Impact Investing Lessons - Understanding and Evaluating the Ecosystem
Impact investing has exploded in popularity over the past few years. U.S. assets under management using socially responsible strategies rose from $3.74 trillion at the beginning on 2012 to $6.57 trillion at the start of 2014 – a 76% increase. We made our first impact investment in 2008 and have since helped our clients direct about one-third of our approximately $2.8 billion in assets under management (AUM, numbers as of 12/31/2015) toward impact investing. All of this positive momentum invigorates us and excites us about the future of the impact economy. At the same time, we realize the importance of pausing to reflect on what we’ve learned over the last eight years in the realm of impact investing. One of our core values at Threshold Group is the pursuit of lifelong learning and we take these lessons learned to heart as we continue to hone our impact experience.
We also believe shared learning and collaboration is one of the key ways to continuously advance the impact ecosystem.
Green washing is real and it is happening.
Unfortunately, sometimes we meet investment managers that treat impact as an afterthought in their investment process. If a manager is going to walk into our offices professing to have an impact investment strategy, they need to be able to answer the following question, “What is your theory of change and how do you measure success related to your non-financial objectives?” A manager who is unable or unwilling to thoughtfully answer this question is, at best, operating significantly behind the state of the art. At worst, they are green washing investors about the true environmental or social benefits of a product. Green washing is, in essence, the practice of creating the appearance of being a green-focused organization yet actually operating in a contrary manner, which can be misleading to investors. Internally, we develop our own theories of change for the impact themes we pursue– environmental resilience, education, and financial wellness. Our team has built mechanisms to assess and measure these non-financial objectives (assessing the greenhouse gas emissions reductions associated with a potential asset allocation change, for example) which we apply early and often. In reviewing hundreds of impact strategies to date, we seek investment strategies where the impact outcomes are inextricably linked to the success (or failure) of the financial outcomes – not an afterthought or even a marketing scheme.
All dollars can be leveraged for social and environmental change – in all asset classes.
Impact investing is not a “new asset class” or one that should be addressed only through private equity or venture-capital. Building comprehensive, diversified impact portfolios is something we call “full portfolio activation.” Utilizing equity and debt instruments through both public and private markets may allow investors to activate the full power of their portfolios. Tools such as loan-guarantees and first-loss capital provisions can be equally if not more, powerful instruments to achieve the desired impact outcomes. It is important to understand the problem you’re trying to solve before leading with a financial instrument. We’ve developed a full suite of strategies and continuously refine these “ingredients” in light of an ever-changing marketplace. We reserve that some asset classes and segments of the market are more challenging than others to generate direct impact and we strive to strengthen these through our own intellectual capital. Our recent work with Trucost around “How to Account for Greenhouse Gas Emissions in Derivatives” as well as collaboration with Forefront Analytics on the creation of the newly launched “Impact Resiliency Strategy” are two examples of this field building work with industry partners.
Impact due diligence can and should be collaborative.
We’ve learned that educating impact investment managers is a critical role that the investment advisory community can play in building a stronger, more resilient impact investing ecosystem. Through our impact due-diligence process, we apply a rigorous methodology but also engage investment managers in discussions related to areas of concern or aspects of their processes that could be improved in order to become more attractive to institutional capital. This engagement and feedback (unique in our industry) enhances the entire ecosystem and also gives us an advantage in attracting high quality impact managers.
There are no “generally accepted accounting principles” for measuring impact; metrics are not yet standardized and/or applied.
Analyzing impact outcomes across strategies can be messy. While significant progress is being made by the Global Impact Investing Network, Aeris, B-Lab, and others, the industry has a ways to go in terms of the development and adoption of a generally accepted impact reporting methodology. We believe impact reporting should contain both quantitative and qualitative outcomes. Moreover, we believe that impact reporting needs to be both longitudinal (meaning it can be measured over time) and serve as a useful decision making tool for follow-on investments. We’ve learned a lot since developing our first impact reports. While our early impact reports were data rich, they were not dynamic or qualitative. Applying our learnings, we’ve evolved these reports to measure portfolio migration and even extrapolate tangible stories to bring data to life.
Patience is a virtue in impact investing.
Impact investing is at the heart of our Goals Based Investment philosophy. Like traditional investing, it requires patience and a long-term perspective. Developing thoughtful strategic plans, while at times can feel like an arduous process, actually leads to quicker implementation and more meaningful outcomes. As an example, several years ago, we outlined an ambitious plan to “de-carbonize” the portfolio of a large family foundation. What was originally envisioned as a five year strategic plan is nearing completion in three years. While this fossil fuel divestment occurred more quickly than we envisioned, our current focus on lowering the greenhouse gas emissions will be front-and-center as we “re-invest” in low-carbon strategies within clean-technology, and carbon sequestering themes such as slow-rotation forestry, soil remediation, and sustainable agriculture as markets develop. Alongside this foundation’s goals for perpetuity, a focus on low-carbon investing is written into the Investment Policy Statement – so we’re in it for the long-haul. The collaborative nature of that strategic plan development, and its success factors, led to enhanced productivity, quicker implementation, and more meaningful outcomes.
Impact investing is not homogeneous and is uniquely influenced by personal values, experiences, and unique points of view.
Clear communication and education is critical to successful implementation, both from the advisor and client. We have developed educational content and a proprietary toolkit to help clients frame and articulate their impact goals. These tools include a client impact profile, decision making framework, and a unique, phased-based “Tug of War” exercise that seek to establish short and long-term goals (financial and non-financial). Applying these, we seek to prioritize the issue areas that can, and should, be addressed through the power of capital markets.
We are privileged to have intrepid clients whose hunger for impact investing has pushed and inspired us to become pioneers in this space. Their drive has enabled us to learn these lessons and we hope that sharing them will help cultivate the impact ecosystem.
We welcome your thoughts. Please feel free to click the “Connect” button below to tell us about any impact investing lessons you have learned throughout your journey.
 Impact Investing 101. The Calvert Foundation. http://www.calvertfoundation.org/storage/documents/impact-investing-101.pdf
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Impact investments are investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending upon the circumstances. Impact investors actively seek to place capital in businesses and funds that can harness the positive power of enterprise. Impact investing occurs across asset classes, for example private equity / venture capital, debt, and fixed income.
Impact investors are primarily distinguished by their intention to address social and environmental challenges through their deployment of capital. For example, criteria to evaluate the positive social and/or environmental outcomes of investments are an integrated component of the investment process. In contrast, practitioners of socially responsible investing also include negative (avoidance) criteria as part of their investment decisions. Threshold Group makes no representations or guarantees that any specific investment opportunities will meet such goals of impact investors or impact investments.