Frans Verhaar: Growing pressure on impact investing calls for a reality check
This column was originally written in Dutch. This is an English translation.
By Frans Verhaar, Managing Director, Head of Contintental Europe at bfinance
A few years ago, impact equity seemed to be the ideal answer to an age-old question: how can you make the world a better place without compromising on returns? The promise of 'non-concessionary returns' – impact without financial sacrifice – caused a stir among institutional investors. But recent figures are putting that optimism under pressure. The harsh reality is that many impact funds continue to lag behind the market.
Take global impact funds in listed equities. Over the past three years, they have lagged behind the MSCI ACWI index by an average of 6.4% per year; over five years, the difference was 3.8% – net, i.e. after costs. And although there are positive outliers, the trend is clear. With many investors now reaching the crucial three- or five-year evaluation point, the question arises: is the belief in impact without compromise still tenable?
Impact ≠ ESG
Part of the confusion lies in the definition. Impact is not the same as ESG. ESG assesses how a company operates. Impact looks at what a company does. It is about intention, measurable outcomes and added value. A fund that invests in water technology or biodiversity is not automatically an impact fund. Yet in practice, there are many 'grey areas' where themes are leading, but measurability and intentionality are few and far between.
This diversity creates a broad but also difficult-to-compare market. There are now more than 125 fund houses with impact equity strategies – twice as many as two years ago – ranging from growth stocks to value approaches. But it is precisely this heterogeneity that makes benchmarking complex.
The 'perfect storm'
The headwinds for impact funds did not come out of nowhere. There was a confluence of recent market factors that, when combined, formed a toxic cocktail:
- Index concentration: The so-called “Magnificent Seven” – mega tech stocks such as Apple and Nvidia – dominated the picture. In 2023, they accounted for more than 60% of the S&P 500's returns. Impact funds had an average exposure of only 3.4%.
- Sector bias: Impact funds logically avoid fossil fuels. But in years when oil and gas are booming, such as 2022, this results in a significant lag.
- US underweight: Many impact strategies are structurally underweight in US equities. Given the strong performance of the US relative to Europe or emerging markets, this is having a negative impact.
Expectations versus reality
Nevertheless, most institutional investors do not expect any concessions. At bfinance, we see that virtually all clients want returns that are at least in line with the market – after costs. Only a small minority (around 11%, according to GIIN) are prepared to accept lower returns for public impact strategies.
And that is where the problem lies. If impact portfolios systematically differ from the index – in terms of sector, region and style – is it fair to judge them against that same index? Or should we be more tolerant of temporary deviations, as long as the long-term impact remains intact?
Separating the wheat from the chaff
The pressure on impact managers is increasing. Some are responding sensibly: more risk diversification, stricter valuation discipline, better risk management. Others are secretly tweaking their impact targets to get closer to the benchmark. But that undermines the very thing that sets impact investing apart.
This phase is decisive. Many funds are now reaching the evaluation moments that will determine whether investors stay or leave. Strategies without a clear impact philosophy – or without the support of patient institutional investors – will struggle.
However, this does not necessarily have to be bad news. This 'purification' could actually lead to a stronger group of providers: parties that truly stand for their mission and are prepared to show the long-term commitment that impact requires.
What now?
Investors should not be deterred by the headlines. Yes, the sector is struggling. But there is considerable variation between funds. Now more than ever, it is important to select carefully: does the benchmark match the strategy? Does the expected return match the impact you want to achieve? And how much relative volatility are you willing to accept?
Impact investing is not a hype, but neither is it a guarantee. It requires clarity, discipline and sometimes uncomfortable conversations about expectations. But for those willing to look beyond the short term, it remains a promising route – to returns and results.
