Tsao: building a credible impact equity allocation

Diana Watson
Head of Sustainability and Impact Investment, Tsao Family Office

Impact investing in listed equities is often treated as the hard case compared with private markets. Critics argue that buying shares in the secondary market creates little ‘additionality’, since no new capital is being provided. That argument overlooks the additionality that comes from constructive engagement with portfolio companies, aimed at measurably better outcomes against clearly defined goals.

Tsao Family Office (TFO), a Singapore-based investor, has built a dedicated listed-equity impact allocation designed to meet the same standards of additionality, ‘measurability’ and ‘intentionality’ as private equity impact investments. Diana Watson, Head of Sustainability and Impact Investment at TFO, explained to bfinance Investor Spotlight how this has been achieved.

TFO is careful to treat ESG and impact as distinct – how does this look in practice?

ESG is largely about risk management, whereas impact is about the outcomes and solutions you are actively trying to support. We think in terms of a spectrum of capital, categorising investments as traditional, responsible, sustainable or impact. Our sweet spot is finding opportunities that are genuinely strong on impact and also generate good returns. Some will fall either side of that sweet spot, and that is fine; you just have to be honest about where each one sits. This categorisation is far more of an art than a science. The frameworks help, but it remains subjective: things other investors describe as impact, we would often class as sustainable. We reserve the impact label for investments we are confident deserve it, which keeps the whole portfolio honest.

How do you address potential questions around the additionality aspects of listed-equity impact?

We look for managers with enough influence and clout in their sector to bring real change to the companies they hold. That goes well beyond turning up at an AGM and voting for or against a resolution. The managers we chose have the ear of senior management at their portfolio companies; sometimes they have expertise in a particular area, and the board will actually invite them in to present on it. Choose the right manager and a meaningful level of engagement becomes possible. What we are really talking about is strong, constructive engagement: helping a senior team at a portfolio company reach better outcomes, particularly on sustainability. That, to my mind, is where additionality in listed-equities impact comes from.

Where do you stand on the distinction between ‘improvers’ or companies in transition, versus the established ‘leaders’?

We have leaned more towards leaders that still have room for improvement. In that regard, we have seen our managers help companies align with science-based targets and, crucially, build a credible plan for meeting them. To take an example, one of our funds has particular expertise in deforestation and the risk it poses to supply chains, and that manager has been invited to brief the boards of several of its holdings. Whether a company is a leader or an improver, we look for the same thing: high engagement and a clear, evidenced pathway to change, or ‘theory of change’.

What tends to be most revealing when you are trying to separate genuine intent from good marketing?

Greenwashing is still an issue, but it is becoming less of one. A lot of the ‘sustainability tourists’ have drifted away, particularly in the US, where attention has moved away from ESG and impact, and that has quietly removed many of the players who were never sincere in the first place. The ‘orange flags’ I look for, the things that prompt me to dig deeper, might include issues of measurability related to the UN’s Sustainable Development Goals (SDGs). If a manager claims SDG alignment only at the headline level of one of the 17 goals, without engaging with the specific targets associated with each goal, that is a warning sign. So is claiming to support more than a handful of goals; I doubt any manager can genuinely advance more than five or six well. Beyond that, I want specifics: the other frameworks they align to, and evidence that they can actually map their progress against.

Family offices often lack the in-house resources of large institutions for impact assurance. How do you use external verification?

For our impact funds, we put managers through a process with BlueMark, which carries out impact verification and benchmarking, letting us compare a fund’s impact policies and processes against its peers. It will not tell you which fund will generate the strongest outcomes, but funds with the strongest strategies and practices in place tend to be more likely to follow through on their intentions, with less risk of mission drift along the way. It does not replace our own due diligence, which we still do in-house, but it is a useful piece of third-party assurance.

How do you think about the relationship between financial return and impact, and how do you respond to the assumption that one must be sacrificed for the other?

There is no exchange rate between financial returns and impact; you cannot simply trade one for the other. We get asked the trade-off question a lot, and our view is that you do not have to sacrifice returns, but you may have to be mindful of risk. A good example is emerging and frontier markets. We are trying to allocate more there, because the impact can go considerably further for your money. Those markets tend to carry a higher risk profile and more volatility than developed markets, so the risk is a little higher, but you would also expect the return to be a little higher to compensate. That is simply a balance you have to manage.

More generally, what learnings have you taken around the portfolio design and listed-equity impact?

In the past we favoured thematic funds to satisfy our focus impact themes such as climate and healthcare. It’s very hard however to time themes, and concentrating on one or two of them can introduce a fair amount of volatility, so we have now moved to a more diversified approach. This involves managers working across a range of themes, and issues of timing is now their job, not ours. For our set-up, that simply works better.

Beyond the numbers, what do you look for in a long-term partner on impact?

Above all it is whether values align, and not just at the level of the firm but with the individual portfolio managers running the strategy. That matters a great deal to the family. It is not something you can pick up from a written questionnaire; it comes out in conversation, often in the questions you ask slightly tangentially to the core strategy discussion. One of the things I try to establish is why a manager wants to run an impact strategy at all. If it is simply to attract more capital from development finance institutions and impact investors, that is not a good enough reason. If the team genuinely believes in the impact itself, that tells you a great deal about whether the partnership will work.

What would be your advice for another family office or institutional investor seeking to build a listed-equity impact allocation?

I would challenge the idea, still surprisingly common, that you cannot do impact in public markets. I simply do not think that is true; you just have to work harder to find the right managers. Within listed equities you can still apply the rigorous impact practices you would expect from a private equity fund. The best managers we have seen maintain a theory of change for every theme they work on, and each holding has its own impact metrics and strategy linked to the theory. Very few managers have genuine clout over mega-cap companies, so think about where engagement can bite: a mid-cap specialist that is a top ten shareholder in its holdings, perhaps, or a manager large enough in sustainability to command the attention of bigger boards.