WMA JOURNAL Working for the Investment Community & their Clients
SOCIAL IMPACT BUSINESSES
The opportunity to ‘do good’ and to ‘do well’ together It is the contention of the Social Stock Exchange that social impact businesses can offer sound investment opportunities. In order to test this hypothesis, an investible ‘virtual’ index was created. Empirical evidence from this index demonstrates that it is possible to invest in businesses that ‘do good’ (socially/environmentally) without sacrificing the opportunity to ‘do well’ (financially).
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here is a growing desire on the part of individuals and organisations to use their wealth more productively. Increasingly, people are driven to invest their money in ways that address a social need, such as a prison or affordable homes or address an environmental issue, such as sustainable energy or recycling. Recent developments in the regulation of financial services offerings are supportive of the concept that the consumer may have goals beyond financial. In a recent survey of financial planners, 75% suggest that their clients have an interest in social investment.(1) Financial www.thewma.co.uk
advisers who establish whether a client has social objectives alongside financial objectives will need to take these objectives into consideration when putting in place a financial plan. As a consequence, a third dimension is being added to the traditional management of risk and return and this is ‘Impact’. Impact investment Impact investing is a new field, which offers a wide variety of asset classes and forms. Impact investments are made with the intention of generating measurable social and environmental impact (a “social dividend”) alongside a financial return. A segment of impact investments may seek to achieve market-rate risk-adjusted financial returns while others offer below market returns in return for the impact created in so-called ‘blended value’ investments. Impact investing does complicate the job of the investment manager by adding this third element of impact; which is one that is often difficult to quantify. The good news is that many initiatives are underway to report impact. One of these is the Impact
Report format developed by the Social Stock Exchange. This report seeks to provide a standardised platform in which companies across a variety of industries are able to disclose, articulate and evidence their social or environmental impact. Opportunity for impact investing in publicly listed companies Impact investing opportunities cut across a variety of asset classes, from cash to debt to equity to real estate. Debt financing dominates equity financing by a large margin. Within equities, investment into the equity of publicly listed companies that are social
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There is an inherent conflict between the financial goals of a publicly listed company (and a duty to shareholders) WMA JOURNAL 7
SOCIAL IMPACT BUSINESSES
impact businesses is being recognised as a viable investment strategy by a growing number of industry participants. There is a concern among both investors and companies that perhaps there is an inherent conflict between the financial goals of a publicly listed company (and a duty to shareholders) and the impact goals of being a social impact business. Frequently there is not. High returns do not disqualify an investment from being social. The environmental space is a prime example of this. The initial investments in sectors such wind, solar, and fuel cells were attracted by the perception of high financial returns. There is reason to believe that the growth and return prospects for many of the areas which address a social need will also be strong, the strong policy push in the UK to open up public sector markets is one driver for this. From a corporate perspective, managing a business for sustainability and stakeholder returns is an extension of managing a business well. Recent acknowledgement of this in the form of standards and guidance around Corporate Governance is moving this into mainstream management and organisational behaviour. The Social Stock Exchange, which officially launched its platform in 2013, has been actively researching and seeking out socially and environmentally minded businesses. It has been tracking a number of businesses that are often not easily visible or distinguishable as high impact businesses on stock exchanges. The Social Stock Exchange has used an element of this portfolio focusing on those entities that are listed on London equity markets as the basis for this research. Testing the hypothesis As opposed to being a difficult area in which to find good financial returns, it is the contention of the Social Stock Exchange that social impact businesses can offer sound investment opportunities. In order to test this hypothesis, an investible “virtual” index was created to investigate the financial performance of the equity of publicly listed companies that are also high social or environmental impact businesses. Data for publicly quoted UK stocks and is used and results over one, three, and five years presented. Empirical evidence demonstrates that it is possible to invest in businesses that ‘do good’ (socially/environmentally) without sacrificing the opportunity to ‘do well’ (financially). 8 WMA JOURNAL
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The SSE chose to create an index of social impact businesses in the UK which equities are traded on the London Stock Exchange The Social Impact Business Index (SIB Index) The SSE chose to create an index of social impact businesses in the UK which equities are traded on the London Stock Exchange. It identified a list of 60 companies that trade currently and that fit into its criteria for being a social impact business. Taking into account the liquidity constraints of creating a £100 million portfolio, the list narrowed to 38 companies. The index created is market capitalisation weighted and rebalanced weekly. If a company listed its shares during the measurement period, the shares were added and the portfolio rebalanced at the time of entry onto the LSE. There were five new entrants over the five-year period. Only one of these appears in the Top 10 constituent list and joining June 2013 had limited influence on the overall performance of the index over the period. We based the index on 28 August and examined historical data for five years. This period includes the extreme volatility and lack
SOCIAL IMPACT BUSINESSES
of liquidity of late 2008/early 2009 as well as the bull market run in smaller capitalisation stocks of the past 18 months. The sector weighting of the SIB Index is shown below. The most significant variations versus the FTSE indices are lower weightings in energy/materials and telco/utilities, made up for by higher weightings in financials, healthcare and technology.
