The world is currently experiencing a “polycrisis” – the simultaneous occurrence of multiple, interconnected challenges that compound each other, making them harder to address and resolve. The list of these challenges is daunting, including ongoing repercussions of the COVID-19 pandemic, a war in Ukraine leading to energy and food security shocks, inflation reaching levels not seen for decades in most countries, and recent banking crises that are exposing old and new vulnerabilities of the financial system. In the background, the looming specter of climate change and increasing prevalence of extreme weather adds to the complexity of the situation.
The polycrisis is having a devastating “scissor effect” on the investment gap – the difference between the amount of financial resources needed annually to achieve the United Nations Sustainable Development Goals (SDGs) by 2030 and the current amount being invested, due to increased spending needs and a reduction in available resources. According to UNCTAD, the economic aftershocks of the war – including inflation, an impending recession, and heightened geopolitical tensions – have widened the investment gap to $4.3 trillion per annum, doubling the pre-COVID-19 value.
So, how did we get here? A growing consensus suggests that the conventional economic model is flawed. The focus on shareholder value and free markets, which are the fundamental principles of capitalism, have demonstrated limitations in their ability to create prosperity. While lifting the standards of living in emerging countries, globalization has also created global market failures that local and national policies cannot effectively address. Furthermore, geopolitical events have raised concerns about the vulnerability of supply chains across various industries, leading to a trend of deglobalization and reshoring.
In the pursuit of a more sustainable economic paradigm, the debate around stakeholder capitalism has been growing in recent years. ESG considerations are increasingly being integrated into investment decision-making, with many investors and asset managers incorporating ESG analysis into their research and due diligence processes. While this approach has certainly improved enterprise risk management practices, concerns have been raised about the effectiveness of ESG in driving real change. Moreover, the proliferation of sustainable funds has given rise to accusations of “greenwashing” and more recently to the politicization of ESG. In the US, elected officials from several states hold diametrically opposed and partisan political positions on whether asset managers can consider ESG factors without violating their fiduciary duties. The debate culminated last March in President Biden’s veto of the Republican’s proposal to prevent pension fund managers from engaging in ESG investing.
Given the current state of polycrisis, how can companies, investors, and policymakers effectively address the sustainability challenges of the 21st century? Specifically, how can research contribute to the shift towards a paradigm where environmental sustainability, social inclusion, and shared prosperity are prioritized? Additionally, how can academic research help restore credibility, effectiveness, and predictability in sustainable investment, and encourage large-scale capital deployment to close the SDG investment gap?
Exploring these questions is TIL’s primary mission, and we do this by developing rigorous and actionable research that will support positioning NYUAD and Abu Dhabi as a knowledge hub for investments aligned with the 2030 agenda for Sustainable Development. The UAE hosting COP28 will be an incredible enabler for our research, and a tremendous opportunity for turning TIL’s aspiration into a reality.
Transition investment is a distinct investment philosophy from conventional responsible investing practices, with a stronger emphasis on intentional, incremental efforts and strategic shifts towards achieving quantifiable impact and solid financial returns. The ultimate goals of transition investment are measurable impact and financial performance, shying away from the consideration of concessionary, below-market returns often associated with impact investing.
Transition investment is thus not philanthropy, but rather an investment strategy that aims to achieve profitability while fulfilling a purpose. At the same time, it sets itself apart from the functional approach often summarized by the catchphrase “doing well by doing good”. Purpose is not instrumental to financial returns, but the moral foundation of investments aimed at delivering tangible societal improvements. Without impact, stellar returns alone would not fulfill the ethical requirements of transition investments.
In this second edition of TIL’s annual report, we present the results of our most recent research efforts, a balanced mix of articles containing original data, qualitative analyses laying down the foundations of our agenda, and relevant case studies from our target geographies.
It is clear that the world is woefully off course to meet the SDGs by 2030. The scale of the financial response required to address these crises is immense. Yet, OECD estimates that global financial assets amounted to a staggering $469 trillion in 2020. The estimated $30 trillion SDG financing gap for emerging markets for the next 7 years represents less than 6% of global private capital, certainly a less intimidating number. But how can this private capital be unlocked at scale and quickly?
Arnoldi and Spengler article is a call to action to step up institutional investments along the SDGs, and specifically on impactful investment. Once the domain of pioneer players exploring what was seen by many as a frontier investment landscape, impact investing is now squarely in the mainstream. The traditional investment approach of building portfolios based on risk-adjusted performance has been replaced for many, at least for part of an investor’s portfolio, with the three-dimensions risk, return and impact. An increasing number of institutional investors have developed exciting impact investing portfolios. To date, the most active and dynamic actors are domiciled in North America and Europe. While Middle Eastern investors represent a significant amount of AUM, these investors have yet to move significantly into the impact investing arena. This is important not only because there is a financing gap but also because Middle Eastern investors are advantaged by being proximate to emerging markets – markets that others perceive as remote, unfamiliar and risky. Middle Eastern investors can select proven pathways to activate their intent and build solid investment impact portfolios. Simply put, they can ‘build’, ‘buy’ or ‘partner’. These pathways are not mutually exclusive and combinations can be pursued in tandem, offering ways to accelerate deployment.
