Impact investing: a conversation with Sarah Norris, manager of the Abrdn Global Equity Impact fund

As the 2021 United Nations Climate Change Conference, COP26, kicks off in Glasgow, we’re sharing a conversation with Sarah Norris, fund manager of the Abrdn Global Equity Impact fund, on investing with impact.  Watch or read the transcript below to learn more on putting your money into funds with strong environmental, social and governance (ESG) values.

Sarah herself came to the finance industry from the international development industry, and talks about the rise of impact investing, and what differentiates it from ESG and ethical investing.

In our conversation Sarah also discusses her fund’s approach to stock selection and why investing for sustainable outcomes has a bright future.

This is an edited transcript of the conversation, recorded as part of Pensions Awareness Week 2021.

2020 and 2021 have been the years in which ESG investing has come of age and finally started to get the attention it deserves. But maybe we could start by hearing what ESG stands for, where it’s come from, and how some of the different kinds of ESG investing.

ESG is the shorthand for environmental, social and governance, investing. And increasingly, we’re seeing all funds all asset managers talking about integrating ESG into their investment approach.

That is because there’s a growing recognition that environmental, social and governance issues at a business will have serious financial repercussions to that business’s profitability, or to the multiple that the business trades on in the stock market.

That growing awareness has made ESG a more popular way to analyse companies. And apart from just ESG integration into the investment process, which you see at most firms, you’re now also seeing ESG outcomes.

What I mean by ESG outcomes are specific products and specific targets around environmental, social and governance characteristics. That can be your typical ethical investment where that’s normally exclusion based, and the ethical portfolio construction is around avoiding sectors like alcohol, tobacco, armaments, animal testing.

Then you also have sustainable and responsible investing, where you’re focused on how is a business running itself. And you’re looking for businesses that are managing those ESG risks better than their peers. So they have better employment programs, better environmental policies.

And then more recently, we’ve seen an increase in impact investing, which is what I’m actively involved in. And that is allocating capital to companies whose products and diverse services are solving some of the world’s problems.

So you can see that slow evolution from just exclusion to focusing on those risks and opportunities, and if there’s a mispricing opportunity, and ultimately, to products and services which are transforming our world.

Tell us how you came to impact investing Sarah

My background is actually non-traditional. I have been working at Abrdn for the last 10 years. But before that, I worked more with development organizations, specifically focused on Africa and education programmes. So my background is not finance at all. I’ve definitely picked up those skills, but my passion was on the development side of things and I came to impact investing as a way to marry those two.

We sometimes tell people is that the world of ethical investing is a continuum. If that’s right, you are definitely at the sharp end of it, asking the hard questions that filter down to other fund managers who are only beginning to introduce some of those ethical criteria to how they evaluate their investment choices.

It’s definitely a spectrum of capital. There’s no right or wrong way, but there are layers. You slowly layer on to get to that impact side of things versus the baseline exclusions approach. It just depends on your preferences as an investor and what aligns with your belief system and how you think about them. Of course there are risks associated with different types of strategies.

Yeah, the question I’ve always thought about, when we say ethical is, well, that’s great, but whose ethics? And I think certainly from an Irish perspective where the choices historically been quite limited in terms of ethical investment, will we start to see more choice to align fund strategies with one’s personal ethics? Is that coming into the market?

Yes, and no. On the one hand, in that you’ll have more products that you can choose from, I certainly think that there’s a big push to have more ESG products, so not just have that ESG integration into analysis, but thinking about these different outcomes. And you’re starting to see more products are focused only maybe on environmental concerns, and social concerns.

But when it comes to impact investing, I always tell my clients, it’s not about your morals, it’s not about your ethics, because everybody’s morals and ethics are so very different. So when you’re buying an impact product, specifically, you’re not going to have a say on what are the most pressing problems once you’re invested.

With an ethical fund, we send out a survey to our clients, we ask them about their morals and persuasions, and we build our universe based on their views.

With impact investing in the global fund, we define the world’s most pressing problems using the United Nations definition of where they see the greatest need. And that’s their 2030 agenda and the sustainable development goals.

So, for example, within ethical investing will exclude companies that test on animals within the Impact Fund, we don’t. So I think as an investor, you have to be conscious that there will be different mandates, and hopefully you have more choice to align. But you’re not going to have a say, in the direction of each of those mandates.

And that’s interesting, because I suppose that disrupts my neat, nice idea of ESG investing being a continuum. Because arguably, at the impact investing end, if you are not excluding those animal testing investment opportunities, that that could be controversial to some investors’ minds.

It might be, yeah. And then I’d say there’s an ethical range that is probably more suited to you, if you want to have a say in what you invest in. I guess with ethical investing, you get a say in what we don’t invest in, and you help us pick what we don’t invest in. With impact investing, you don’t get to say at all the way we’ve set it up, but you can have confidence that we’re aligned with the UN [sustainable development goals].

