Discussion around the relationship between financial and extra-financial (or “non-financial”) outcomes of companies has evolved from the two concepts being mutually exclusive, to being integrated.

Integrating social responsibility into investment portfolios can add value by addressing macro-economic risks through investing in society and the environment. This article assists large asset owners such as sovereign wealth funds and pension funds to strengthen their role as “universal owners” by bringing broader societal outcomes into their portfolio objectives.

The purpose of impact investing is to achieve social and environmental targets, in addition to financial targets. This is in contrast to other similar forms of investments, such as Socially Responsible Investing (SRI) which involves avoiding companies that harm society or the environment.

Impact investing is more focused on aligning with companies whose core business is generating impact. This enables portfolios to align with societal objectives, which is also of concern to the members of the investment funds.

Asset owners may be constrained from impact investing due to their perceptions of:

• Fiduciary duties, which are commonly seen as restrictive to trustees. It may be unclear to asset owners if extra-financial areas can guide their strategy given their fiduciary duties.

• Prudential regulation, whereby there is an obligation to invest in rational, risk-adjusted and relevant criteria.

Regulations may discourage the superannuation industry from impact investing. Commonly referred to as the “sole purpose test,” legislation binds the trustees to maintain the fund solely for one or more of a set of certain “core” purposes.

However, the guidelines have provisions for defining “ancillary purposes” where social impact can fit in. Asset owners can therefore satisfy fiduciary duties and prudential regulations while integrating social responsibility into their portfolios.

Opportunities in impact investing include investing in:

• Social enterprises;
• Social impact bonds; and
• Social impact investment funds.

Investments which consider social and environment standards, and which encourage a stable economy for the beneficiaries of the fund to retire in can be considered as a part of fiduciaries’ decision making process. This can improve the overall health of the economy and society.

Challenges for impact investors include:

• Organisations which are deemed suitable for such investments are generally small-scale, resource-scarce and dependent on grants. They may lack capability to manage complex contracts bound to their impact outcomes.
• Financial advisors, intermediaries and law specialists have generally not yet gained the expertise to deal with such investments.
• Transaction costs are relatively high as the scale and scope of such investments is limited.
• Concern over greenwashing and the reporting of outcomes in terms of true sustainability, due to lack of standards and frameworks which can evaluate them effectively.
• High due diligence costs and complexity in quantifying the outcomes and the levels of success.

The early stage of the impact investment market may not attract significant attention from large asset owners. However, the advantage of early adoption lies in becoming a key stakeholder in shaping the impact investing market which is well suited to the needs of superannuation asset investors.

1. Large asset owners can shape how impact investing industry in Australia evolves over time, if the opportunity is taken while the industry is still in its nascent stage. By becoming a key stakeholder, superannuation funds can ensure standards and frameworks are formed keeping their portfolio objectives in mind.
2. Due to the early stage of impact industry in Australia, the challenges faced - scope and scale, resource scarce, difficulty in measuring outcomes, lack of frameworks, etc. are typical of many emerging industries. These should be tactfully handled by asset owners in gearing their portfolios towards creating an impact.
3. The “sole purpose test” applying to superannuation funds does not prohibit trustees from making investments that may have a positive impact, where the financial attributes of the investment are compelling. Impact investing offers the possibility of asset owning fiduciaries satisfying extra-financial objectives, such as social or environmental impacts, without prejudicing the financial imperative of the best financial interests.
4. Employer sponsors and members of superannuation funds are often involved in working towards social or environmental outcomes. There may be opportunities to align the extra-financial investment objectives of fiduciaries with the objectives of members and employers alike.
5. Both the health of the economy and the stability of the society in which beneficiaries retire are relevant considerations for fiduciaries decision making when allocating capital.