The Practice of Impact Investing
The World Economic Forum’s report, From Ideas to Practice, Pilots to Strategy, is a collection of articles that offer concrete approaches and actionable insights for professionals interested in engaging more with impact investments.
Zurich Insurance Group offers a variety of general and life insurance products to clients in more than 170 countries, and currently manages more than $200 billion of own assets. As a global insurance company with a growing presence in emerging markets, Zurich is exposed to many of the risks associated with climate change, competition for scarce natural resources, and extreme poverty. We believe that impact investments, which can have a targeted, positive, and measurable effect on society and the environment, while generating a financial return commensurate with the risks they entail, are one way to help mitigate and address the exposure to such risks; this is also why Zurich has direct interest in sustainable economic growth and in developing resilient communities.
While some investors may accept a trade-off between returns and impact, Zurich focuses on opportunities where the return fully compensates for the risk. Both types play an important role. The former can provide higher-risk capital to fund, for example, early-stage social ventures and small entrepreneurs. The latter can make capital available in greater quantities that can be scaled up to fund sustainable growth.
We are convinced that such profitable investment opportunities exist across various asset classes. Our approach is to develop a strategy for impact investing within each of the major asset classes in which we invest. This process begins by analysing the universe of potential impact investments in a particular asset class, and making sure the impact is in line with the intended outcome. The underlying assets’ risk and return are then analysed to determine which fit best within the overall portfolio. At the same time, other potentially limiting factors are considered, including regulatory requirements and balance-sheet capacity. The final step is to determine the best structure for investing in those assets. The same process is used to assess any new type of investment and it requires close collaboration among people throughout the organization. For Zurich, the natural place to start impact investing is to look at simple, low-risk investments.
Leadership and Vision Are Required to Establish a Responsible Investment Culture
As impact investing is a strategy across asset classes, and definitions of responsible investment can vary, an investment institution must develop a clear and coherent set of vision, mission, principles and rationale for its approach.
At Zurich, this process of defining what we consider to be responsible investment was initiated at a senior level by the group chief investment officer (CIO), and took well over a year to complete. The CIO, intrigued by the notion of “impact investing,” held discussions with peers, other asset owners, industry practitioners and leading asset managers. The insights from that process, along with those obtained through internal discussions, provided the outlines of a vision and strategy for responsible investment: to create long-term value for all our stakeholders while remaining true to our mission of achieving superior risk-adjusted returns relative to liabilities.
Zurich’s Investment Management (IM) business strategy team assessed the PRI, a global investor initiative that promotes responsible investment, to learn from best practices while developing our approach. As a consequence, Zurich became a signatory to the PRI in July 2012. Within Zurich, IM is the driver for including responsible investment in the overall investment management approach. This philosophy is also aligned with the Group’s overall corporate responsibility (CR) strategy to fully embed the respective CR-focused topics within the topic-owning departments.
Zurich’s responsible investment strategy was finalized with the IM executive team as well as its external advisory council. The strategy articulates three pillars: ESG integration, impact investing, and collaboration and thought leadership. This approach was endorsed by the group’s executive committee and the board of directors.
Pillar One: Investing for ESG integration and generating superior risk-adjusted, long-term financial returns
The first pillar of Zurich’s responsible investment strategy is based on our conviction that ESG factors do matter. Reflecting these factors in the investment process—across asset classes and alongside traditional financial metrics and competent risk management practices—will support us in generating superior risk-adjusted, long-term financial returns. While our investment approach is primarily based on economic considerations, integrating ESG factors and taking an active approach to ownership are a critical part of a sound investment process. We are convinced that markets in which all relevant ESG risks and opportunities are correctly priced offer powerful incentives. Companies that effectively manage their impact on the environment and society, while adhering to high standards of governance and integrity, should also enjoy a premium. However, the positive impact of integrating ESG factors in an investment strategy is likely to be indirect and difficult to quantify and measure.
Pillar Two: Investing for targeted and measurable impact without comprising financial returns
It follows that the second pillar of our responsible investment strategy is to look for investment opportunities that allow us to generate a much more targeted, direct and potentially measurable outcome, but without compromising financial success: this is our definition of impact investing. We acknowledge that our approach will only have a true impact if responsible investment becomes mainstream.
Pillar Three: Collaborating to build the sector while becoming a leader in responsible investing
With that in mind, our strategy’s third pillar is focused on thought leadership and industry initiatives to provide insights and raise wider awareness about topics related to responsible investing.
Responsible investment must be led by a person highly familiar with the organization and the existing investment approach. Specialist know-how in the field is also required. For this, Zurich recruited an analyst with experience in responsible investment. However, the ultimate goal is to have everyone in IM thinking as a single responsible investment team.
Resources Need to Be Allocated and Incentives Aligned
A strategic approach to responsible investment, based on a clear vision and supported by strong leadership, will ensure that an organization devotes the resources necessary to accomplishing the task. Effectively managing change, driving engagement, and ensuring that responsible investment goals are expressed in general investment management concepts and vice versa, require both strong leadership from the top and diffused ownership and empowerment of the objectives throughout the institution.