And so if you believe that is our kind of international guidance or standards on where we should allocate capital, and what are the most pressing global problems, then you can take confidence that is the direction of travel.

So I guess it just depends on how you as the client, are thinking about ethical investing. And it’s frustrating that we throw so much jargon at investors and we say ESG, SRI (socially responsible investment), impact, ethical, what does it all mean? And unfortunately, you can’t just look at the labels on funds, you have to read. What is the objective?

Looking at your portfolio in the Impact Fund more specifically, it’s quite a concentrated portfolio – around 40 stocks. So my question would be, how do you see fitting with a wider portfolio? Is it possible to have a kind of balanced portfolio, which is pure ESG, or pure impact? Or how does it fit with a wider portfolio?

I think with sustainable investing overall, there is a natural bias to higher quality companies, because these businesses are managing their risks better. And they’re capitalizing on opportunities.

So having that quality bias within the portfolios is probably something that you’ll see within most sustainable portfolios and that tilt within the impact strategy specifically, because we’re looking for companies that have a material exposure to one of the eight themes we’ve got for environmental and for social.

We’re focused on to being a material [investor to each business in the fund]. So we do have a natural gravitation towards more mid cap names. We also have a bias away from maybe some of the more popular sectors in the market? So it does provide a nice counterbalance.

We don’t invest in any of the FANG stocks, Facebook, Apple, Netflix, Google, because if you think about those business models, for us, we’re very much focused on how was the company investing to change the world? And is that change in the world good? Is it aligned with the UN?

It’s hard to argue that Facebook, Apple, Netflix, Google are solving any one of the world’s most pressing problems, and that it’s core to why they exist.

So global fund does have slight tilts. And I think sustainable investing overall has slight tilts. But in my opinion, that’s where the market is going. I think the market is moving away from those “sin sectors” to use the ethical terminal terminology. Not necessarily because they’re bad. I think that’s a relative term. But because that’s not the focus of regulation.

If you think about what government is saying around climate change and carbon targets, traditional energy companies are not going to look the same in 20 years. There is going to be a much larger skew towards renewable energy, for example. And that naturally transitions you away from certain sectors and also biases portfolios away from certain sectors.

Yeah, [it seems like change in the energy sector is] not yet all priced in. For big oil in particular, has the risk around stranded assets been priced in? Great to have discovered lots of reserves under the Arctic. Will it ever be pumped? It’s pretty difficult to represent that value in the share price and price up that risk accordingly.

So one of the things that, that the ethical investing movement has done is shone a spotlight on some of the risks around kind of old style portfolios as well as the opportunities of an ethical one. And it’s probably a good point to note that your fund is up kind of knocking on for 14% annually over the last three years and, and 30% over the last 12 months.

I think that that comes back to the fact I always call it kind of the twin forces. You and I, we know where our food comes from, we’re more conscious of what we’re eating. We’re conscious of how we’re shopping and those consumer awarenesses and shifts, is also guiding public policy that’s shifting towards me being greener and being fair.

So it’s the businesses that are positioned to manage that transition the best and manage those risks and also capitalize on that opportunity that are going to be the ones that deliver the most sustainable outperformance.

We own a business in the US that’s focused on renewable energy generation. They’re the largest renewable company globally, a company called NextEra. And for them, they’ve built such a market position that it’s cheaper for them to buy up old coal fired power stations, shut them down, and build renewable energy facilities and sites.

And that’s helping keep up with the demand in the US because the US has phenomenal demand. And it really likes supply. And so they had enough foresight to be able to position and manoeuvre the business in that direction. And it’s that kind of business that we’re looking for.

Well, that that leads on to something I was really just interested to discuss. How do you go about evaluating a stock for your fund. How often do you introduce new stocks? How many ideas might you have, at one time, those kinds of questions?

The first thing to say is that you can’t screen for impact. You can’t use MSCI or other data providers. You really have to have fundamental bottom-up analysis. So we meet our companies a couple of times a year, we’re very focused on what is their strategy, and how does it align with the UN’s overarching agenda?

Rather than just a revenue screen, which can be misleading, we’re focusing on how are companies positioning themselves now and what do they what are they going to look like in the future? And can we also get to a point where we can measure that impact? Because impact investing has a double bottom line objective.

There is what we call it the outperformance which our fund has delivered very strongly, as well as that impact measurement.

We produce an annual report with all the stories of the companies that we’ve invested in. We’re looking for alignment to four environmental themes and four social themes.

For us, once a company has met our thresholds for impact, and we’ve decided yes, the strategy aligns, we can see the business direction and we expect them to begin to report on the impact their products and services are having, we focus more on the financial case.

And because we do have that outperformance objective, when we introduce a name, it’s based on confidence around the financial outperformance, and we tend to have very low turnover. If we build enough conviction, both from a financial point of view and the impact case, we tend to hold for multiple years.

