Global philanthropic funds, even when combined with the development or aid budgets of governments, add up into the mere billions of dollars. Meanwhile, the cost of solving the world’s most critical problems runs into the trillions, according to the Rockefeller Foundation, including an estimated $2.5 trillion annual funding gap needed to achieve the sustainable development goals in developing countries alone. Private capital is urgently needed in order to fill this gap and address pressing global challenges.
Fortunately, people of means are showing an increasing appetite for committing a share of their assets to impact investing — as well as its closely related cousins ESG and socially responsible investing. Millennials in particular are investing in organizations that prioritize the greater good more than any previous generation, according to a U.S. Treasury survey. In other words, millennials prefer working with socially responsible entities. Meanwhile, institutional investors have also begun taking an interest in the space and have enormous capacity to drive impact investing far beyond its current scale.
In light of this burgeoning trend, we asked several financial professionals who specialize in impact investing to elaborate on some of the key issues surrounding the practice.
Define impact investing vis-à-vis socially responsible or ESG investing.
Amit Bouri, CEO, Global Impact Investing Network
Impact investments are investments made into companies, organizations and funds with the intention to generate social and environmental impact alongside financial return. Now, there are a lot of different strategies that look to manifest values through investments, but the terms — such as ESG and SRI — often mean different things to different people. The way I think about impact investing alongside other strategies is that the others are about avoiding harm or mitigating risk. Impact investing isn’t just about avoiding harm or mitigating risk; it’s about proactively investing in solutions to social and environmental issues. For example, you might invest in affordable housing projects or green real estate because you care about making the planet more sustainable or addressing the needs of underserved communities.
Give us a sense of scale. How many billions of dollars were committed to impact investing during 2016 compared with a few years ago?
Amit Bouri, CEO, Global Impact Investing Network
The best data we have is from our 2017 Annual Impact Investor Survey, which analyzes the activity and perspectives of over 200 investors. The survey doesn’t capture all impact investors, but it serves as a best available “floor” for the size of the impact investing universe. What we know from the respondents is that they invested $22.1 billion in 2016 and they plan to increase that by 17 percent to almost $26 billion in 2017. Speaking from our unique vantage point in this space, I’ll say this is a healthy and fast-growing market.
Interest in impact investing has surged. What has been the impetus?
John Tennaro, senior vice president and senior investment analyst CIBC Atlantic Trust Private Wealth Management
While philanthropy and government aid continue to be integral elements in response to some of the world’s most difficult problems, impact investing offers a unique opportunity to help address the extraordinary rise in global issues. Previously, investors had to deal with the conflicted decision of whether they wanted to make money or do good. But impact investing is based on the belief that investors can help others while still helping themselves. At the end of the day, a growing number of investors, through impact investing, feel empowered to make a difference and initiate the kind of change that can improve lives. Furthermore, impact investors have the opportunity to address what matters most to them — and do so in a meaningful and effective way.
What are the most popular areas of interest?
Will Tickle, partner, senior investment adviser, and the director of impact investing Ballentine Partners
Investors are moving beyond vague ESG screens and getting deeper into the details. Gender lens investing is really taking off and social justice investing has been invigorated by the global uncertainty over the past year. One area that has been a lightning rod for client interest is affordable housing, particularly among next gens and those living in markets like San Francisco, Seattle, Boston and Los Angeles, where a lack of workforce and affordable housing is a threat to communities. Fortunately for impact investors, there are many ways to invest to address these challenges. Among our environment-first investors, we see very different perspectives. There are those focused on efficiency and greening of the built environment, and those focused on conservation and ecosystem protection. Whether clients want to be building green buildings, conserving a valuable watershed or facilitating an organic conversion of a farm, there are ways to invest to accomplish their goals and earn a return while they’re at it.
The big issue for many investors is whether they have to sacrifice returns while directing their dollars for impact. What do the metrics say about that?
