Businesses that incorporate “material environmental, social and governance (ESG) factors into their strategy, operations and culture will outperform [others that do not] over the long term,” is the underlying philosophy at New York City-based Inherent Group, a family office that manages equity and debt investments.
Two factors lie at the core of Inherent’s investment philosophy, said Tony Davis, the firm’s founder and CEO: “One, a desire to figure out how do we do good while investing our money, and secondly, the excitement around the ability for business to address some of these challenges.” Inherent’s website states that such businesses are also uniquely positioned to address environmental and social challenges through innovation, operational excellence and sustainable advocacy. It invests in businesses in power generation, clean water, transportation, education, sustainable agriculture and healthy food.
When Annie Chen started out nine years ago to manage a part of her family wealth, one question in her mind was: “What’s the purpose behind having wealth, and how can we really use it in a more proactive and purposeful way?” Chen is the founder and chair of RS Group, a Hong Kong-based family office, whose website notes that it wants to “build a global community where social progress and economic development occur in harmony with nature.” In an effort to answer her own question, she eventually began “investing in social enterprises that had a mission to produce positive social or environmental impact.”
Davis and Chen shared their perspectives on the guiding principles for investing in ESG-driven companies with Knowledge at Wharton for a new podcast series called “From Back Street to Wall Street.” The series is being produced in partnership with Impact Investment Exchange (IIX), a Singapore-based organization that works to serve as a bridge between investors and development goals in Asia. (Listen to this episode using the player at the top of this page. Find the first episode here.)
Applying the ESG Filter
In putting together an asset portfolio aimed at impact investing, “the primary impulse was to use my money and our family’s wealth in a way that was aligned with our values,” said Davis. He didn’t want to take the route of making routine, risk-adjusted investments and give away those returns. Instead, he wanted to begin that process by handpicking investments in businesses that could bring the desired social or economic impact. “If our goal is to use our wealth in a responsible way to improve the lives of others, to improve the environment, why would we jump over that initial step of the investment itself?”
Inherent looks for investment opportunities that are aligned with its mission where its expected return is commensurate with the risk it takes on from a market standpoint, or are program-related investments where it expects to receive less than market rates of return, said Davis. An example: Its investments in Women’s Livelihood Bonds, “which is very much aligned with our mission and we believe will generate a nice return to the foundation as well.” The IIX-run bonds, which are listed on the Singapore stock exchange, help expand credit access, improve market linkages and enhance goods and services for women in Cambodia, Vietnam and the Philippines.
Such impact investing has its challenges. “We’ve struggled a little bit in finding investment opportunities in those classes that we were excited about,” said Davis. “We need more product, [especially] more fixed-income products.”
Davis notes that Inherent goes beyond the passive investing model to meet its goals. “We engage with companies around what we believe to be the material ESG factors in their businesses. We intend to gently nudge towards improving those.”
$60 Trillion in Assets
He is convinced that those investments will generate above par returns over time. “There’s research that shows that, over the long term, companies that engage in ESG perform better financially. In the more short term, typically, the markets will take their cash flows and revalue those cash flows. They’ll put a higher multiple on them because they’ll view those cash flows as being less risky, higher quality cash flows.”
“Any time you talk about impact or any time you talk about sustainability, people often assume you’re talking about below market rates of return, and we fundamentally don’t believe that.”–Tony Davis
Davis faulted the conventional assumption that impact investing won’t generate handsome returns. “Any time you talk about impact or any time you talk about sustainability, people often assume you’re talking about below-market rates of return, and we fundamentally don’t believe that.” By demonstrating that the returns are attractive, “we hope to encourage a lot more capital into this space,” he added.
Sufficient momentum exists for such impact investing, he said, and pointed out that the United Nations-supported Principles of Responsible Investing now counts some $60 trillion in assets pledged by its signatories “to move towards the incorporation of ESG factors in decision making through screening, integration, thematic investments and active ownership.”
An ESG Lens for All Investments
Over time, Chen has been able to substantially achieve those investment goals at the RS Group. “Close to 100% percent of our portfolio is invested sustainably,” she said. “We apply an ESG lens to all of our investments.” Back when she started out, few in the investment world were conversant with PRI or ESG, “and so I had to create my portfolio pretty much by myself,” she recalled. Numerous philanthropy conferences, reports, discussions and other research led her to put together an investment portfolio with businesses “trying to accomplish some social or environmental impact, while generating some returns.”
Among the milestones was a decision in 2013 to be part of the “Divest Invest movement” that encouraged investors move away from fossil fuel to renewable and clean energy. “From that point onwards, we decided we were going to apply a climate change lens to how we invest.” That became a factor the RS Group considered in all subsequent investments.
Businesses committed to ESG principles that attract impact investors have tended to do well, and multiple factors could be credited for that, said Chen. “They are usually created by strong entrepreneurs with great passion, a very strong focus on their mission and tenacity. They are focused on creating something that’s bigger than themselves; that probably gives them that drive to not give up so easily.”