Schroders Capital on values-based investing

Investors are now looking for complete private markets solutions that are aligned with their financial and non-financial objectives, say Emily Pollock and Jack Wasserman at Schroders Capital

This article is sponsored by Schroders Capital.

What are some of the key evolutions you have witnessed in private markets in recent years?

Emily Pollock

Emily Pollock: One of the key trends we have witnessed over the past 10 years is that less and less value is being created through a liquidity premium and more and more value is being created through a complexity premium. That complexity premium manifests itself in a number of ways, including specialisation and the importance of being local.

In private markets, your network and access to information are what enable you to generate outstanding returns, and the complexity premium means you cannot be all things to all people. You have to specialise. To that end, Schroders has put a great deal of emphasis on ESG and sustainability over the past 20 years on the public equity side and it is a priority for Schroders Capital as well. ESG and impact are core to what we do across the whole business, and we have a partnership with BlueOrchard, a member of the Schroders Group, which has been dedicated to impact investment for over 20 years.

Another important trend is the democratisation of private markets. Part of this trend is driven by the increase in liquidity which has meant these asset classes now appeal to a broader audience. In particular, we are working with the high-net-worth/personal wealth and defined contribution pension markets, which historically would not have been able to access these investments due to high costs and a lack of liquidity.

Jack Wasserman

Jack Wasserman: Encompassing all of that is the ability to deliver a solution. Historically, private markets allocations were considered in terms of the individual component parts, each looking to address a specific requirement. Today, investors are coming to us with broad objectives around income, growth, liability matching and more recently sustainability and other non-financial outcomes.

Private markets allow you to build solutions to those problems, which is why players like Schroders Capital, with a diverse suite of specialist private markets capabilities, can position themselves as those solutions providers. It can be harder for managers that focus on one asset class or strategy to deliver that one-stop allocation that addresses a number of their needs.

What is driving that increased focus on non-financial outcomes from investors?

EP: Northern European and UK pension funds have been leading the charge on this. The trend has been ongoing for the past 10 years but has picked up pace over the past 12 months. Now, with new regulations coming in, including the Sustainable Finance Disclosure Regulation and the Task Force on Climate-related Financial Disclosures in Europe, that is only going to increase. As an industry, there is now a recognition that while the objective is to make companies better from an environmental, social and governance perspective, that means nothing if you are not setting targets and measuring progress against those targets. That will make it easier for investors to benchmark, which will in turn intensify managers’ focus on ESG.

JW: I think there are a number of forces at play that have collided at this particular moment in time. We now have international standards on both ESG and impact. These include the Operating Principles for Impact Management, for which BlueOrchard, the microfinance and impact investing specialist in which Schroders holds a majority stake, is a founding signatory.

The impact industry is coalescing around what it considers to be best practice. There is a recognition that while we do not yet have consistency in reporting methodology, we are starting to get more consistency in outcome objectives, particularly in line with the Sustainable Development Goals, which have provided an important framework for investors when setting non-financial objectives. Then, alongside all that, we have this huge wave of regulation.

However, perhaps the most significant force is the individual on the street. There is unprecedented interest in what is happening globally from a climate and socio-economic perspective. That is putting pressure on governments and regulators, certainly, but also on asset managers and asset owners.

We saw the publication of a new report by the G7 Impact Taskforce recently and the recommendations are clear – private capital must be mobilised to address these environmental and societal challenges. That makes perfect sense with private markets central to this. In public markets money is moved around. However, with private markets you own and operate the asset to be the driver of change.

Why is consistency in reporting so important and what challenges remain?

JW: Another of the recommendations of the Impact Taskforce focused on harmonisation, integrity and transparency. While there is not currently a consistent methodology for how we report on these things – and, after all, one of the defining characteristics of impact is measurement – it is critical that there is integrity and transparency around reporting methodologies.

That is why I think the most important principle for impact management is independent verification. You do not necessarily need to have the same tools being used or even the exact same methodology for calculations. However, you do need transparency and integrity and you can achieve that by opening up your books for independent and external verification.

What is your approach to tackling climate change and what sorts of opportunities is that creating?

EP: It is creating a huge amount of opportunity and we are seeing a great deal of interest from clients, not least because climate change is something we can all relate to and something that we should all be trying to solve. It is important to take a diversified approach to portfolio construction and we believe there are three key pillars to invest behind – climate mitigation, climate adaptation and carbon capture. Only by allocating capital to all three are you able to address the issue.

Climate mitigation is about the reduction or avoidance of greenhouse gases. Adaptation is about helping communities adjust to climate change and become more resilient. Carbon capture involves sequestration, either naturally through trees, soil and oceans or through the development of new technologies.

JW: Those different pillars lend themselves nicely to different asset classes. Renewable energy is central to climate mitigation and so that plays an important role in any climate-focused portfolio, alongside other infrastructure assets around energy efficiency and green transport, for example. But then you also need the power of private equity to provide growth capital to some of these new climate change technologies to deliver a full solution to a client.

I would add that it is critical that any climate-focused solution also takes into account the people who will be most impacted. There is a huge need for capital to flow into the geographies where it is most needed, which is why BlueOrchard is focused on impact investments in emerging markets.

Does that then bring us to the adaptation pillar?

EP: Absolutely. A lot of organisations are setting targets around emissions avoidance, but it is important to also take that adaptation pillar into account. How many people can we help through the investments that we are making? That people element probably does not get the airtime that it deserves.

JW: Social implications have to be central to any climate strategy, particularly nowadays, when there is so much focus on reducing inequality and exclusion. At the same time, socially orientated impact strategies need to be very aware of their climate output. You cannot have one without the other. It is important to put a lot of thought into the intent of a solution – that starts with the product strategy and design well before any dollars are invested. You must be clear on what you are looking to deliver and what KPIs you are going to measure, then manage the asset against those objectives throughout the life of the investment.

What role do you see impact playing in investors’ portfolios going forward?

JW: We are ultimately agnostic in terms of how clients bucket impact. Some are bucketing it as a sidecar allocation of 10 percent, 15 percent, or even more of their portfolio. However, a growing number of clients are looking for entire solutions that are aligned with their beliefs and values.

Something else that we are witnessing is a desire to have a domestic and international impact allocation. For example, a UK client may be looking to address impact locally – not at a national or even state level, but within the city or county that they operate in. They then complement that with international impact, predominantly targeting emerging markets. All that matters is that capital is flowing to areas where it is needed, and we believe you can build a complete solution that addresses all your objectives including impact, income and return.

EP: Impact used to be the preserve of US endowments and forward-thinking family offices, but we are starting to see many more large, institutional investors entering the space. I agree they tend to start locally, which makes sense. That way, they can see the impact their money is having.

Over the next couple of years, as reporting standards improve and the industry has longer and more robust datasets to work with as the industry continues to mature, I think those institutions will move into impact in a more meaningful way. At the moment, there tends to be some emerging manager risk because impact is still nascent, but I fully expect it to become more mainstream. The hope would be that in the future, investors will no longer have an impact bucket but rather impact will just become synonymous with good investment.

The views and opinions contained herein are those of Emily Pollock, solutions director, and Jack Wasserman, investment director, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.