Voted Best in Class Impact Reports Smartermoney Review
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SmarterMoney + Review Spring 2015 / Volume 3 Presents © Carr Cliſton Maximize Impact + Maximize Return Across Asset Classes Thought leadership for impact investors Voted Best In Class Impact Reports ™
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Transcript of Voted Best in Class Impact Reports Smartermoney Review
SmarterMoney+
Review
Spring 2015 / Volume 3
Presents
© Carr Cli� on
Maximize Impact + Maximize ReturnAcross Asset Classes
Thought leadership for impact investors
Voted Best
In Class Impact Reports
™
Overview. Leveraging one of the largest networks of Impact Investors globally, Big Path Capital assists purpose-driven companies and funds ensuring mission preservation across financial transactions, including acquisitions, mergers, and capital raises. Big Path has worked in over 100 engagements, more than any investment bank in the sector. As a global firm, Big Path Capital is advancing a sustainable economy connecting mission-driven companies and fund managers with mission-aligned investors. Big Path Capital’s clients include entrepreneurs, companies, and fund managers advancing an expansive economy built on natural, social, and financial capital.
Mission. Big Path Capital's principals are dedicated to fund managers and business owners expanding the path for business interests seeking multiple bottom lines, taking the new economy from the margins to the mainstream, and purusing business that generates good as it generates return. Big Path champions the client's mission, scaling growth, perpetuating and expanding impact. Big Path Capital is proud to be a founding B Corp member.
Key Focus Areas. Big Path represents the largest impact investing network in the sector and focuses on:• Companies. Big Path assists business owners with financial transactions including company
sales, acquisitions, and capital raises. • Funds. Big Path assists fund managers in capital introductions. • Events. Big Path curates events focused on institutional investors. Those include the
Impact Capitalism Summit (Chicago, Nantucket, and The Hague), the Five Fund Forum, the Impact & Sustainble Trade Missions in collaboration with the U.S. Department of Commerce, and the Impact Capitalism Train Stop Tour which will be providing half-day educational sessions in 15 different cites.
• Education. Big Path has launched the Impact Academy to assist institutional investors how to integrate impact investing into their investment strategies.
About the Organizer
About the Review
In less than a decade, “impact investing” – investment that intentionally seeks to generate
social and environmental benefits in addition to financial returns – has emerged into a recognized
force in the capital markets. With an estimated $60 billion in assets, according to the latest research
from the Global Impact Investing Network (GIIN) and J. P. Morgan, the impact investment market
remains a relatively small component of a much broader investment universe that incorporates social
and environmental considerations, but it is one of the fastest growing segments that has attracted
increasing attention from investors of all stripes, as well as investment consultants, policy makers,
and leading investment firms.
As impact investing mainstreams, Big Path Capital recognizes the importance of the
dissemination of research and thought-leadership to those new and experienced in the sector. Along
with the sponsors of SmarterMoney+TM Review, Big Path Capital is proud to offer this compendium
comprised of excerpts of recent research and resources about leading impact investing trends and
developments. Each article references a url link to the full article. These selections represent the
impressive breadth and depth of impact investing and we are grateful to our contributors for their
leadership.
Given the explosion of interest in the field, our aim is to be more curatorial than
comprehensive. Working with a Selection Committee which includes Luke Apicella of Prudential
Impact Investments, Noelle Laing of Cambridge Associates, Michael Lear of Athena Capital
Advisors, and Christine Looney of the Ford Foundation, the review will compile a selection of
some of the most influential articles, reports, and essays about this growing field, providing
readers with a wide-angled overview of this rapidly changing landscape.
In this inaugural issue, we spotlight ten papers that have recently helped to define,
conceptualize, and develop the impact investing space. They range from major trends reports
describing the scope and scale of the impact investing market to primers targeted at specific
audiences as well as analyses of specific impact investing themes and conceptual frameworks for
understanding how to pursue impact investing and expand the field further.
