Should the money in Israeli pension funds be invested in preventing cancer, helping women escape prostitution, and rehabilitating prisoners? Three large investment institutions are considering for the first time impact investments in these areas, following new rules published by the Capital Market Authority that encourage investment institutions to make responsible investments promoting environmental, social, and corporate governance (ESG) values, while ensuring a return for savers. ESG investments have developed very extensively in Western countries in recent years, but in Israel have until now been restricted to philanthropists and private investors.
"This idea is becoming more relevant and more substantial," says IBI Investments VP business development Ela Alkalay. "These products have three sources of investment. The first is plain vanilla - long-term investment institutions. The second is qualified investors (investors with financial training and over NIS 8 million in liquid capital, A.B.). The third source, which will probably be added starting in January, is ordinary investors. Ordinary investors will also be able to invest up to NIS 10,000 in the instrument."
"Globes": What does experience to date show?
Alkalay: "There are financial investors that have come in in the past one or two years. These are relatively negligible and marginal investments, compared with those managed by investment institutions. Is the risk much greater than investing in a new shopping mall? In my opinion, the risk is reflected in the return, but every institutional investor makes its own calculations. In my opinion, at the current level of interest, it should be market perform."
"Choosing the best in class"
Last month, the Norwegian national pension fund, which manages a $1 trillion investment portfolio, announced its intention of exiting from investments in energy companies. The decision by the fund (which accumulated its capital from oil and gas sales, ironically) was interpreted as a victory for the environmental organizations in their struggle against companies whose activity causes global warming. In terms of responsible or value investment, the fund's decision is classified as "negative screening" - a policy based on non-investment in companies making products considered unethical, such as tobacco or weapons, companies employing children, and companies that violate international law. Negative screening is the oldest tool in the framework of what is regarded as ESG - investment policy that takes into consideration environmental, proper corporate governance, and social considerations, without detracting from the basic consideration of generating a return for investors. Over the years, negative screening has attracted considerable criticism for its lack of effectiveness. In the value sphere, it has been criticized as a tool that may make investors feel better about themselves, but does not improve society or the environment. Tobacco and weapons companies have no trouble finding alternative sources of financing. This led to the creation of positive screening, which works in the opposite direction. Positive screening is the selection of companies that create environmental or social benefit. The experience accumulated in the use of positive screening leads to a focus on companies dealing in renewable energy sources, recycling, organic food, and companies producing substitutes for wood products. Positive screening has been criticized for leading to under-investment in large companies, because such companies have more trouble preserving a clean record.
Social Finance Israel (SFI) VP Ira Friedman says that positive screening finds it difficult to meet competitive targets for returns, because avoiding investments in entire sectors of the economy and concentrating excessively on other sectors eventually has a negative impact on the diversity of investments in the portfolio. "Investing according to the ESG rules does not rule out an entire sector in advance; it means choosing the 'best in class' in each sector," Friedman says. "If you have two banks with the same financial figures, you will prefer the bank with a higher ESG rating, meaning in corporate governance, the environment, and society. ESG has become a standard to which every fund that raises money must pay attention."
The official entry card of ESG investments to the club of acceptable investment is the MSCI KLD 400 Index, launched in May 1990. The index includes 400 US companies with the highest ESG ratings, based on 36 different corporate governance, environmental, and social responsibility criteria. It does not include companies whose activity has a negative social or environmental impact. The 10 leading shares on the index include most of the familiar names: Microsoft, Facebook, Alphabet (formerly Google), Cisco Systems, and Intel in the IT sector; Coca Cola, and Procter and Gamble in the retail sector; and Walt Disney and Verizon in the media and communications sector. The figures published by MSCI for the index's performance, compared with the Benchmark (IMI USA shares of 400 US companies) show that it achieves market performance, with little fluctuation.
The third stage in the evolution of investments is what is called impact investments. These are investments reflected a positive selection of an investment having a social or environmental benefit that can be measured simply and clearly.
The most common example of impact investments in the US is the green bonds issued by local authorities in order to finance the reclamation of neglected and polluted land, usually through energy-saving and environmentally friendly construction methods. The most prominent example of an impact investment outside the US and in Israel is social bonds - an instrument for social financing based on the principle of payment for success. The money raised from social investors is channeled to the financing of projects dealing effectively with social problems, usually by guaranteeing a minimum return for investors. The first social bonds in the world were issued in the UK in 2010 by Social Finance UK in order to address the high rates of recidivism among released prisoners. The proven effectiveness of this financing tool led to its expanded use, and 90 social bonds are currently issued in 19 countries and used to finance a range of social ventures.
In Israel, SFI launched two social bonds in the past two years: the first aimed at reducing the dropout rate among computer science students at the Academic College of Tel Aviv-Yaffo and Haifa University, and the other for preventing Type 2 diabetes.
Moral conflicts
The only social bond already operating in Israel is for reducing the dropout rate in computer science studies at two academic institutions. The project, designed to last for seven years, is in its first year. Another social bond launched this year is designed to reduce the incidence of morbidity in diabetes through preventative intervention among 2,250 pre-diabetic patients. The basic scenario of the program relies on the results of a 16-week US program, which reduced morbidity from diabetes by 58%. The program in Israel is much longer. In the diabetes venture, the target return is a 6.5% internal rate of return (IRR) under the basic scenario, which is also likely to reach an optimal scenario of 13%. The venture has already raised NIS 19 million from 15 private investors. SFI's next bonds will be for prisoner rehabilitation and preventing morbidity from intestinal cancer. SFI is also carrying feasibility studies for future ventures in rescuing women from prostitution and employment of single mothers. Friedman says that there are additional possibilities in the impact investment sector in addition to social bonds. "One excellent example of this is Amidar, which is issuing bonds to financing the purchase of public housing, green bonds, credit assistant funds for small businesses, and micro-financing for those excluded from credit."
