Public equity markets have historically been overlooked in the impact investing space, traditionally a domain for credit and private market financing. We see public equities playing a growing and indispensable role in the impact ecosystem.
A common question in the industry is: how exactly can investing in public equities create impact? At BlackRock, our Active Equities Impact team views investing in public equities in two segments: firstly, the role of the impact investors to facilitate and catalyse impact outcomes; and secondly, the role of each impact company and the inherent theory of change.
Through a long-term, ownership mindset, we believe impact investors in public equities create impact by:
- providing an exit pathway for private enterprises pursuing impact;
- supplying the capital needed for impact companies to grow;
- engaging with companies to enhance impact outcomes;
- increasing the visibility of undervalued impact companies, and
- democratizing access to impact investing.
On the first point, the Global Impact Investing Network’s June 2019 Annual Investor Survey of impact investors and leading impact investment organisations from around the world, revealed that 61% of respondents identified the lack of suitable exits on private impact investing as a key challenge. Because preserving their impact identity is at risk, many enterprises hesitate to exit via the public market where they may or may not be able to manage this risk. Compared with a traditional exit from private equity where investors are typically only interested in a company’s financial attractiveness, a responsible exit in impact investing means the company attracts new investors who value two additional attributes: impact and a long-term partnership.
One channel for impact investing in public markets to achieve its impact is through the capacity to participate in Initial Public Offerings (IPOs). Very often, a smaller impact enterprise approaches its growth phase and must turn to the public markets to raise funding at a significantly bigger scale. In the absence of public-markets impact investors, the social or environmental impact of such companies can become severely diminished as it responds to the preferences of hedge funds and other short-term investors. One example, in my experience investing in IPOs, is of a remarkable company with a dual-impact purpose: it buys and rehabilitates abandoned and dilapidated homes in the depopulated towns of Japan, reselling them profitably to first-time homebuyers at a price that’s cheaper for that family than it would cost to rent an apartment. With the support of impact shareholders like our BlackRock Global Impact Fund, the company is encouraged to stand by its unique model and is now comfortably broadcasting widely about its social benefits to these families and its value in resuscitating struggling towns. We continue to meet with venture capital firms, private impact companies, and with BlackRock’s own teams to ensure that we can contribute to impact companies’ success at these transformational moments.
We also recognise that a company’s need for capital continues throughout its business lifecycle. People commonly think of corporate fund-raising as an event that happens only in the private markets and at the time of IPO. But publicly-traded companies often must raise debt and equity capital at many points in time and for many reasons. In particular, the need to raise funds can arise at an inconvenient time — sometimes when a stock is out of favour. This can be a life-or-death moment for a company, when an inability to raise capital might mean that it won’t survive to continue delivering its impact. In my experience, this happened dramatically to one of our women’s health companies, where rapid cash-burn forced it to seek more capital at a moment when the market was not interested. The stock price dropped, yet as a critical part of our extended period of ownership in the company, we had come to be a trusted partner with management; as a result, they were receptive to our suggestions for future cash management and fundraising, and we agreed to give them additional equity funding. Over the ensuing two years, the company has followed this game plan to raise funds regularly and successfully; it has grown and is delivering more impact than ever. We continue to seek partnership and engagement with all of our portfolio companies, believing that this is the best path to deliver both impact and financial returns over the long-term.
A recent example that highlights the role of company engagement tailored to enhancing impact from our own Global Impact Fund portfolio, is with a company on the leading edge of a potential new treatment for Alzheimer’s disease. In January, members of my team and I met with the CFO of a pharmaceutical company to discuss an innovative path towards achieving large-scale, impact outcomes. Understanding the company’s culture of seeking to make both a positive impact on society and generating attractive financial returns, we proposed the idea of the company providing discounted or even free treatment in select, underserved markets where the company would not otherwise have market penetration, highlighting that the marginal cost of production would be negligible. We offered to help connect the portfolio company with an aid agency or NGO partner with known capacity to distribute medications in developing countries. The CFO was receptive and noted how such a program would also serve to boost employees’ sense of purpose and morale, creating a virtuous cycle within its corporate culture.
We also expect our portfolio companies to drive impact by meeting two criteria: materiality and additionality. We typically define materiality as deriving greater than 50% of the company’s revenues from products and services helping to solve a major social or environmental problem, as represented by our impact themes and the United Nations Sustainable Development Goals 2020 (SDGs) and underlying targets.
To meet the additionality criterion, a company’s products or services must address a need that is unlikely to be fulfilled by others (such as competitors or governments). We believe the primary sources of company additionality are the application of leading technologies or innovative business models, as well as the delivery of a company’s products to underserved populations. By requiring additionality for impact companies, we are effectively investing in disruptive innovation helping to meet essential needs where there is strong demand but inadequate supply.
More broadly, beyond impact contributions from a company and from us as an investor, we also see impact contributions coming from public equities as an asset class. On the one hand, if we were to accept the view that impact investing can only be achieved in private markets, we would also be accepting that impact investing must be relegated to a relatively modest role in solving the world’s great problems, due to the inherent scale limitations of private equity. Moreover, with private equity being the dominant asset class for impact investing globally, impact may inherently be reserved only for institutional investors and qualified, high-net-worth individuals, and typically only for those who can operate with multi-year lockups of their investments.
We hold a different view. Quite simply, the global need for impact capital is an order of magnitude greater than what could conceivably be provided by the private markets. For developing markets alone, there is an expected shortfall of approximately US$2.5 trillion annually to meet the SDGs by 2030. Existing contributions from companies, governments and other organizations are not nearly enough to meet this need. By offering impact investing through public equities, a broad new cohort of investors can participate and provide much needed capital.
It is long past time for the democratization of impact investing. There is much work and exciting innovation to be done to advance the impact investing ecosystem. Together we can nurture growing seeds as well as build great forests with the complementary roles of private and public market impact investing.
Eric Rice is BlackRock portfolio manager of the Global Impact Fund and Head of Active Equities Impact Investing.