What ESG and Impact Investing Mean for the Alternative Investment Sector

ESG, an acronym for environmental, social and governance (ESG), along with impact investing, have been prominent topics in the alternative investment sector, with both allocators and managers alike determining how to embrace them.

On July 15, EisnerAmper hosted a panel discussion titled “What ESG & Impact Investing Mean for the Alternative Investment Sector.” The conversations focused on the latest developments and trends in ESG as well as impact investment strategies and trends in the alternative investment space and what the future might hold.

Panelists included:

Ana Hung, Partner, EisnerAmper LLP (moderator) Deborah La Franchi, Founder and CEO, SDS Capital Group Josh Tanenbaum, Managing Partner, Rebalance Capital Allison Yacker, Partner and Co-Chair, Investment Management and Funds, Katten Muchin Rosenman

Overview

ESG investing, fueled by the current social and political environment, has become one of the most popular alternative investment trends in the past five years. Alternative investment managers who have long ignored the ESG impacts on their investment strategies now face a sense of pressure and social responsibility to incorporate ESG investing strategies into their portfolios. Additionally, over the past few years, impact investing has taken a more visible place within institutional investors – ranging from products that have positive environmental, racial equity or poverty alleviation outcomes.

ESG: The Current Environment

Investors have poured record amounts of money into funds incorporating ESG and impact principles and impact funds in the last five years, according to Morningstar. In 2020 alone, the amount of investor contributions into funds layered with ESG considerations has more than doubled. The last five years have also seen a huge diversification in the investor base. La Franchi specified at one point, 90% of the capital was funded through institutional banks; now they represent less than 50% of the investor base, with pension funds entering the space over the last few years.

It once was the prevailing mindset that ESG or impact strategies were counterproductive to maximizing profitability for investors; that investors might have to settle for a lower rate of return with the caveat that their investment will incorporate ESG principals or have a positive societal and environmental impact. However, it’s been noted that incorporating ESG/investing in an impact strategy and profitability are not mutually exclusive. The panelists discussed how, especially in light of marketing their investment strategies to prospective investors, their portfolios that are weighted 100% to ESG strategies their targeted rates of return are comparable to products not incorporating ESG principles or non-impact strategies within the same asset class. 

ESG: The Future

As alternative investment managers look to embrace both ESG principles and consider the impact of their overall investments, there are certain challenges and obstacles to consider. Although there are no current ESG specific regulatory standards in the United States, investment managers must consider their fiduciary duty to investors and ensure their investment strategies are aligned with their ESG goals.  Allocators to strategies layered with ESG are becoming increasingly sophisticated and are asking tough questions during the due diligence process. It is essential for alternative investment managers to have their fund offering documents aligned with how their firm is incorporating ESG.

One of the biggest challenges noted by the panelists was the lack of a standardized financial reporting metric to measure for ESG. The reporting requirements for compliance or analytical purposes can be time-intensive and not entirely straightforward. Many fund managers have to weigh this cost and consider the potential for a growing regulatory landscape surrounding the topic.

Final Thoughts

• ESG considerations are not a fad and the alternative investment industry is likely to see a sizeable increase in allocations to strategies layered with ESG over the next decade.
• Strategies with an ESG component can be as profitable to investors as those without. In addition, they also offer investors the opportunity to make a positive environmental and societal impact.
• Alternative investment managers need to consider the challenges posed by any potential regulatory and compliance requirements that might arise as ESG become more scrutinized.  

To view the webcast, click here.