Although primarily associated with direct investments in private equity and debt, impact
investing is increasingly being pursued and conceptualized as an investment process applicable
across asset classes found in diversified investment portfolios. This is the basic insight of Total
Portfolio Activation: A Framework for Creating Social and Environmental Impact across Asset Classes, a key
conceptual intervention in the field co-authored by Joshua Humphreys, Christi Electris, and Ann
Solomon, and jointly sponsored by Tides, Tellus Institute and Trillium Asset Management. As J. P.
Morgan’s most recent impact investor survey conducted with the GIIN, Eyes on the Horizon,
documents, the vast majority of impact investing assets – nearly 75 percent – continue to be
allocated in private debt and equity. However, the relative share of other asset classes being deployed
for positive social and environmental impact, from listed equities and bonds to property and other
real assets, has grown in recent years, from less than 10 percent to more than 25 percent,
highlighting a gradual diversification of impact investment opportunities.
3
As Yvonne Bakkum from the Dutch emerging markets investment firm FMO Investment
Management stresses in her article “The New IRR: Impact, Risk and Return,” every investment
needs to be assessed not simply for its projected “internal rate of return” but rather for its impact,
risk and return. From this vantage point, she sees new opportunities for impact investing across the
risk continuum, from relatively low risk green bonds within liquid fixed income allocations to
emerging market debt and private equity funds-of-funds that provide greater diversification with a
bias toward growth equity over more traditional forms of venture capital or leveraged buyouts.
Widening the opportunity set along these lines would make impact investing far more appropriate
and compelling for pension funds and other institutional investors that have not yet participated
very actively in the field, initially dominated by philanthropic foundations, high-net-worth investors,
sustainable and responsible investment firms, and family offices.
The World Economic Forum’s report “Impact Investing: A Primer for Family Offices”
highlights the growing interest among wealthy families for resources to orient them. The much-
projected $40 trillion generational wealth transfer from baby boomers to millennials is anticipated to
drive growing demand for impact investing because younger wealthy people appear more socially
and environmentally conscious when it comes to business and investment than their parents and
grandparents. WEF’s impact investment team, led by Abigail Noble and Michael Drexler, usefully
stress opportunities across the full spectrum of asset classes and situate the emergence of impact
investing with broader approaches to sustainable and responsible investing. The report also provides
concrete steps for family offices to develop a vision for integrating impact into family investment
portfolios and to develop guidelines and execute an impact investment strategy, in close consultation
with advisers.
Along similar lines but more broadly targeted to mission-related investors, the investment
consulting firm Slocum’s paper “Governance: A Critical Aspect to Impact Investing Success”
highlights the need to clarify key questions about how decisions will be made before beginning an
impact investing program. Too often investors have dived into the impact investing space before
clarifying basic governance matters. Who should be making key decisions about which investments
are aligned with the investor’s mission and impact objectives? Are the kinds of trade-offs
occasionally encountered within the impact investing space acceptable? Answering these questions
early provides a more solid foundation for a successful experience with impact investing.
Within the private debt and equity spaces, new models of structuring impact investment
transactions are beginning to emerge to address the specific risks and returns impact investors have
begun to achieve, as Diana Propper de Callejon and Bruce Campbell detail in their paper
“Innovative Deal Structures for Impact Investments.” Private equity impact investors are exploring
the use of new kinds of terms in order to structure deals with predetermined liquidity payments,
from staged dividends to flexible redemption-based exits, altering the risk-return profile normally
associated with traditional venture capital investment that typically ignores social and environmental
impact. Private debt investors are extending their time horizons, developing more flexible repayment
structures, and abandoning pre-payment penalties and other conventional terms that place
unreasonable burdens on social and environmental enterprises.
