The weight of capital flowing towards environmental, social and governance (ESG) oriented assets over the last year has been stratospheric. According to data from Morningstar, rising demand for such investments over the course of 2020 prompted European fund managers to change the strategy or investment profile of 253 European funds, helping to push regional assets invested in funds with an ESG focus to a record €1.1tn (£860bn). On top of these repurposed vehicles, Morningstar also flagged 505 new ESG fund launches in Europe in 2020.
The frenzied attention surrounding ESG has caused some confusion in terms of its terminology, its potential impact on returns and how it informs investment decisions. Sustainability is likely to remain a key priority but investors require transparency and clear solutions to meet their needs and objectives. With this in mind, there are several options investors and their advisers could consider, the most straightforward of which are in four key areas: VCTs, EIS, investment trusts and REITs.
VCTs and EIS
For investors looking for positive impact opportunities outside of listed vehicles, then venture capital trusts (VCTs) and the Enterprise Investment Scheme (EIS) are potentially attractive options, with the added benefit of their government-promoted tax reliefs.
This is due to their focus on investing in young, high-growth enterprises, which means VCT and EIS products offer investors the opportunity to support precisely the types of companies that will be so important to the UK’s economic recovery. Indeed, since their inception over 25 years ago EIS has raised some £24bn, while VCTs, which were introduced in 1995, have raised around £9bn. The investment focus for both vehicles today is in early-stage, innovative UK businesses.
Investing in such businesses does not always have to mean a greater level of risk. Indeed, different VCTs pursue different investment strategies, with the most discerning looking at which companies have already achieved some form of market validation. VCT managers may, for example, use a ‘challenge-led’ approach – identifying businesses with the potential for growth that are already actively solving problems for established corporates, rather than those that have yet to determine their market demand.
VCTs provide investors with tax benefits due to the risks being taken – for instance, investors are able to invest up to £200,000 and claim up to 30% income tax relief a year on newly issued shares. Dividends are free of income tax, and investors can benefit from relief on capital gains tax when selling their shares at a profit subject to a minimum holding period.
Turning to EIS, returns are made by investing in unlisted growth companies that have the potential to provide a significant capital return over a three-year or more holding period. Depending on their circumstances, investors can also benefit from various tax reliefs, including income tax relief of 30%, inheritance tax relief and tax-free growth.
There are now also impact-focused EIS products, which not only target fast-growing, innovative companies, but specifically those that have a positive impact on society in key areas, such as healthcare, children and young people, the environment and inequality.
Furthermore, many high-growth businesses attracting EIS and VCT investment in the coming months should stand a better chance of success than they might have done in pre-COVID times. That is because the disruption caused by the pandemic has reduced the costs of starting-up a business, such as rent, while also giving business-owners greater access to the wide pool of talent needed to accelerate growth.
Investment trusts should be an appealing option for those targeting a long-term, sustainable investment strategy. Depending on the strategy and sector, they can provide a diversified, yet robust, sustainable investment portfolio that offers the dual benefits of long-term capital return and income.
At the end of 2019, the total assets under management in UK investment trusts was estimated to be around £200bn – double what it was a decade previously. With more than 400 trusts currently trading on the UK stock market, focused on more than 30 different sectors, there is an abundance of choice.
While investment trusts are not devoid of risks, those that effectively incorporate ESG issues into investment analysis and decision-making processes can strengthen their credit risk mitigation and bolster long-term asset performance. For investment trusts, ESG integration can therefore be key to delivering wider social and environmental benefits for investors and wider stakeholders.
As an example, Digital 9 Infrastructure (DGI9), is a Triple Point-run investment trust, whose strategy aligns with the United Sustainable Development Goals – as indeed does its name. The ‘9’ refers to the UN’s ninth goal – ‘Build resilient infrastructure, promote inclusive and sustainable industrialisation and foster innovation’ – which reflects the trust’s commitment to improving global digital communications in an environmentally sustainable manner. The company addresses the exponential demands for supporting the internet by investing in a range of digital infrastructure assets that seek to achieve sustainable income and capital growth for investors.
Real estate investment trusts
Real estate investment trusts (REITs) invest across a broad range of property types and can provide investors dividend-based income, transparency, liquidity, inflation protection and portfolio diversification. Historically, they have proved to be an attractive way for investors to gain exposure to the world’s largest asset class, while gaining the liquidity of a tradeable security.
Not all REITs have been able to demonstrate resilience over the last year or so but thise that have are likely to have done so by focusing on ESG or impact-related sectors, including healthcare and social housing. These REITs have continued to collect rent without interuption during the pandemic, as they invest in much needed real estate whose rent is paid for by the government.
As an example, social housing REITs fund the development of specialised supported housing, either newly built or renovated, for people with long-term care needs such as learning and physical disabilities. These developments are designed in tandem with local health commissioners to accommodate people moving out of institutional care facilities.
As a result, these homes both improve resident wellbeing and also free up resources at a time of ever-increasing demand. For investors wanting to make a positive impact on society, social housing REITs can therefore represent an opportunity to generate sustainable, long-term, inflation-linked income while helping to address one of society’s most pressing challenges.
After a year of frenzied interest in ESG investing, it is no wonder investors and their advisers may be left feeling dizzy from the risks and opportunities of a growing sector. But there remain clear and attractive options for those seeking profitable long-term investment strategies, designed to create value for communities and the people who live and work in them. VCTs, EIS, investment trusts and REITs all have the potential to meet the needs of investors with sustainable goals and priorities.
Belinda Thomas is head of sales at Triple Point