Impact Investing for Insurers: A win-win alternative?
Adam Cadle at Insurance Asset Management speaks to AXA IM head of impact investing Jonathan Dean about the growth of impact investing and the potential benefits on offer.
Impact investing is capturing the attention of a broad range of asset owners on a global scale and the market has grown ten-fold in recent years. Can impact investing be a win-win alternative for asset owners? Jon what does impact investing mean to you?
JD: Let’s start with a definition - and what importantly impact investing does not mean. For us, impact investing is not about delivering concessionary or charitable returns. We are not looking for anything which is below market rate when we are making an investment, meaning everything in our portfolio has to be underwritten to achieve market rate return depending on what asset class we are looking to invest in. This is not just an Environment, Social and Governance (ESG) investment, which is more of a risk management tool where we are avoiding negative stories. For us, impact investing is about looking for problems in society, looking for problems in the environment, and then looking for solutions to those problems which we can invest in. We measure the success of those investments in delivering the solution to the problem, therefore being accountable for the impact change, all while looking to deliver a market rate financial return for our clients.
How has impact investing evolved and why is it capturing attention from institutional investors?
JD: We began our impact investing programme in 2012 and since then we have seen a huge growth in the market – from a $50bn market in 2012 to over $500bn today. Investor demand is driving this expansion and investors are now becoming more conscious of what their capital is being used for. To supply assets to meet that demand, we have seen a huge growth in the types of companies and projects delivering business models which are associated with an impact investment. There is this fantastic balance between demand from clients and the supply of an investable universe to meet that.
Impact investing is very aligned with what an institutional investor is looking to achieve:
- Firstly, it is long term. These are private market investments, so we are working with different asset classes such as private equity, private debt, real asset and project-finance type structures through long-term investment strategies. This is very aligned with what an insurance company or pension fund may be looking to achieve.
- Insurance companies are interested because as global corporate citizens they need to be conscious of their position and their corporate responsibility activity. Impact investing is very aligned with the messaging that they want to send in those areas
- It is also about being strategic. If you are an insurance company, you are typically involved in financial services or healthcare, and will also be interacting with climate risks. All of these activities may affect your day-to-day business. If you can invest in a strategy which is aligned with solutions to problems in these areas, it is naturally something to look at in terms of how to deploy capital aligned with an insurer’s core business activity.
- Thirdly, as an insurer, once you can show good corporate responsibility activity and business strategy, if you can do that with your balance sheet capital delivering a market rate financial return then you are creating this idea of a win-win-win model where all parts of your business can benefit and there is clear alignment between all of them. Pensions funds are similar because they have a long-term view and members are wanting their capital to be used in this way.
How do you identify the impact themes and projects in which to invest?
JD: I think the starting place has to be with your end client, the investor. You are looking to build a portfolio which is suited to what their needs are and therefore the conversation has to be taken to them. Typically, the client may want to have a specific nuance or a specific bias in their strategy to cover certain impact themes. When we talk about themes, this can be translated into sectors, whether its healthcare, financial services, education, environmental activities or it might be covered by geography. Where are these clients based? Where are there supply chains based? Where are their stakeholders based?
If you were to ask us, as an asset manager, where we have seen the biggest growth of assets and how do we create a portfolio on what our evidence has seen, we are looking for two things:
- We want to see what is delivering market rate financial return. Over our seven years of activity, we have a lot of data points showing where investment performance has delivered what we would expect - at or above market rate financial return - for those asset classes.
- Secondly, there is the question of how we achieve scalable impact. We are putting capital to work. Some of the measures we are looking for are how many people we are reaching and what is the current demographic or situation those people are in. We don’t want to direct a lot of money into a space which is very niche. Two big areas for us are financial services and healthcare where we have seen good performance financially, and also in terms of scalability. We have an emerging consumer concept also in these areas where people have previously been excluded from access to products or services, and where through technology or business model disruption you can now reach a wider audience. You are therefore satisfying a key investment criterion in terms of creating scalable impact outcomes. And where we have seen exits and where we have seen financial performance in these areas, you’ve clearly seen alignment as to what we would expect to be market rate. This can all be tied back to the UN Sustainable Development Goals (SDGs). Within that we see SDG 1 No Poverty and SDG 3 Good Health and Well-being as providing a very good supply of opportunities going forward.
What do you mean about meeting the basic needs of the emerging consumer and how do you create a positive impact as well as a financial return?
JD: When we talk about basic needs, I think you can isolate it to creating access to a product or service, which would be considered a basic necessity. A very easy example would be something around healthcare, with the end customer needing to be identified. This idea of an emerging consumer is someone who's not at the very bottom of the pyramid (who is typically reached by charitable intervention), but it's someone who is emerging from that area. They may have some disposable income but maybe don’t have access to the same type of healthcare services and products as people in comparable countries or other parts of the world. They have a need for creating access to these areas. Access is closely linked to affordability, so it has to be cost effective, but it also means outreach.
We then need to assess who we are actually reaching. What is their current situation? Are we reaching a scalable population? What we don't want to do is really target just the top 1% of the population group and make a slight improvement to their access and outcomes. We want to target a much bigger population group in the middle. Because with that bigger size, you've got scalability and that's important for two reasons. Scalability in terms of the size of the impact means you can create measurable outcomes around the number of people you're reaching. Scale also reduces cost and makes the product and service affordable, and lastly, scalability tends to bring you the opportunity for profitability. So, there is this link between scalable impact outcomes and profitable financial outcomes.