Finally, the papers we present here raise several recurring thematic issues. The first is the key
role that government policy can potentially play in developing the impact investing field in
4
supportive ways. The Impact Investing Policy Collaborative, a joint initiative of InSight at Pacific
Community Ventures, the Harvard Initiative for Responsible Investment, and the Rockefeller
Foundation, has become a leading platform for identifying government policies that support impact
investing capital markets in order to generate positive social and environmental benefits. Allocating for
Impact, a “Subject Paper of the Asset Allocation Working Group” of the Social Impact Investment
Taskforce, established under the United Kingdom’s presidency of the Group of Eight (G8),
highlights the growing interest among policymakers in using impact investing as a complement to
public investment in order to address issues such as clean energy, affordable housing, education,
clean water, employment and social protection, infrastructure and agriculture, among other key
themes. And at a time of rampant wealth disparity – and in the US a veritable social and civil rights
crisis – it is particularly timely to have increasing focus within the impact investing community on
questions of economic mobility and income inequality, as the Aspen Institute’s The Bottom Line:
Investing for Impact on Economic Mobility in the U.S. and Cornerstone Capital Group’s flagship report
“Income Inequality: Market Mechanism or Market Failure?” each does in different ways.
We hope you enjoy this inaugural issue of SmarterMoney+ Review. We welcome your reactions
and recommendations for articles for our Selection Committee’s future consideration.
Joshua Humphreys Shawn Lesser Michael Whelchel President Managing Partner Managing Partner Croatan Institute Big Path Capital Big Path Capital
5
Focusing exclusively on sustainable and responsible investing
We are the oldest investment advisor exclusively focused on sustainable and responsible investing (SRI), managing equity and fixed income portfolios for high net worth individuals, foundations, endowments, and religious institutions since 1982. A leader in shareholder advocacy and public policy work, our goal is to deliver both impact and performance to our investors.
800-548-5684 • www.trilliuminvest.com
Table of Contents
Article Contributed by URL
The Bottom Line: Investing for Impact on Economic Mobility in the U.S. (excerpt)
The Aspen Institute bit.ly/AspenBottomLine 11
Introducing the Impact Investing Benchmark (executive summary)
Cambridge Associates & Global Impact Investing Network (GIIN)
bit.ly/CambridgeBenchmark 15
Income Inequality: Market Mechanism or Market Failure? (excerpt)
Cornerstone Capital Group bit.ly/CornerstoneIncome 18
Innovative Deal Structures for Impact Investments (executive summary)
Diana Propper de Callejon & Bruce Campbell
bit.ly/InnovativeDeals 23
The New IRR: Impact, Risk and Return (excerpt)
FMO bit.ly/FMONewIRR 26
Allocating for Impact (executive summary)
G8 bit.ly/G8AssetAllocation 30
Eyes on Horizon (executive summary) GIIN & J.P. Morgan bit.ly/GIINJPEyeonHorizon 33
Governance: A Critical Aspect to Impact Investing Success
SLOCUM bit.ly/SlocumGovernance 40
Total Portfolio Activation: A Framework For Creating Social & Environmental Impact Across Asset Classes (executive summary)
Trillium Asset Management, Tides, & Tellus Institute
bit.ly/TotalActivation 44
Impact Investing: A Primer for Family Offices
World Economic Forum bit.ly/FamilyImpactInvest 47
Articles contained herein have been reprinted with permission
7
Consulting Editor
Selection Committee
Joshua Humphreys is the President and Senior Fellow at the Croatan Institute, an independent institute for advanced social and
environmental research and engagement. A leading authority on sustainable and responsible investing, Dr. Humphreys has taught at
Harvard, Princeton, and NYU. His insights on trends in sustainable finance and impact investing have been widely published in the
press, most recently in Barron’s, Bloomberg, BusinessWeek, the Financial Times, Forbes, Institutional Investor, Pensions and Investments, and
the Journal of Investing. He currently serves on advisory boards of the Dwight Hall SRI Fund at Yale University, the Responsible
Endowments Coalition, and the Coalition for Responsible Investment at Harvard. He also serves as an Associate Fellow at Tellus
Institute, the sustainability think tank in Boston.
Luke Apicella has eight years of impact investing experience.
As an associate with Prudential Impact Investments, he is
responsible for the origination and asset management activities
to grow the portfolio to $1 billion. He covers numerous
relationships, industries, private asset types, and impact
objectives. Apicella serves on the boards and/or committees
for several portfolio companies including a Real Estate
Investment Trust, a Community Development Finance
Institution, and a local start-up. His signature transactions
include a term loan for an innovative charter school in New
York City with performance pay for teachers, a co-investment
with a leading private equity fund in a high growth sustainable
consumer goods company, and a next vintage investment in the
top performing affordable housing fund. Apicella started his
career with Prudential and soon after became an analyst with
Impact Investments responsible for the portfolio management
activities including valuation, forecasting, and reporting.
