What came first, the impact or the alpha?

I don’t know about you, but I’m fed up with the term “impact investing”. It has almost taken up “hoover” like proportions in describing any investment where anything in addition to fundamental analysis is used in stock selection. It masks a wide variety of approaches and in some cases doesn’t even do that very well. Lets take ESG (Environmental, Social and Governance) integration in stock selection, which we use at Alquity. Most of the stocks in our funds have no demonstrable social objective or purpose. They are just well run companies, making money by building sustainable profit streams into the future. They respect the environment, look after their staff and follow regulations because it’s the right thing to do.

ESG integration has now been conclusively proven to drive returns, primarily through minimizing portfolio risk but in Alquity’s case by also allowing us to create alpha through Forward Looking ESG. Understanding the direction of ESG momentum in a company can highlight opportunities ahead of the market, especially when related to governance issues.

So back to the question- can impact drive alpha. For me, yes, but only if the impact activity has a positive feedback loop into a tangible resource in the company. For example, does it help to win more customers or help them spend more, does it help keep or attract the best people or provide a information advantage that improves product efficacy. That is not to say, companies with a sole impact purpose cannot drive returns. It’s just that they will struggle to deliver competitive returns without the above feedback loop. At a portfolio level, these feedback effects can compound to generate investment alpha. At Alquity, our ESG considerations are “necessary but not sufficient” for stock selection ensuring that our focus is on high performing responsible businesses. We then donate up to 25% of our revenues to impact projects designed to facilitate entrepreneurs and create opportunities for ambitious individuals to succeed in the economies in which we invest. By growing people, we help economies grow sustainably and foster a fertile environment for our stocks to prosper. As a consequence, our investors are the ultimate beneficiaries from our donations.

As the Chinese proverb says:

If you want 1 year of prosperity, grow grain.
If you want 10 years of prosperity, grow trees.
If you want 100 years of prosperity, grow people.

We call this our virtuous circle and it sits at the heart of our business.

In conclusion, the implications for impact investors are clear. If you want impact and are happy to accept a lower return, focus on the impact intentionality of the fund rather than it’s relative return. If you want returns as well, then look for how the impact intention tangibly increases the funds ability to deliver alpha.

Suresh Mistry will be presenting 'Impact as a source of Alpha: How contributing long term beta to developing communities can be a source of investment alpha' at FundForum Africa taking place in London, 14 - 16 September.