Gone are the simple days when investing with a conscience meant excluding alcohol and tobacco from a portfolio. With new reports every other day laying bare existential threats, investors want their investments to align with innovative solutions to the climate crisis, like clean energy. 

This has seemingly increased interest in impact investing, which has long made the case that investments can do social good without sacrificing returns.

Mirroring trends in international markets, impact investing has been gaining momentum in the Middle East over the last decade, “although not at the speed and quantity necessary to combat the enormous challenge of climate change,” says Noor Sweid, Founder and Managing Partner of Global Ventures.

Understandably, impact investing cannot be just for doing good.

Innovative solutions to the climate crisis require enormous financial investment. And increasing impact investments can be difficult to achieve if a solid return, which is hard to measure, is the goal. 

However, today’s investors want their investments to align with a more rigorous standard of good while achieving a maximum return. Different types of investors are widening the pool of resources to support and scale innovative climate solutions. 

“These investors believe that the next generation of successful businesses is not those that only produce the highest financial returns, but those that do so while creating large-scale impact in the communities in which they operate,” says Sweid.

“Investors are seeking entrepreneurs on a mission to do well and do good, blurring the lines between impact and commercial investing.”

According to a report by Wamda Research Lab in 2019, over 150 startups in the UAE were focused on sustainability and eco-friendliness. This represented a 17% increase from the previous year. In 2020, a report by Magnitt found that out of the top 10 funded startups in the UAE, three were focused on sustainability and clean energy.

“At Flat6Labs, we have seen the share of sustainability-related businesses applying to our flagship Ignite startup seed funding and mentorship program steadily increase, and we have even invested in some of these organizations,” says Ryaan Sharif, General Manager at Flat6Labs UAE.

REMARKABLE RETURN

Undeniably, the GCC region, particularly Saudi Arabia and the UAE, is advancing blue hydrogen and targeting 60GW of renewable energy by 2030. And according to experts, investors recognize this, especially in the UAE, where according to a Standard Chartered report, more than 40% of investors want to put their money toward climate mitigation opportunities.

“Investing in climate adaptation also presents a remarkable return on investment,” says Habib Abdur-Rahman, Head of ESG at Investcorp.

The Global Commission on Adaptation estimated investing $1.8 trillion in five key areas could yield $7.1 trillion in net benefits within this decade. These five areas include early warning systems; climate-resilient infrastructure; improved dryland agriculture crop production; global mangrove protection; and investments in making water resources more resilient.

Bahrain-based Investcorp has invested in companies committed to making an environmental impact and is ramping up efforts in the sustainable investing space. “We will be looking to take stakes in companies in high-impact pathway sectors ranging from carbon management and clean mobility solutions to sustainable buildings and food production,” says Abdur-Rahman.

STUCK IN GREENWASHING?

One of the pitches for socially conscious investing is that their performance will be similar to the stock markets. The trouble with impact investing is one is tempted to rely on surface-level sustainability measures. Some indications are that this makes investors stuck in a cycle of greenwashing and individualism that prioritizes short-term returns over long-term impact and financial upside. 

The mechanisms that back so-called “sustainable investment” are subjective and inconsistent, which undermines the credibility of impact investing, making it easier for an investor’s due diligence to extend to simply seeing “impact” mentioned somewhere on a term sheet and holding back the capital from companies whose businesses are truly impactful. Investors are missing out on profits as much as ventures are missing out on delivering impact.

This has traditionally been a concern in impact investing, but it is changing, says Sweid. “The lack of standardized metrics and definitions for measuring and reporting impact have made it easier for companies to engage in greenwashing practices and provide misleading claims about their environmental and social performance.”

Agreeing with Sweid, Sharif says the lack of clearly-defined reporting measures in the region certainly left room for organizations to portray their operations to be highly sustainable without any checks or balances to verify the authenticity of these claims. 

“The GCC Exchanges Committee announcing the launch of unified ESG metrics for GCC-listed companies is, therefore, a step in the right direction. While this pertains to publicly listed companies, it will no doubt elevate the standards of ESG reporting for all organizations across the region. Doing so will create a higher degree of transparency and accountability. This will guide better investors who can align themselves with organizations measurably committed to sustainability.”