Apicella has degrees in sustainability management from
Columbia University (MS), finance from New York University
(MBA), and entrepreneurship from Syracuse University (BS).
Joshua Humphreys
President and Senior FellowCroatan Institute
Luke Apicella
AssociatePrudential Impact Investments
Noelle is a Senior Investment Director in the Mission-Related
Investing (“MRI”) Group in Cambridge Associates’ Arlington
office. She identifies and researches MRI managers across asset
classes and serves as a resource to generalist investment
directors in the firm by monitoring managers in clients’ MRI
programs.
Prior to rejoining the firm in 2010, Noelle was a senior
investment advisor at the IAM National Pension Fund, where
she focused on alternative assets, including portable alpha,
hedge funds, natural resources, infrastructure, opportunistic
debt, and private equity. She also worked as a public markets
investment analyst for the American Red Cross, where she
conducted asset allocation analysis and manager due diligence
for the public market portfolios of the endowment, pension,
corporate accounts, and 401K program.
Noelle began her career at Cambridge Associates as a
consulting associate in 2003. During her time at the firm, she
was promoted to senior consulting associate and team leader
responsible for overseeing consulting associates and liaising
with firm wide management. In addition, Noelle was involved
in the firm’s consulting associate recruiting initiatives. Noelle is
a CFA Charter holder and received her BS in Mathematics with
Honors from St. Lawrence University.
Noelle Laing
Sr. Investment DirectorCambridge Associates
88
Selection Committee (continued)
Michael Lear is a Vice President on the Portfolio Management
Team. An experienced portfolio manager, Michael came to
Athena from MetLife Investment Strategies Group where he
worked as a portfolio advisor. Prior to that Michael worked as
a portfolio manager at Carruth Associates managing assets for
an investment division of the single family office. He also
spent eight years as a portfolio manager at State Street Global
Advisors. In his time at SSgA he worked on the Multi Asset
Class Solutions team focusing on exposure management and
portable alpha as well as in the Investor Solutions Group where
he focused on tax efficient solutions for high net worth clients.
Michael earned his B.S. in Marketing from Boston College and
holds an M.S. in Investment Management from Boston
University. Michael has received the Certified Investment
Management Analyst designation, the Chartered Alternative
Investment Analyst designation, is a member of the Investment
Management Consultants Association and the Boston Security
Analyst Society. Michael is a CFA charterholder and currently
holds the Series 6 license and Series 63 license.
Michael Lear
VP, Portfolio Management Athena Capital Advisors
Christine Looney manages the Ford Foundation’s $280 million
Program-Related Investment Fund. In this role, she originates,
structures, and monitors Ford’s program-related investments
across the foundation and ensures alignment and
complementarity with program strategies and goals. Prior to
joining Ford, she was president of the Urban Business
Assistance Corporation, a nonprofit consulting firm serving
minority businesses in New York City. Previously, she was an
associate in Chase Manhattan Bank’s Structured Finance
Group. Christine has a MBA in finance and management from
New York University’s Stern School of Business and a
bachelor’s degree in economics from Holy Cross.
Christine Looney
Sr. Program Investment OfficerFord Foundation
9
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THE BOTTOM LINE: INVESTING FOR IMPACT ON ECONOMIC MOBILITY IN THE U.S. 1
THE BOTTOM LINEINVESTING FOR IMPACT ON ECONOMIC MOBILITY IN THE U.S.