At the core of TIL’s beliefs is the notion that long-term institutional investors play a pivotal role in driving change. Sovereign Wealth Funds (SWFs) rank high in this echelon due to the vast size of their assets. The article by Bortolotti, Loss, and Robert van Zwieten presents the first results of a research partnership that TIL has established with the International Forum of Sovereign Funds (IFSWF), a voluntary organization of SWFs committed to fostering good governance and transparency, on the sustainability footprint of sovereign investors.
By classifying according to a widely used categorization for SDG alignment (the IRIS+ taxonomy) 1,000+ direct equity investments by 77 SWFs over the 2020-2022 period, the authors find that sustainable investments account for 19 percent of total deal value, representing a relatively minor part of the overall SWF investment activity. However, sustainable investing is on a slow but steady rise in SWFs’ portfolios. The lion’s share of the sustainable investments during these pandemic years were in healthcare, with several SWFs investing to combat COVID-19, followed by renewable energy. Mobilizing this money to fight climate change has been tough, as only 3 percent of the investments have been geared to adaptation and mitigation. Given the relevance of SWFs in the region, these figures will be food for thought at COP28.
One of the major roadblocks holding back institutional investors is the lack of high-quality data to prove the effectiveness of the impact investment interventions. Bortolotti, Chen, Scheck, and Tran address the issue by introducing TIL’s approach to impact measurement. The Signature Impact Framework (SIF) provides a methodology for conducting a rigorous, actionable, and cost-effective assessment of the impact of a given business. The key principle underlying SIF is that while the overall effects of an enterprise on society are extremely difficult if not impossible to measure, companies can demonstrate if and how they are intentionally delivering positive change along a clearly defined set of goals enshrined in their mission. We call this “Signature Impact”, which denotes the precise and distinctive contribution that a business can make to societal welfare. The SIF involves three stages, allowing ex ante impact underwriting, interim impact reporting, and ex post impact additionality assessment. By applying the framework in the field of financial literacy, the article provides a glimpse of how SIF can be used in practice with the hope that the adoption of measurement systems such as SIF would increase confidence in impact investment opportunities, and unlock large scale capital deployment in this space.
One of TIL’s primary focus areas is the broad region comprising Middle East, Africa, and Southern Asia (MEASA). We firmly believe that the “Global South” is the region with the highest potential in terms of economic growth, but at the same time the one facing the most severe socioeconomic and environmental challenges. Indeed, a successful transition in MEASA will have a tremendous impact on the global economy. For this reason, the report devotes a special section to the MEASA, with analyses covering each sub-regions.
As the UAE heads towards COP28, Fernandez’s article designs a “ClimateTech Compass” to capture and understand the different types of technologies that can drive the region towards a sustainable future. MENA is one of the most vulnerable regions to climate change, and its countries are expected to lose at least 14% of their annual GDP by mid-century. Achieving a net zero economy places the region as one of the most benefited ones globally, mitigating over 17% of GDP losses and creating over 1 million jobs in the GCC alone. The paper highlights the importance of technology in achieving this transition by increasing accessibility, enabling multi-solving products and services to tackle numerous social and environmental issues at once, and enabling the economy to be more resilient to future external shocks. The article locates different innovative tech startups operating in the region in the four quadrants of the compass, such as the North (Star), focusing on reduction and mitigation of greenhouse gas emissions, the West, leveraging data to monitor progress across several levels, the East engaging in adaptation, and the South pushing regeneration via the protection of biodiversity.
Africa, despite being frequently overlooked as a viable investment destination, has recently garnered the interest of a wider range of investors eager to take capitalize on its strong growth potential, favorable demographic trends, and abundant natural resources. Thomas focuses on the potential impact of diversity, equity, and inclusion (DEI) in driving investment return and impact in African markets, contrasting the widely held view that risk and impact sit on a spectrum and frequently offset each other. The thinking is that to achieve better returns, you have to sacrifice impact and to achieve robust impact, you have to dampen your return expectations. For certain areas of deep impact, this may be true and risk capital may simply not be the right fit. However, the evidence is clear that scaling impact alongside investment returns can be achieved by utilizing a gender lens and incorporating DEI principles into business cultures.
Finally, Reyes, Addis and Buckley describe an investment approach focused on unlocking women’s potential in the growth-driven contexts of South Asia. In their article, they first outline why focusing on the potential of women as leaders, entrepreneurs, investors, consumers and decision-makers is integral to shared prosperity and ripe for integrating impact considerations holistically into the investment cycle. Then they share some key lessons from our experience for how this can be achieved with measurable, positive social and environmental outcomes for communities alongside competitive financial returns.
We hope that our readers will enjoy this issue of the report. The forthcoming Transition Investment Workshop, where this publication will be officially launched, marks an important milestone for us. We hope it will consolidate the relevance of transition investment in academia and the financial community. We will continue to conduct further research and analysis, and we invite you to stay tuned for updates. For what we have achieved so far, we extend our warm thanks to our sponsors, Mubadala Investment Company and Al Maskari Holding, the TIL Steering Committee for its continuing support, and to our fellows and students for their passion and invaluable contribution to research.