Wed, 11/12/2013 - 10:32
Impact investing holds tremendous promise for institutional investors wishing to address social or environmental issues, but ensuring that the pursuit of impact investing actually helps an investor maximise its social mission is hardly straightforward.
This is according to "Impact Investing: A Framework for Decision Making," a new report from Cambridge Associates, the global institutional investment advisor.
An impact investment is one made in a corporation, government, fund or other entity because it offers a market-based solution to social or environmental challenges that the investor wants to address.
While such an investment sounds - and is - very strategic, it does not mean that dedicated impact investment allocations always work well as part of a top-down portfolio policy, says the report, which provides a framework for deciding whether and how to incorporate impact investments into a long-term investment pool to maximise social returns.
"What investors must always keep front and centre is that the impact investing opportunity set is a tremendous variable - completely a function of the investor's social return objective. The opportunity set will vary in size depending on that objective and, in many cases, be unproven. So, trying to set hard, top-down impact investment allocations as a matter of policy could prompt investors to sacrifice quality for the sake of quantity, actually jeopardising their ability to maximise their overall social returns," says Cambridge Associates managing director and report co-author Kyle Johnson. "Therefore, we believe that allocation sizes are generally best left to opportunistic, bottom-up decisions.”
With that backdrop, the report addresses impact investing's nuances and the mindset Cambridge Associates believes investors should adopt as they review opportunities. For example:
• It is all about the investor's intent. All investments arguably have impact. However, what differentiates impact investments from any other investment is the investor's intent to create a particular social or environmental impact through the investment. As such, impact investments are not constrained to any particular social return objective, e.g., education or job creation. The spectrum of social return objectives that an impact investment might address is as broad as the social return objectives of investors themselves. Further, since investor "intent" is the defining characteristic of an impact investment, a portfolio investment could be considered an impact investment even if the manager to which the investment decision-making is delegated is indifferent to social returns.
• When impact investing does more for the mission than spending, e.g., foundation grants. Investors are often drawn to impact investments when they enable greater resources to address social return goals than would charitable spending alone. If the investment is profitable, the returns generated can expand the financial resources available to the investor to address the social issue. Endowment spending, on the other hand, reduces financial resources. And if the investment's returns are competitive with those of non-impact investments with a similar risk profile, the investment may attract other investors, even those indifferent to social returns. Therefore, funds going to the social goal could be even greater.
• Balancing spending and impact investing. The onus is on investors to determine the optimal blend of spending and impact investing that will enable them to maximise social returns. Many investors will decide to exclusively spend because of a lack of appropriate impact investment opportunities or resources to build out an impact investing program. For those who decide to pursue impact investing, they must assess whether or not these investments will have a positive or negative impact on their ability to achieve their spending targets. If the impact is negative, they must then determine whether the social returns generated by these investments more than offset any negative impact to spending.
• When there is a good case for "experimenting" with impact investments. In cases where the social returns of an impact investment are truly interchangeable with the social returns generated through spending, there could be significant implications for portfolio construction. In such cases, there would be less pressure to build portfolios for the sole purpose of maximising sustainable and predictable spending and more incentive to increase the organisation's willingness and ability to pursue and experiment with impact investments.
• Effective impact investing requires sophisticated resources. An organisation that moves forward with impact investing will need to make sure that the team it puts together to implement the program has the multidisciplinary skills to execute the allocation successfully. In addition, given the common attributes of many impact investments (e.g., illiquidity, limited track records, etc.), the oversight team may need heightened due diligence capabilities.
"If a social or environmental problem can be tackled through a profitable means, rather than through a charitable or governmental intervention, we are hard pressed to see why an investor would not want to explore doing so, given the likely sustainability and scalability of such a solution. With that said, investors must make sure that any impact investments are truly additive to the organisation's ability to maximise the overall social returns it hopes to achieve," says Johnson.
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