11
WWW.ASPENINSTITUTE.ORG
WHAT YOU WILL FIND IN THIS REPORT:
�Aspen Institute and Georgetown University Survey – Findings and analysis of a survey of active and emerging impact investors;
�Case studies – An opportunity to go under the hood on deals with the Bank of America, W.K. Kellogg Foundation, Acelero Learning, and others;
�Point of view essays – Insights and lessons from leaders in the field;
�Deals at a glance – Snapshots of impact investors and what they have learned;
� In-depth chapters on investments in education, economic assets, and health and well-being – Investment areas with the potential to advance economic and social mobility for low-income families. In each of these chapters you will find key facts, investment examples, lessons learned, and recommendations; and
�Appendices – Investor and sample investment profiles from the Aspen Institute survey and a glossary of key terms.
12
THE BOTTOM LINE: INVESTING FOR IMPACT ON ECONOMIC MOBILITY IN THE U.S.
EXECUTIVE SUMMARYAs a country, we have long believed in the “American Dream” – through hard work and opportunity, we can reach our goals. But with millions struggling, those dreams are being eroded. Social and economic mobility has stagnated, and inequality is rising. Not only are families at risk but so is our nation’s economic security.
Interest in the field of impact investing has skyrocketed. Potential market size, amount of available capital, and the opportunity for financial and social impact, particularly for our country’s most pressing problems, are all factors in that growth. This report and accompanying survey were designed to explore the landscape and lessons learned of this growing field in the United States, with a focus on deal flow and returns. We paid special attention to investments in education, economic assets, and health and well-being, investment areas with the potential to advance economic and social mobility for low-income families.
Adding rich depth and perspective throughout the report are the following:
� Case studies – An opportunity to go under the hood on deals with the Bank of America, W.K. Kellogg Foundation, Acelero Learning, and others;
� Point of view essays – Insights and lessons from leaders in the field; and
� Deals at a glance – Snapshots of impact investors and what they have learned.
Guiding research questions: � What is the current level of
investment activity and interest in the U.S. related to education, economic security, and health and well-being?
� What tools, strategies, and models can be distilled from early investments that could lead to better results for children and families?
� How can strategies be effectively shared with on-the-ground innovators, foundations, policy makers, and impact investors?
Aspen Institute and Georgetown University Impact Investing Survey
In partnership with the Georgetown University McDonough School of Business, the Aspen Institute conducted a survey of investors to assess activity and interest in impact investing in the U.S., with an emphasis on investments in education, economic assets, and health and well-being. Thirty-nine individuals responded, representing 32 institutional investors from across investor types.
Nearly 69 percent of respondents invest in the study’s target impact areas of education, economic assets, and health and well-being.
� For these respondents, impact investing is not a new practice. Sixty-four percent indicated they have been active impact investors for more than 10 years.
� Their work is overwhelmingly backed by an institutional commitment to poverty (86 percent). Furthermore, 32 percent reported employing a gender lens in the investment decision process, while 27 percent reported having a racial equity lens.
Among all respondents, the average investment transaction size varied from less than $100,000 to more than $10 million. Of target impact area investors, the majority of respondents indicated an average transaction size between $100,000 and $3 million.
13
WWW.ASPENINSTITUTE.ORG
The majority of investments are delivered via funds or intermediaries.An increasing number of foundations are active impact investors. Private sector players, such as Goldman Sachs, Bank of America, and Morgan Stanley, are developing business units dedicated to impact investing.
As with venture capital, a majority of impact investors find deal flow from peers and other investors.
Forty-five percent of respondents establish formal financial and social benchmarks, and 80 percent of those said their portfolios are meeting or exceeding the established financial metrics, and 90 percent are meeting or exceeding the social metrics. This provides evidence that good deals exist.
The Aspen Institute used the survey to gauge how investors’ work supported economic and social mobility. We noted the following trends in advancing mobility:
� A majority of respondents are investing in target areas that support low-income families and those most in need.
� Significant dollars are supporting strategies to build mobility.
� Investors are leveraging varied organizational structures to facilitate impact on parents, children, and families.
� The pipeline for investments is based on social capital (trusted networks and relationships).
� Good deals exist to advance economic mobility for U.S. families.
Looking at the field as a whole, the top five trends among impact investors include:
� Increased market players – moving beyond private foundations;
� Foundations moving from experimentation to institutionalization;
� Focus on ‘place’;
� Leveraging CDFIs to increase efficiency; and
� Emerging interest in metrics.