Additional examples cited by Friedman are the Or (non-profit) movement, which is promoting neighborhood projects in outlying areas where National Outline Plan 38 ventures are not economically worthwhile, and Chemi Peres's New Era fund, which is designed to raise money from investment institutions for world-changing technologies in accordance with the vision of Shimon Peres, Chemi Peres's father. "What makes this fund an impact fund is that it also promises to present the expected measurable social return on investments in terms of new jobs, increasing nutritional security, and other aspects," Friedman explains.
The Capital Market Authority notes that the investment institutions currently manage over NIS 1.3 trillion, and this amount is growing by NIS 80-100 billion a year. This money drives the economy, and the question of what to do with it will become increasingly important. In view of the growing global trend towards ESG investments, the Capital Market Authority has initiated new rules requiring investment institutions to state their projected investment policy, and whether they invest in responsible investments, and if so, in what. The definition of responsible investments was extended to include ESG investments and impact investments. The rules were approved two weeks ago, after a hearing in which people from the Capital Market Authority met with representatives of the investment institutions interested in responsible investments. The main concern raised by the institutions at the hearing was that these investments were not consistent with their fiduciary duty to maximize financial returns for investors. The Capital Market Authority made it clear that there was no internal contradiction between this duty and responsible investments, as long as the institutions believed that the investments would generate a return, not ventures that from the start were clearly not economically viable. "We got the impression that there is a growing demand for ESG investments from the institutions' members," a Capital Market Authority source said. "We are not imposing obligations on the institutions, but we want there to be transparency. It is true that transparency carries with it a degree of legitimacy, and that will give this sector a push to some extent."
"Most investors are unaware of this phenomenon," says Alkalay, "and the Capital Market Authority's measure is therefore important, because it puts it in the spotlight and increases awareness. As of now, instruments are very small, but the fact that the Capital Market Authority has told people, 'This exists, and we are encouraging it. We will not complain that you suddenly invested in a new financial instrument; on the contrary, we think that this is an interesting and important sphere to be in' - this is a positive regulatory message that says, 'You are not taking a regulatory risk when you look at this area'."
Has the lack of interest up until now in responsible investments been due only to a lack of awareness, or it is also because such investments are not perceived as economically worthwhile?
Alkalay: "There is still an idea about this sphere, which was formerly very widespread, that it consists of tree huggers and people for whom ideology is the most important consideration. Some of the problem was the moral conflicts. On the one hand, Teva produces the cheapest drugs, while on the other hand, it sells pain relievers, opiates, and receives exceptional tax benefits from the state."
In other words, investors do not like entering this field at all.
"Yes, in the end, there are conflicts. What moral consideration takes precedence? Should there be cheap fertilizers for everyone on earth and more food for poor people in Africa? Or is it that Israel Chemicals mines phosphates and causes environmental damage to the Dead Sea? It's very easy to make decisions in the financial world: there is a scale of risk-reward. You take a few things with a low risk and a low reward, and a few things with a high risk and a high reward, and spread things around. What's great about the impact sector is that it's far more financial than moral. The world needs renewable energies, water, more small and medium-sized businesses, more engineering students, and fewer diabetes patients, that is a need that has a very clear financial aspect, and the ethical consideration is straight-forward."
What is the track record of impact investments?
"It's hard to say, because the time interval is very short, and neither the risk nor the reward has materialized yet. Furthermore, at the moment, it's terribly small, so the risk for an investment institution is negligible and marginal, so why not? You spread the investments over so many things, so go ahead and do it. True, there is a risk here, so you invest a couple of hours, learn, and do it. It's a debt investment, not equity. It's true that there is no collateral, but there other debt investments with no collateral, especially when the market interest rate is zero."
Friedman says that the aim is for investment institutions to compete with each other in social responsibility. "We eventually want pension fund savers to look at what their pension fund writes in its considerations, beyond the financial return. People want to leave a better world to their children, obviously assuming that the return is the same."
Will the entry of investment institutions revolutionize the field?
"The money that created this field a decade ago was philanthropic money. Today, the sector is being led by the world's most advanced investment concerns. So, yes, we hope that the entry of investment institutions will revolutionize this field, together with more activism by savers."
Do investment institutions have enough impact investment opportunities in Israel?
"It's true that the current deal flow in Israel is very limited, but tomorrow morning, for example, it will be possible to renew the idea of a fund for assisting small businesses or senior citizen enterprises, which is a painful problem for all of us, and it's very right for the public's money to be channeled into it."
Alkalay sounds optimistic when she is asked what will make investment institutions enter the sector on a large scale. "First of all, awareness. Secondly, a variety of products. Thirdly, once there are visible successes, the appetite will grow," she answers. "It's a process, there is global momentum, and here in Israel, there are very creative products."
Published by Globes [online], Israel Business News - www.globes-online.com - on December 24, 2017
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