And so at the moment, we have a very low turnover rate. It’s sub 15%. But we’re always looking for new and innovative businesses.

One company that we’ve been doing a lot of work on is a company called Insulet. They do insulin delivery systems. They are pods that that just go on your shoulder that don’t have any tubes or wires. And what makes that so unique is those insulin delivery systems are connected with your iPhone. If you’re a child with diabetes, your parents can monitor your glucose levels, and then be able to distribute the insulin when it’s needed.

It’s a really disruptive business model that’s changing how we care for diabetes – and diabetes is one of the most pressing non-communicable diseases that we have identified globally, and it’s only increasing in its prevalence.

So for us, that’s kind of that that’s the type of business that we’re looking for: something that is disruptive, sees a problem and has identified a solution and that solution, therefore, will deliver their sustainable returns both from an impact perspective and from a financial perspective.

Okay. And you might walk the road with that company for seven, eight years. And how do you measure that impact?

We’ve identified these eight themes using the 17, UN sustainable development goals. And when we think about measuring the impact, and each of these themes, we’ve also looked at the key performance indicators that the UN set for the sustainable development goals. And while those are for countries, we were able to aggregate them and identify five or six main indicators per pillar that we want a company to be able to report on.

For healthcare, it’s around patients, it’s around driving down costs. For financial inclusion, it’s individuals with basic financial services, its financial literacy programmes, it’s SME lending small and medium sized business lending insurance coverage.

For some of the environmental-focused investments around water and sanitation, it’s volume of water cleaned, for the circular economy, which is all about reducing consumption and improving reuse and recovery that’s around material and volumes.

So we’ve got multiple KPIs for each of the different pillars, and when we’re doing the analysis, we make sure that at least one of the indicators that we’ve identified will align with the company’s business model and how they’re investing in those products that they’re developing.

A lot of the ethical fund options that are coming out are very focused on very specific industries or opportunities – such as a solar fund. What’s interesting about the Global Equity Impact fund is that there is a very broad perspective from human health to financial inclusion, to sustainability and climate issues.

We develop that intentionally and I think it comes back to your question around some of the biases of sustainable portfolios. I think if you have only a climate [focused] portfolio, that naturally leads you into certain sectors, and that naturally leads you to certain risk characteristics and maybe tilts into certain industries, and doesn’t necessarily always give you the best diversification opportunity.

When we built the Global Impact strategy, we knew we wanted to compete with your core pension fund, to build a portfolio that doesn’t have risk characteristics that are off the charts, and that is attractive to a retail investor.
That gives us a balance of traditional industries. So we have healthcare, we have industrials, financials, utilities.

Where we’re underweight comes back to sustainability. We don’t have alcohol or tobacco, or mining and extractive industries. And that’s probably what you’d expect. But the tilts in the portfolio aren’t too different from a sustainable portfolio.

If we look to the future, how do you see ESG evolving? You’ve mentioned that, there is almost a Betamax-VHS situation with SRI versus ESG and so forth. Certainly at the retail investor level as opposed to the professional level, it’s a bit like the Wild West. But how do you think that’s going to unfold over the next say, two, three years?

We’ll definitely be seeing more funds, more opportunities for investors to choose between different strategies.
And I think we are seeing tighter regulation around definitions.

We’ve already seen the European Union’s taxonomy and how they define climate change and climate solutions. And I know there were a couple of people from Ireland that sat on the task force for developing that. So Ireland’s had a very loud voice in how we define sustainability, and certainly the climate focus.

And I think that’s only going to continue – there’s now a taskforce working on how we define biodiversity. As we see more regulation, then in two or three years, you could look at the labels of a lot of funds, it will make more sense, versus right now, where the definitions are different depending on what firm you go to.

So I hope we’re making it easier for clients to adopt an ESG strategy or an ethical strategy, not harder, both from a choice point of view, and also more homogenization in terms of how we think about labels.

Is there a scenario where ethical investing almost becomes ubiquitous? At the moment, ethical investing has to be a conscious decision. But is there a scenario where this will reverse, and those wanting “sin” funds will need to actively seek them?

No, because there’s that spectrum of capital. Maybe there are a few [industries] that that we will move away from. But I think there will always be a pocket of funds that simply integrate ESG analysis and do that bare minimum of no material harm.

I do think that the bulk of assets is shifting towards more sustainable mandates, simply because that’s where the returns are to be generated.

Certainly with impact [investing], if we think about the world’s most pressing problems, that creates phenomenal unmet need, whether it’s need for environmental solutions, healthcare problems, financial solutions.

And that unmet need is unmet demand. And for a company tapping into that unmet demand, you would expect to see much more sustainable returns in both meanings of the word sustainable. So I think the pivot towards sustainable outcomes is a strategic shift in the industry rather than any a trend or a flash in the pan.