Focus on education, economic assets, and health and well-being:Outlined in the report are in-depth sections on education, economic assets, and health and well-being. Opportunities in those investment areas are highlighted below.
Education: � Investing beyond school
infrastructure to educational outcomes;
� Focusing on quality and efficiency; and
� Leveraging intermediaries to deploy large amounts of capital effectively.
Economic assets: � Using diverse forms of capital to
initiate and sustain economic opportunity;
� Collaborating to invest in local ecosystems; and
� Leveraging data to scale what works and eliminate barriers.
Health: � Reducing disparities in access and
quality of care;
� Managing the costs of care; and
� Investing in health systems.
Enabling policy environment:Federal, state, and local governments are increasingly finding alignment with the goals of impact investors, leveraging a variety of policy levers, such as tax credits, co-investments, and procurement policies to drive improved outcomes for parents and children in communities across the country.
14
Introducing the Impact Investing Benchmark
2015
15
Executive Summary
Cambridge Associates and the Global Impact Investing Network have collabo-rated to launch the Impact Investing Benchmark, the first comprehensive analysis of the financial performance of market rate private equity and venture capital impact investing funds. While the impact investing industry is in an early stage of development, it is poised for growth. One of the chief barriers to industry advancement remains a paucity of robust research on financial perfor-mance. Credible data on risk and return can help both existing and future impact investors better identify strategies that best suit their desired social, environ-mental, and financial criteria.
At launch, the Impact Investing Benchmark comprises 51 private invest-ment (PI) funds. Impact investments are investments made into companies, organizations, and funds with the inten-tion to generate social and environmental impact alongside a financial return. Funds in the benchmark pursue a range of social impact objectives, operate across geographies and sectors, and were launched in vintage years 1998 to 2010.
Despite a perception among some inves-tors that impact investing necessitates a concessionary return, the Impact Investing Benchmark has exhibited strong perfor-mance in several of the vintage years studied as of June 30, 2014. In aggregate, impact investment funds launched between 1998 and 2004—those that are largely realized—have outperformed funds in a comparative universe of conventional PI funds. Over the full period analyzed, the benchmark has returned 6.9% to investors
versus 8.1% for the comparative universe, but much of the performance in more recent years remains unrealized.
Impact investment funds that raised under $100 million returned a net IRR of 9.5% to investors. These funds handily outperformed similar-sized funds in the comparative universe (4.5%), impact investment funds over $100 million (6.2%), and funds over $100 million in the comparative universe (8.3%). Emerging markets impact investment funds have returned 9.1% to investors versus 4.8% for developed markets impact investment funds. Those focused on Africa have performed particularly well, returning 9.7%.
In all private investing, manager selection and due diligence are critical steps in the investment process and are important factors in obtaining superior returns and in risk management; impact investing funds are no exception. There are funds within the Impact Investing Benchmark that have performed in line with top quartile funds in the comparative universe, showing that market rates of return for impact invest-ments are possible and also reinforcing that manager skill is paramount.
Creating and analyzing benchmarks for private investments, especially for a younger, emerging portion of the market such as impact investing, poses a number of chal-lenges. Difficulty acquiring private fund performance data and strict inclusion criteria limited our ability to amass a large dataset, which presented data analysis limitations that are unavoidable at this stage. Cambridge Associates will produce an ongoing quar-terly Impact Investing Benchmark report to track the industry over time.
16
This report was produced by Cambridge Associates, a global investment fi rm and one of the world’s leading developers of fi nancial performance benchmarks, in partnership with the Global Impact Investing Network, an organization dedicated to increasing the scale and effectiveness of impact
investing worldwide. It presents fi ndings from the fi rst comprehensive analysis of fi nancial performance in impact investing. To maintain a manageable scope, this report specifi cally evaluates the performance of market rate private investment funds in the impact investing space. This report also marks the launch of the fi rst ever fi nancial performance benchmark of private impact investing funds, which Cambridge Associates will maintain and update on a quarterly basis going forward.