Responsible investment brings with it a new language, concepts and market participants. This is particularly true where impact investments are concerned. However, Zurich has consciously rejected creating a designated responsible investment department on the side, which would introduce parallel structures to IM. In accordance with Zurich’s overall CR approach to fully embed the respective focus topics within the topic-owning departments, responsible investment will be fully integrated into IM’s culture.
Zurich embarked on this journey by embedding CR targets into individual goals as part of the overall objective-setting process. Within IM, the CIO’s targets, as well as those of the CIO’s leadership team, already reflect the goal of responsible investment. Targets to support responsible investment are also included in the individual objectives of most senior IM staff, and of all those directly involved in responsible investment initiatives.
Selecting and Working with Investment Products: Green Bonds and Beyond
Roughly 30 percent, or $65 billion, of Zurich’s investment portfolio is held in government, government-guaranteed or supranational bonds. Within this “minimum risk” asset class, green bonds have emerged as a potential opportunity for impact investing and have been predominantly issued by supranational institutions such as the World Bank, IFC, European Investment Bank and others. Green bond proceeds are ring-fenced, meaning they can be used only to fund projects that either mitigate climate change or help communities to adapt to its consequences. Currently, no standardized approaches for project selection frameworks and measuring impact exist. However, all major issuers apply well-developed internal methods to set targets and track progress of the environmental impact of underlying projects. Green bonds are of the highest credit quality, and while returns are modest, so are the risks.
The green bond market is still relatively small, with total outstanding issuance at around $10 billion, depending on the exact definition. The market attracts many buy-and-hold investors, and individual issues have tended to be relatively small compared to standard bond issues in the supranational space. While the impact of underlying projects is impressive, most of these would also have received funding through the supranationals’ regular bond-issuance programmes. After a number of conversations with the issuers, Zurich realized that the true impact would lie in its ability to invest in size, and to make a significant contribution to the market’s development by actively and regularly participating in it.
Zurich conducted an in-depth analysis of green bonds that confirmed they would complement the existing portfolio well, and allow for a minimal increase in yield with an equally minimal increase in risk. Zurich also weighed various restrictions and limitations, and determined that up to $1 billion would be a prudent allocation for one of its largest balance sheets. Most of Zurich’s investments in North America are managed by external asset managers, so the same approach was chosen for green bonds and the process supported by the manager selection team. At the outset, a dedicated mandate was established to tie the potential allocation to the anticipated level of green bond issuance in the market. Eventually, green bonds may become part of Zurich’s broader fixed-income portfolio benchmarks.
Once the allocation parameters were established, portfolio guidelines were drafted and the search for an external asset manager began. Standard processes and the established investment committee governance were followed throughout. With regard to the manager selection criteria, a collaborative approach to support development of the green bond market, including an active dialogue with issuers and other market participants, was deemed vital. Despite the relatively simple nature of a green bond, it took many months to complete the process. The very notion of “green” meant that educating people about the bonds and addressing their perceived concerns formed a substantial part of this effort. Joint responsibility, shared by the head of responsible investment together with the regional investment management team, helped to accelerate the process in some cases, but slowed it down in others. Carefully planning joint efforts and defining responsibilities is important. To date, Zurich has invested more than $200 million in various green bonds. Next steps will include following a similar process for green bonds issued in other currencies.
Recently Zurich began two other projects to determine impact investing strategies for private equity and debt instruments. These projects will follow a similar overall process, but they will take more time than the one related to green bonds, as the risks and the return opportunities are considerably more complex. These types of investments tend to be more fragmented and less liquid, and are often not geared to institutional investors of a certain size. Some of the challenges include finding people with the right skills and finding the right partners to engage with. More complicated structures also face more regulatory restrictions; while mandates need to be narrow enough to effectively control risks, they should be sufficiently broad to allow for necessary scale. They also need to take into account any limitations when it comes time to measure impact. As a global team, and with the ability to tap into the know-how of some of the leading asset managers, Zurich is confident that these challenges can be overcome.
The Journey towards Responsible Investment Is Long and Cannot Be Completed Alone
Insurance is a long-term business, as policy holders expect us to provide security for 10, 20, or many more years in the future. Responsible investment can generate the superior investment performance our shareholders and policy holders expect from us in a sustainable and fair way, but to do so requires the right processes and incentives, and gets to the heart of investment philosophy and organizational culture.
It will require many years to establish a culture in which responsible investment practices are fully integrated into Zurich’s overall investment philosophy and approach. The rewards of achieving this in terms of investment returns and positive impact will, however, be well worth the effort. A commitment to responsible investing engages our existing employees and helps in recruiting new talent. It will enhance the Zurich brand not just with today’s customers, but also with those in growth markets who will form tomorrow’s middle classes. It also sends a signal to our shareholders that Zurich truly takes a long-term view. Most important, it is consistent with our long-term company strategy and vision for a more secure world.