Matt Blume, portfolio manager and director of ESG research, Perkin Singer Strauss Asset Management
Many mainstream investors believe that they must sacrifice competitive investment returns in order to direct their assets toward socially conscious investments, but the data simply do not bear this out. In fact, data indicate that returns from impact-oriented investment strategies can keep pace with and may even exceed returns generated by non-impact-
focused investment strategies. Over the past 20 years through March 31, 2017, the MSCI KLD 400 Social Index (KLD) has outperformed the S&P 500 Index by 21 basis points per annum. Similarly, a Morningstar comparison of mutual fund returns indicates that socially responsible mutual fund returns have been in line with non-SRI fund returns over three-, five- and 10-year periods. We believe that this is a reflection of the risk mitigation that is inherent in ESG and impact investing strategies, as well as the high quality of management teams typically found at firms with strong ESG and sustainability performance.
What percentage of an investment portfolio would be committed to impact investing by your most enthusiastic clients?
Gloria Nelund, chairman and CEO, TriLinc Global
TriLinc works with diverse types of investors and have found they have varying degrees of interest and ability to commit capital to impact investing strategies; however, we do have several clients who committed 100 percent to responsible, sustainable and impact investing. In our experience, family offices lead the way in deploying impact investment capital across all asset classes, including ESG/SRI public securities, real assets, private debt/equity investments. Institutional investors have only recently begun allocating, following revised guidance by the U.S. Department of Labor in 2015 allowing fiduciaries to proactively consider ESG factors when investing. A survey by the Global Impact Investing Network showed that of reporting organizations, 18 percent of pension funds and 17 percent of insurance companies were already allocating capital to impact investments, while 44 percent and 43 percent, respectively, were considering them. Retail investors allocate less to impact investments, partially because of less availability of product, but also because they are generally less familiar with impact investing. Since inception, TriLinc has been actively educating retail investors about the opportunity, and the positive trends are encouraging.
What are the risks of impact investing — not simply the losses that can be incurred by any investment, but the risks particular to impact investing?
Lisette Cooper, managing partner and CIO, Athena Capital Advisors
One risk to consider is whether a particular impact investment has the same expected financial risk/reward as high-quality non-impact investments of the same asset class or style; investors need to evaluate the risk of whether they are giving something up in order to gain the social return. How much risk? Is it close enough to market rate to meet their goals?
The second risk pertains to social return itself. For each impact investment there is a risk of meeting the expected impact goal. It’s important to consider whether the investment really generates impact or is it just “green washing” or marketing of a traditional investment as an impact investment?
The third risk for impact investors to understand is concentration risk, or “tracking error.” When an investor has more investments in a particular issue area — for example, solar technology — it causes concentration risk. Even when the risk-adjusted return is the same as a traditional investment, concentration risk can lead to wide swings in value versus traditional benchmarks, called tracking error. Tracking error feels great when you are outperforming benchmarks, but can be painful when underperforming. Impact investors must consider that they may deviate from the market in order to receive a social return. Understanding concentration risk can help investors tolerate the swings in value relative to the benchmarks and stay the course over time.
If impact investing is going to rise to its full potential, what needs to happen?
Margaret Bell, managing director, Fort Washington Investment Advisors
More financial data and performance returns will help make impact investing more credible and acceptable for more people. This is typically part of the G (governance) score of ESG since senior management and boards are always accountable in this increasingly transparent world. As time goes by, the E (environment) and S (social) scores will become a larger part of the financial mosaic and, hence, will also impact its health and performance. The manifestation of more data related to the importance of the E and S will simply take time. Impact investing thus far has been most effective through infrastructure and private equity investing. More recently in the United States, there have been some prominent endowments and public funds that have initiated impact investing. The combination of prominent investors and impact investing will likely add more credibility to ESG acceptance in the United States. The increase in the number of investment firms and consultants becoming and maintaining their status as UN Principles for Responsible Investing signatories will add further weight to ESG globally.