Chart 1: Sector weight of the SIB index
Index Performance – Total Return (August 28, 2013) Annualised 5yr 3yr 1yr SIB Index FTSE 100 FTSE 250
3.7% 4.6% 10.5%
18.8% 11.1% 17.5%
26.4% 15.0% 30.7%
Index Risk and Return Characteristics (August 28, 2013) Volatility (%) 5yr 3yr 1yr
Sharpe Ratio 5yr 3yr 1yr
SIB Index FTSE 100 FTSE 250
0.18 0.21 0.46
20.1% 22.2% 22.7%
11.8% 15.2% 16.1%
10.04% 11.90% 13.22%
1.59 0.73 1.09
2.63 1.26 2.32
SIB Index vs Market Bechmark (August 28,2013)
Annualised Excess Return 5yr 3yr 1yr
Beta Volatility 5yr 3yr 1yr 5yr 3yr 1yr
vs FTSE 100 vs FTSE 250
-2.8% -7.8%
0.74 0.84
5.6% -0.1%
9.1% -1.0%
0.80 0.92
0.62 0.73
17.4% 15.5%
12.2% 11.9%
10.9% 11.3%
Table: Index performance, Risk and Return Characteristics. Source: Bloomberg Data, FTSE, Signia Wealth, Social Stock Exchange.
The results The performance results of the SIB index over one and three years are shown below:
Pricing at 28 August. Source: Bloomberg Data, FTSE, Signia Wealth, Social Stock Exchange. www.thewma.co.uk
The results are supportive of the hypothesis that an investment into Social Impact Businesses may generate risk adjusted returns that are in line with the overall equity market. Over a one-, three- and five-year period, the SIB Index has generated risk-adjusted returns that are in line with that of the major UK equity market indices. On a total return measure (price plus dividends) the SIB Index has delivered equal or superior returns to both the FTSE 100 and the FTSE 250 indices over a three-year basis. Over a five-year basis, the total returns lag. There are two causes for this. On a price only basis, the SIB Index modestly underperformed the major indices in this period. This inferior price performance occurred in the early part of the measured period (late 2008/early 2009) when extreme volatility and the drying up of liquidity had a particularly negative impact on smaller capitalized companies. This can be seen clearly on the price charts above. The other reason for underperformance over this period is the inclusion of what was a relatively high level of dividend payment in the beginning of the period for the FTSE Index companies. Given the index calculations are based on time weighted period returns, these high payments early in the series have somewhat distorted the results. Over a one-year period, the risk-adjusted returns of the SIB Index are in line with the FTSE 250 and significantly higher than the FTSE 100. www.thewma.co.uk
On a correlation basis, the index showed encouraging results. In all periods, the beta of the portfolio was less than that of the market indices. Taking into account returns and volatility, the risk adjusted returns, as measured by the Sharpe ratio, were positive in all years on an absolute basis and superior to the indices on a three- and one-year basis. These results imply that investors in the companies comprising the SIB would be giving up either none or an almost negligible return versus the broader equity market. Of course, they would be gaining ‘the social/ environmental dividend’ of investing in SIBs. Interpreting the results It is not surprising to us to see the favourable price performance of this Index given the industries in which SIBs operate. Many impact areas are growth areas: renewable energy, sustainable agriculture, sustainable trading companies (e.g. organic, fair-trade, natural products), financial services, social housing, health/social care and arts, culture, sports/ fitness and education. The lower beta of the portfolio is most likely explained by the lower industry weightings in energy and materials of the SIB to the FTSE Indices. The major negative performance was due to a lack of liquidity causing price volatility in a period of high uncertainty (late 2008 early 2009 in particular which had a greater impact on smaller companies). As the financing and growth of impact businesses develops, this liquidity penalty will improve.
Implications This study validates the view it is indeed possible to make investments in the public markets that align wealth and social values. The Index was formulated to allow an investment of £100 million to be made; illustrating that investors seeking the liquidity and transparency of the public market can look to achieve their social goals while not sacrificing a financial return. It is important to note that this index was not actively managed. In an actively managed portfolio, investment decisions would most likely be taken that would add to financial returns by taking an active decision to exclude market under-performers. Observations Investors are able to make investments into publicly listed SIBs and achieve financial returns in line with the overall equity returns while, in addition, creating a ‘social dividend’. The pool of investments available to impact investors will grow significantly due to a supportive political and social agenda. We expect to see a significant number of products targeted at this market to be created. By helping to finance businesses that address the challenges of environmental limits and social change, investment and finance have the opportunity to play a key role solving core issues which society faces. Diana Robinson and Jon Grayson The Social Stock Exchange www.socialstockexchange.com WMA JOURNAL 9
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