Brace for Impact

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But events have compelled investors to look for something different for their portfolio, which means that impact investments are getting a closer look. Impact investments have positive social or environmental benefits as their primary raison d’être.

The seeds for the impact investing industry were sewn in the 1980s and 1990s with the socially responsible investment and corporate responsibility movements. They challenged the prevailing attitude that companies’ and investors’ only responsibility is to maximise financial returns. Since then the idea that investment, rather than pure philanthropy or a corporate social responsibility programme, can generate development outcomes has become increasingly widespread. Impact investments offer both a financial return and the delivery of high social or environmental impact.

Financial advisers and institutional asset managers are in a perfect position to broaden their relationship with their clients by offering them advice in this emerging field. They may even be responding to a specific investment brief which contrasts the normal risk-adjusted profit maximizing approach to one where the primary reason for making the investment is the positive social and environmental impact investment capital can make.

In addition to offering considerable social and environmental benefits, these investments are also appealing on a number of financial fronts. Impact investments often operate in geographic areas and sectors outside of the financial mainstream, which are thus less correlated to other asset classes. Incorporating impact investment strategies into portfolio management can lead to better diversification. They can also appeal because these are not volatile instruments requiring delicate market timing or active portfolio management.

Impact investments can also lead to better relationships between investors and their money. The dangers of abstracting borrowers from lenders through complex structures are now only too apparent. Impact investments engage investors directly with the projects they are financing. Moreover, these projects are invariably focused on real rather than speculative needs.

Current interest in social investments is high on both the buy and sell sides of investment capital. Investors can be high net-worth individuals who have been prompted by a liquidity event and who are responding to the entrepreneurial values of social enterprises. They are also private and public foundations who see impact investing as an alternative to perpetuating grant dependency to deliver their mission, through to institutional asset managers of charity mandates who are responding to a requirement that these portfolios be more mission aligned. The construction of impact portfolios reflects traditional asset allocations between cash, structured notes, securities, funds and private equity, each with different yields, risks and return expectations.

A key and differentiating feature in the development of impact investments as an asset class is the measuring and rating of impact, and the stories around the positive use of money that drive these investments. For many investors who are concerned about the better use of their capital it is not sufficient to hold a range of investments that have been subject to a simple negative screen or a light ‘best in class’ approach to managing an ethical portfolio. These investors are prepared to actively use their capital to drive creative solutions to the problems of education, economic development, health, climate change and poverty. The more information and transparency provided for the investment, whether it is a public or private offering, the more sure an investor can be in putting their money there. However it is important to realise this is not old style philanthropy but an intellectual and financial engagement in the issues they are confronting.

These investors expect to be able to measure and rate these investments for their social and environmental impacts as well as a financial return. In this respect impact investments are no different from traditional investments, but measuring impact is not quite so simple. Every social investment has a different impact, and the way it is measured varies investment by investment and organisation by organisation and it can be confusing particularly where an organisation relies on a process of self-accreditation.

But where these investments differ is in how they report their impact and as the sector grows the measurement and reporting of impact needs to be supplemented by an assessment or rating of impact. The need for a standardised framework that allows for comparisons and benchmarking becomes more important as each sector or asset type begins to use different reporting initiatives. Fortunately some analysts are applying new methodologies and analyses to these investments so that investors can more easily compare them.

The Rockefeller Foundation has launched an impact reporting framework. The Global Impacting Investing Network, a non-profit organisation has been launched by Bill Clinton and is dedicated to promoting more effective impact investing among its members. From this it is possible to foresee that an independent rating industry will emerge and underpin the pioneering efforts of these impact investors to build a more efficient and powerful market and attract greater flow from mainstream capital.

Impact investments drive creative solutions to real problems and they mobilise capital to drive change. For the investor, this is an inspiring prospect. They give investors a chance to do something meaningful with their money while also providing added diversification into their portfolio.

But the challenge to mainstream capital is that it is not brave when it comes to doing something new. It does not like to go places where the rules are different or subject to a new set of interpretations, or to go where the expected returns are not calculated in a traditional way or the risks are not standardised.

But we live in times with serious problems. It is no longer sufficient to maintain a convenient disconnect between pressing social and environmental issues and the way in which money is managed. Impact investing is emerging at a time when financial markets around the world are still in turmoil. The economic crisis has shaken confidence in established investment ideologies and their mainstream proponents. The markets desperately need to rebuild trust and respond more effectively and usefully to the needs of their clients. The emergence of the impact investing industry offers a potentially compelling alternative, by offering to imbue investment with social purpose and, ultimately, to increase the scope of solutions to problems that continue to proliferate.

As the late Anita Roddick, founder of the Body Shop, said: “I want something not just to invest in. I want something to believe in.”

Impact investments, as a new asset class, can deliver both. They are investments that inspire.

Geoff Burnand is chief executive of Investing for Good