We made an investment with a partner in healthcare; in a medical device to remove cataracts. Historically, cataract operations have required quite a significant piece of kit, which is typically quite expensive. In European and US hospitals, for example, they have committed the capital expenditure (capex) to have this piece of kit. It works very well and there hasn't really been a need to displace that. However, in the US, a company came up with a piece of technology, which was really a basic tool, that does the job at a much lower cost. It doesn't need to be plugged into the powerful piece of equipment in a theatre, it can actually be used as a handheld tool. The tool can still be used for procedures in the West at a fraction of the cost, but importantly, this same product has a global outreach. This global access commitment means the same product which can be used in a Western or developed market context, can and will be taken into an emerging market context. So the same product, the same technology and the same cataract removal operations can be delivered into the emerging market and emerging consumer context at a much lower cost. The cost per procedure can be reduced to around $1. So you're helping improve the health and life outcomes for underserved people around the globe – by restoring vision to people who would otherwise have been partially impaired or permanently blinded. For us, that's clearly a positive impact outcome. And for this investment the financial return was driven by a strategic exit. This company, with the stimulus of such impact investment, was able to develop its product and its access, and has already been sold to a strategic buyer.
Your focus here seems to be on emerging markets. Why is that? And how does that align with UK and European investor needs?
JD: Focus on the emerging consumer is specific to the strategy I have just described which focuses on financial and healthcare outcomes for underserved populations around the world. That was driven by the scalability of the impact that we wanted to achieve. But for us, we have taken a global approach to all of our portfolio construction since 2012. It really is driven by what are you trying to invest in. Something which truly is global, which does have a European, or a developed market context would be climate change. You can address the needs of climate change across several different factors -protecting natural capital and protecting biodiversity, investing in communities to make them more resilient to the changes taking place around them and through adaptation (meaning how we can adapt to living in different environments that we're moving into in this day and age). That's a global strategy. You have two avenues for how you can put money to work here. One is project based, finding a project which is going to protect the natural capital and that has a local location. You can go in globally looking for these kinds of projects, which will really deliver impact outcomes by showing things like conservation, preservation, biodiversity and sustainable land use restoration. The other one is technology - around circular economy, waste management and access to energy. These kinds of areas are more global in their nature. If you're investing in a technology which might remove the carbon output from a manufacturing process, that has a global context.
The specific emerging market basic needs strategy is really driven by where we're seeing the size of the opportunity set. And when you're looking at healthcare and financial inclusion, where we can create a biggest impact is in the areas where you've got this emerging consumer context. We are measuring our impact in terms of the people in the markets that we are delivering a product or service to. Our financial risk is quite diversified because the capital that we're investing is across companies globally. The company could be a European company, which is delivering a product or service into the emerging markets, as well as developed markets. So when you look at where your capital is and where the jurisdictions are that you are investing in, it truly is a global portfolio.
In terms of European investors and how this could be complimentary to them, it comes back to what their intentions are with their strategy. Some investors might only want to make an impact in the market they're serving now, or the market that their stakeholders exist in. And for them they’re going to have a reduced investment universe in terms of where they can source assets from. Other investors, even though they're European-based might want to satisfy something which is more global. For example, investing in projects or companies that are going to support their supply chain. So, there's a very complimentary approach. It's really driven by, firstly, what the investor’s appetite is and where they are placing impact in their asset allocation. It does however need to be a diversified approach as you don't want to be taking specific concentrated country risk. You want to have limits per country and limits per region but you want to allow yourself the flexibility to be able to move between sectors, themes and across different geographies.
What are the key risks that should be considered when investing?
JD: We look at risk in three ways when we're making an impact investment:
- The first is financial. We need to underwrite every single opportunity to the same standard that we would in any other private market asset class. We're looking at things like country risk, political risk, currency risk and illiquidity. It is all of the things that you would normally assess when underwriting an investment – the team develops a base case scenario, you stress those scenarios, and you need to be able to ensure that you're still coming out with your target return.
- The second is operational. This is looking at non-investment risk, very important when making long-term investments working with global partners in different jurisdictions. We put a lot of emphasis on the non-investment risks – people, process, governance and IT security.
- The third key part is impact assessment. We need to be super rigorous when we're looking at an investment and underwriting the impact risk return. We spend a lot of time thinking about what we are trying to achieve and what is the company's day-to-day activity. So really there's a lot of work that goes pre-investment into defining how we think about impact. To do that, we've signed up to some very important industry standards. A group of investors have got together and worked on a project called the Impact Management Project. That really gives a consistent group of criteria that through every investment you're looking at the impact opportunity risk can be judged.
What is the role for impact investing given the current economic outlook and global pandemic?
JD: The interesting element here is that we are seeing how a global health event is having a direct impact on the global economy.
Within AXA IM’s impact healthcare strategy global health has been a long-term focus. This definition specifically covers seeking equality of healthcare access worldwide whilst recognising the interconnectedness of global populations in addressing this issue. We are experiencing a global health crisis now – so a lot of our focus over the past few months has been mobilising capital to back initiatives covering medical devices, diagnosis techniques, drugs and vaccines which have a global health application – to address not only this current health crisis but to better prepare for the future. Another response, beyond healthcare, is to focus on the subsequent recovery and how impact investing can play an important role there. For example, financial inclusion, or providing access to financial services, will be a very important catalyst in supporting the recovery for certain population groups around the world. In fact, we see the relationship between health and financial inclusion to be so closely related, and vital as a response to the current global context, so a lot of our focus has been to develop investment opportunities there.
There has been a lot of references to a “Green Recovery” leading out of the pandemic, and there certainly seems to be some merit in suggesting that the disruption to society and business does create the opportunity in certain areas to reset and rebuilt with societal and environmental objectives in-mind. Impact investing will play a leading role in this.
Would you say impact investing is now mainstream?
JD: I think the case can be made that it is. We’re seeing more and more household asset managers come to the market with impact investing projects and products. And an increasing number of asset owners are bringing capital to this space. I think there’s a lot of room to grow, and I can see that there’s a huge tailwind behind us.
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