The decision to focus this report on PI funds was motivated by several factors. Investing via funds is a common strategy for impact investors of all types and sizes, including development fi nance institutions, foundations, commercial banks, pension funds, insur-ance companies, and family offi ces. Nearly 75% of investors that responded to the J.P. Morgan and GIIN global impact investor survey, Eyes on the Horizon: The Impact Investor Survey, published in May 2015, indicated that they invest via intermediaries (regardless of whether they also invest directly in companies). Additionally, within fund invest-ments, private equity and venture capital are particularly common vehicles. Out of 310 impact investing funds profi led in the ImpactBase Snapshot, published in April 2015, 153 are private equity or venture capital vehicles. Cambridge Associates’ Mission-Related Investing (MRI) database is further evidence of private equity’s prevalence in impact investing: of the 579 private MRI funds Cambridge Associates’ tracks, 392 are private equity or venture capital funds (the remainder are private real assets funds).
Introducing the Impact Investing Benchmark
For the sake of brevity, the phrases “private investments” and “Impact Investing Benchmark” are used throughout this report. However, as explained in detail in the Methodology section, the benchmark only includes data from private equity and venture capital funds that target risk-adjusted market rate returns and social impact objectives. Accordingly, the benchmark does not include private debt funds, funds targeting environmental impact objectives, or funds seeking below market returns, all of which are also prevalent strategies in the impact investing landscape. Our use of these simplifying phrases, therefore, is not to imply that impact investing is restricted only to private equity and venture capital; rather it is to enable simple narrative flow.
17
Global Thematic Research
Income Inequality: Market Mechanism or Market Failure?
Tools to assess corporate performance and enhance investment decisions
Executive summary
Income inequality is a normal feature of a free market economy. However, in recent
years, it has been on the rise in most developed countries and has reached relatively
high levels, especially in the US. Extreme income inequality affects economic growth
prospects and societal stability. It also impacts business models, corporate
profitability and value creation.
Our report provides insight into the investment implications of this socio-economic
phenomenon. It offers a comprehensive review of the facts, data and economic analysis
related to income inequality, and
establishes the relationship
between the macroeconomic
perspective and individual
investment decisions.
We have identified two simple
tools that can help investors
estimate the consequences of
their investments regarding
income inequality. The first is a
check-list of indicators and
questions to help assess
companies’ human capital
strategies in the perspective of
high inequality. The second,
related to the external socio-
economic impacts of business
activities, opens the debate regarding companies’ awareness of their influence on the
local economy.
Flagship Report November 13, 2014
Margarita Pirovska
Policy and
Sustainability
Analyst
+1 212 874 7400
Reprinted with permission from
Cornerstone Capital Group. Contents are
only current as of publication date.
18
I. Defining income inequality
Income distribution trends have become a mainstream discussion topic since the global financial crisis of
2008-2009. For the third year in a row, in 2014, 700 world leaders at The World Economic Forum in Davos,
Switzerland identified the increasing income gap as one of the biggest risks facing the world economy. This
same year, the International Monetary Fund, Standard & Poor’s and the Organization for Economic Co-
operation and Development (OECD) also issued warnings about this increasing disparity. But what exactly is
income inequality – and how does it affect investors and markets?
1. The broad concept: economic inequality
Economic inequality is the uneven distribution of financial and material assets and income among
individuals or households within a country, or between countries. Wealth inequality illustrates the variation
between the net worth of different groups of individuals or households, while income inequality refers to the
disparity in real disposable incomes. This report focuses primarily on the latter. We will attempt to describe
and analyze the socio-economic phenomenon of high and rising inequality of real disposable incomes within
the US population, and its impacts on financial markets and investment decisions.
Although related to the issue of poverty, and often referred to as the “difference of income between the rich
and the poor”, income inequality is a different topic, illustrating the dispersion of all incomes within a given
population. This does not imply that the lowest earners are actually living in poverty (which may be
understood in absolute or relative terms). However, in some situations, extreme inequality can lead to an
increase in poverty, and threaten future economic growth1.
