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The Art and Science of Impact Investing

By
Amberjae Freeman
April 28, 2017
11 min read
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How can impact investing add value? To find out, we'll need to find key differentiators.Research is the foundation of every investment strategy. Income statements, balance sheets, cash flows—are all valuable inputs that point to a company’s overall financial health. But for impact investors, these aren’t the only considerations. We think it’s important to understand a company’s impact on people and the planet, too. This is where the art of impact investing can be a key differentiator, and where we believe we add value at Swell. 

What is impact investing, anyway?

At Swell, we follow The Global Impact Investing Network’s definition of impact investing, which says:

“Impact investments are made into companies, organizations, and funds with the intention to generate [positive] social and environmental impact alongside financial return.”1 - GIIN

Until now, impact investing has mostly been the domain of private equity and venture capital firms with vast sums of money and an increased appetite for risk. But Swell has taken the concept of impact investing and applied it to public markets, which makes impact investing available to everyone.

Impact investments are made into companies, organizations, and funds with the intention to generate [positive] social and environmental impact alongside financial return.1

- The Global Impact Investing Network (GIIN)

At Swell, we start with the art...

There are some business indicators you just won’t find on a balance sheet. So we begin by identifying important global trends that need to be addressed through innovative technologies, products, and services. This helps us unearth interesting investment theses that we use as the basis for our thematic portfolios.

For example, as we began designing our Clean Water portfolio, we identified the following long-term trends:

  • Water demand is expected to be a full 40% above the current accessible, reliable supply as soon as 2030.2
  • By 2050, two-thirds of the world will be “water stressed,” with two billion people facing water scarcity.3
  • Increased demand for water will be driven by increases in- Population- Agricultural pressures- Urbanization

These trends, coupled with the realities of inadequate supply and the increased need for investment in infrastructure and water technology, make for a very compelling investment opportunity.

...then we add the science.

Once we’ve identified an investment theme with potential for both high impact and high returns, we curate the list of individual companies to make up each portfolio. First, we assess whether a company addresses a natural resource or human health concern, and then we rigorously analyze the sustainability of their business practices, as well as the quality of their financial performance.

Before a company can make the cut into one of Swell’s portfolios, we ask:

  • Are the company’s environmental, societal, and governance practices up to snuff?
  • Are they in a good position to capitalize on global trends, including emerging markets?
  • How much of the company’s underlying revenue points to a theme we’re interested in, like urbanization, rising living standards, infrastructure, etc.?
  • Are they profitable and growing? And is the stock reasonably priced?

Finally, we assign each company a percentage weighting based on expected returns and risk levels, trying to optimize for both.

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The Type OfCompany That Fits The Mix

Xylem, Inc (from our Clean Water portfolio) is a great example of the kind of company that meets our standards. Their tagline, “Let’s Solve Water” sums up their story perfectly. Whether they’re providing equipment to solve a complex water transfer challenge in the Panama Canal, or offering water recycling solutions for reuse plants in Qatar, the company works to address the global need to conserve our limited freshwater supply in the face of increased demands.

But that’s just part of the story. We also like Xylem because they allocated a handsome $1.8 billion toward strategic infrastructure acquisitions. Their footprint is expanding in high growth markets like China and India, and they’ve opened an engineering and assembly facility in Dubai. To top it off, they’re increasing the percent of revenue that’s being put toward R&D, from 2.6% in 2015 to 5.0% in 2020.4

Getting Poised ForGrowth And Positive Impact

So it’s all about impact, right? Well, not entirely. An investment strategy focused solely on impact is great for the world, but it can cause investors to miss out on opportunities to generate returns. That’s why Swell’s approach to impact investing is growth-oriented.  

We don’t like investing in fossil fuels, like coal and oil, any more than you do. But we also don’t want to broadly eliminate companies that aren’t “pure plays.” We do this by taking a holistic view of our portfolio companies. Which means we look at where the company is today as well as where it’s heading tomorrow. For example, what’s the company’s 3-5 year plan to replace non-sustainable products with sustainable alternatives? This nuanced approach helps us surface companies that are poised for growth within an impact theme.

So, while a company with 77% power derived using conventional sources, might not meet our impact criteria, a company like Enel, with 45.5% renewable capacity and a solid 5-10 year renewable expansion plan that’s being executed on, might make the cut. Additionally, Enel is expanding their renewable portfolio in South America and Africa. They also plan to be carbon neutral by 2050.5

At Swell, we understand that sustainable investing involves “the full integration of environmental, social and governance (ESG) factors into investment analysis and decision-making” and that such considerations are “premised on the financial materiality of ESG factors.”6 (So says Joe Keefe, a leading thinker of the impact investing world.) We also understand that the things a company does to address critical global issues are where the growth and long-term financial and impact performance will shine through.

Short term trends aren’t enough for impact investors. We take the long view. Our portfolios are made up of companies whose impact and value extends beyond the bottom line.

1 Global Impact Investing Network “What is Impact Investing?” 2017.https://thegiin.org/impact-investing/

2 The 2030 Water Resources Group “Charting Our Water Future: Economic Frameworks to Inform Decision Making,” McKinsey & Company, 2009.  http://www.mckinsey.com/~/media/mckinsey/dotcom/client_service/sustainability/pdfs/charting%20our%20water%20future/charting_our_water_future_full_report_.ashx

 

3 Nathanial Gronewold“Oil Companies See Opportunity in Another Precious Commodity,” Greenwire, July 28, 2008.http://www.eenews.net/greenwire/2008/07/28/stories/67456

 

4 Xylem, Inc. 2017 Investor Presentation, April 4, 2017 http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NjY1Njg4fENoaWxkSUQ9MzczNTE0fFR5cGU9MQ==&t=1

 

5 Enel Our Vision: New Era. New Energy." https://www.enel.com/en/aboutus/a201608-vision.html

 

6 Joseph F. Keefe“Sustainable Investing and the Next Economy” (Speech to the Boston Economic Club, Federal Reserve Bank of Boston), PAX World Investments, June 15, 2010.http://paxworld.com/system/storage/17/a0/8/553/si_next_economy.pdf 

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