Kunal Kapoor, CFA, CEO of Morningstar
How is Morningstar contributing to the impact investing space?
Sustainable investing is more than a trend; it’s becoming part of the fabric of investing. Increasingly, investors seek data about impact – in addition to risk and return – as part of their investment decisions. So at Morningstar, we are growing solutions that support these investors’ growing environmental, social and governance (ESG) concerns in the public and private markets.
Companies in public markets continue to adopt more transparent practices, but impact may be more difficult to measure. Since 2016, Morningstar has launched a number of tools to help investors interested in sustainable investing -- a Sustainability Rating for mutual and exchange-traded funds; new carbon-focused metrics for funds, including the impact-oriented Green Solutions metrics; a Portfolio Carbon Risk Score and Low Carbon Designation for portfolios; and a range of ESG-focused indexes.
Data is generally opaque and hard to find in private markets, and our PitchBook team has started aggregating data on impact funds, LPs, and companies that have received investment from these entities. It is currently tracking 704 impact funds; 732 LPs that have contributed to those funds, and 1,838 companies that have received capital from impact investors.
We’re not stopping there. We’ll be doing more as part of our recent FundVotes acquisition to examine proxy voting and how firms bring shareholder interests – including ESG interests – to bear on firm behavior. After all, investing for impact is often higher touch – it can include working with investee companies to achieve social and environmental goals. This is what investor stewardship is about.
In what ways is impact investing making headway, and where is it lagging?
On the headway front, there’s no question that interest in investing for impact is growing globally—and not just from new players in the investment world. Even beyond the talked up HNWIs, millennials and women, we also see large institutional players pursuing impact measurements. It’s what their investors want.
One of the areas that’s particularly challenging is that the term “impact investing” isn’t consistently understood. We think Morningstar can help here. We hear from different types of clients who have trouble distinguishing between ESG, SRI, sustainable and impact investing. We need a more common understanding of what can be measured and how.
Can you really tell when businesses are “being good”?
Like anything else, it depends on your definition. Today, the measurement approaches that characterize traditional “impact investing” are fragmented and not uniform. They’re more widely used at the far ends of the spectrum—either among small, specialist firms or as reference points for large, institutional players in private markets.
Morningstar, PitchBook and our partners at Sustainalytics approach investing for impact in a way that’s somewhat more expansive than traditional approaches and designed to meet the needs of our different audiences. Sustainalytics considers company performance and preparedness, in addition to any involvement in controversies. They also assess whether a company’s products are aligned with a sustainable future—like renewables—or whether they’re fit for a more energy-intensive, less sustainable future—such as thermal coal.
At Pitchbook, Morningstar’s Seattle-based private equity data and equity research platform, the research team defines impact investing quite explicitly: Impact investors are those investors who invest for financial returns while seeking to intentionally create a positive social and/or environmental impact and while actively measuring that impact. In short, Pitchbook is currently defining “impact” through the lens of investor objectives.
What are the payoffs and costs associated with impact investing for all parties?
It’s a blend of financial returns with social or environmental impact. Investors decide how they balance these two values. In private markets especially, we find that investors are often willing to seek higher impact at the cost of returns.
As impact investing becomes more mainstream, investors may be challenged to find teams with enough experience to deliver the financial and impact returns they want to see.
Without a universal standard of performance measurement, a robust, skilled research effort is critical—and there is a cost to building that kind of expertise. Reporting is similarly complicated and nuanced in this space, requiring investment in tools and data and an understanding of what constitutes a reasonable benchmark for success.
Finally, in exchange for often-patient capital, recipients of impact investments face the costs of increased scrutiny, transparency and reporting requirements.
Where have you seen impact investing make the biggest strides in recent years?
As impact investing has matured, we’ve seen three important areas of development.
First, impact investors are getting better at measurement. The 2012 introduction of the UN Sustainable Development Goals provided a framework to evaluate firm behavior. Plus, it’s a better roadmap for how we go forward.
As an asset class, the growth of the green bond market is important. Green bonds fund sustainable, climate-friendly projects but they trade in the public markets, can be used in a diversified portfolio, and exhibit many of the characteristics of traditional fixed income instruments.
Finally, newer, prominent institutional investors are getting involved. This suggests that the market better understands this opportunity, and it’s bringing mainstream credibility.