initial public offering (IPO). The result is that promising businesses face a disadvantage precisely when they enter public markets.

As a private market investor, if you help a company grow from seed to going public, you want it to find investors who will value it for similar reasons. Could public market impact investors fill that gap by providing patient, committed capital after an IPO?

More investigation is needed but it’s an enticing question.

Why does this matter?
Private markets impact investing is valuable and already dominates impact investment globally and in the UK. The private/public markets debates are important and should be aired (hence this article). But I believe there is a risk they could hold back investors from being more intentional about their impact in the first place.

The important questions are:

• What impact are we trying to have?

• What tools can we use to contribute to that impact, across asset classes?

• How do we manage any potential trade-offs between impact, financial return and financial risk (including liquidity)?

Both private and public markets impact investors should be prepared to work together, as well as argue for their contribution. They should be mutually aware of the strengths and limitations they both bring. In private markets there is the opportunity for more focused and, perhaps, transformational impact, particularly with earlier-stage companies. Public markets have the potential for much greater scale and important, if perhaps more incremental, change.

Given the global context, what matters now is deploying every available impact tool as effectively as possible, across asset classes.

Acknowledgements:

The viewpoints and any mistakes in this article are mine. But I am very grateful to the following people for their thoughtful comments and challenges:

Sean Gilbert, GIIN

Seb Beloe, Foresight (WHEB)

Erinch Sahan, Joseph Rowntree Foundation

Sarah Teacher and Sophia Omar, Impact Investing Institute

Harry Catchpole, Tribe Impact Capital

Sanjay Joshi, Hymans Robertson

James Anthony and Sarah Heathwood, Friends Provident Foundation