The Global Impact Investing Network is paving the way for standardizing impact measurement, while investors also demand more rigorous reporting and accountability from companies.

INVESTMENT WITH VALUES

According to Abdur-Rahman, the ongoing wealth transition to a younger, more environmentally conscious generation drives investments that align with their values.

“The private equity community, managing $6.3 trillion in assets and $2 trillion of untapped capital, has immense potential to drive sustainability outcomes. The challenge lies in effectively directing this capital towards projects that offer genuine long-term benefits, and investible, revenue-generating companies must deliver strong returns to set precedents that can, in turn, further galvanize investor confidence.” 

It’s been a widely accepted trend in financial circles for nearly two decades. But suddenly, there’s advocacy on a philosophy that says that companies should be concerned with not just profits but also how their businesses affect the environment and society. Whether that’s taking millions of tons of CO2 out of the atmosphere or solving agriculture’s water crisis—investors need back the tangible solutions to the world’s biggest problems. 

Sharif says that’s necessary. “Anything else would likely fall into the category of greenwashing rather than aiming to drive impactful change. And there are plenty of opportunities for VCs to identify and invest in organizations that not only aim to tackle pressing environmental issues but turn a profit while doing so.” 

“For example, with the UAE having set a goal of generating 50% of its energy needs from renewable sources by 2050, we can expect significant government support for the sector. This would make it attractive to invest in companies that offer innovative solutions for solar and wind power generation, energy storage, and smart grid technologies,” he adds.

Abdur-Rahman says Investcorp’s research and experience indicate that by focusing on companies whose core business addresses societal or environmental challenges, “investors can tap into significant opportunities for financial performance, risk reduction, and long-term value creation.” 

“There is compelling evidence to show that considerable financial value can be gained by improving performance on material ESG issues, leading to lower risk and better risk-adjusted returns over the long term,” he adds. 

There is no cosmetic fix to climate change, says Sweid. “Reversing or halting its effects will result from a systemic industry and infrastructural shift. The events of the last decade – climate degradation, geopolitical uncertainty, and the lingering socio-economic effects of the pandemic – have pushed a range of stakeholders to re-assess how, why, and with whom they do business.”

CHANGING LANDSCAPE

Some visionary entrepreneurs have perceived these challenges as prospects to create highly successful enterprises, and other investors are increasingly backing founders that solve those problems with innovative solutions, as ultimately, they serve sizable markets and growing customer needs.

“The current investment landscape is witnessing a meaningful directional shift toward businesses that generate sizable returns and have a positive, large-scale impact. The lines between impact, ESG, and returns are blurring,” adds Sweid. 

In the coming years, new industries and value chains will be developed. “It’s an exciting period, and we’re already seeing positive responses from different sectors,” says Abdur-Rahman.

Retail banks, for instance, are catering to the demand for sustainable finance with products like green home-improvement loans, carbon-neutral banking, and sustainable ETFs. There’s a rise of “green underwriting” in capital markets, with the popularity of ESG-linked funds and bonds. Private market managers are launching ESG-focused funds, thereby committing to integrate environmental and social considerations into their investment decisions.

Despite these advances, some areas need further attention. “Standardized reporting and measurement present a significant challenge. Current inconsistent measurement and reporting approaches hinder the industry’s ability to track and benchmark progress effectively while making it challenging to gain meaningful insights. Moreover, assessing the long-term impact of climate change demands comprehensive data analysis, posing another challenge,” says Abdur-Rahman.

DIVERSITY WILL FUEL IMPACT INVESTING

Research has shown that diverse companies are more likely to outperform their less diverse peers, partly because they are better equipped to understand and serve a diverse customer base. Opening up space for diverse entrepreneurs and investors is good business. 

“Diverse perspectives improve the investment decision-making process. By including diverse voices, investors have a more expansive view and understanding of underserved communities’ needs and pain points,” says Sweid.

Suffice it to say, by investing in companies where the profit model is directly tied to solving a pressing global challenge, investors will end up out-performing the market. After all, impact-first investment was what made the business possible.