Income inequality is closely related to wealth inequality. As incomes constitute one of the main sources of
wealth accumulation, persistent income inequality may fuel wealth inequality over time, and can be
exacerbated by inequality of opportunity and other social inequalities. Income inequality is therefore an
important short-term driver of wealth inequality.
Economic inequality has always been embedded in free market economies, and is not a problem per se. But
the return of pre-war levels of income inequality in the US, especially after the economic and financial
crisis, saw renewed interest in the subject. The biggest issue is that while the spread in income distribution is
increasing, economic growth is slow, and unemployment and underemployment of young graduates are
rising. In addition, over the long term, real growth of incomes at the lower end of the spectrum has been
stagnant.
2. The origins of inequality
The origins of the word “equal” stem from the Latin aequalis – meaning “uniform, identical, equal" but also
from aequus or "level, even, just". Equality can refer to what is the same, but also to what is fair and just.
Therefore, is inequality also unfair? Unjust? Or only “different”, and “not equal”?
1 These issues will be further developed in the second part of this report.
19
All developed, post-industrial societies share a commitment to principles of political equality2. However,
economic inequality, as a natural result of market forces, has withstood most attempts at reform. Some
political philosophers have argued that the mere existence of equality of opportunity justifies economic
inequalities 3 . Inequality of income could therefore be a natural characteristic of the capitalist system.
However, as inequalities in developed countries have widened over the past three decades, it becomes useful
to ask whether these trends are socially or economically sustainable.
3. The income distribution gap in numbers
Over the past three decades, income inequality in the developed world increased along with sustained
economic and employment growth4. This contradicts widely accepted post-war economic analysis of income
inequality and economic growth, such as the one proposed in 1955 by Nobel laureate and Harvard professor
of economics, Simon Kuznets5. As an economy develops and undergoes industrialization, Kuznets argued,
income inequality grows at first and then starts to recede, as human capital develops and wages increase.
According to this analysis, in developed post-industrial markets, inequality should be low. This theory
was true in practice until the 1970s, when inequality began to rise again.
Income distribution within a given population can be assessed using data on real disposable household
income. Additional variables, such as consumption, or other monetary attributes can also be used as proxies.
However, data on real disposable income provides the most accurate and widely used source of information
to assess income inequality6.
The variance in income distribution can be expressed with different ratios and coefficients. Among the most
common measures are:
The Gini coefficient, measuring the extent to which the distribution of income or consumption
expenditure among individuals or households within an economy deviates from a perfectly equal
distribution. A Gini index of 0 represents perfect equality, while an index of 1, with completely unequal
distribution, implies full inequality.
The share of total income earned by the top 1% or the top 0.1% richest people in the population.
2 The Declaration of the Rights of Man and of the Citizen of 1789, the Declaration of Independence and the Declaration of Rights of 1776 were inspired by the philosophers of the Enlightenment, such as Rousseau (Discourse on the Origin and Basis of Inequality Among Men, Jean-Jacques Rousseau, 1754), who defined inequality as a social convention, an artificial construction stemmed from the social contract which guarantees peace in exchange of limited individual freedoms. Based on the theories of a pre-existing natural, original equality among human beings, they state that beyond the social contract and the organization of human societies, human beings are, in essence, equal. This political and legal equality, implying equal dignity and respect for all human beings, has been adopted as a founding principle of Western societies. 3 Understanding and explaining why societies, composed of legally and morally equal individuals, are characterized by persisting material inequalities has been a continuous endeavor of moral philosophers (see John Rawls, A theory of Justice, 1971). Overall, the past two centuries have seen a progress towards equality not only in political and legal terms, but also socially and economically. Both the maturing welfare states of Western societies, and the exponential globalization of nations, have contributed to expose, understand and address, fully or partially, many social inequalities, such as racial, gender or social group based discriminations. 4 Divided We Stand: Why Inequality Keeps Rising, OECD (2011), http://www.oecd.org/social/soc/dividedwestandwhyinequalitykeepsrising.htm 5 Simon Kuznets, "Economic Growth and Income Inequality". American Economic Review 45 (March): 1–28. (1955) http://www.aeaweb.org/aer/top20/45.1.1-28.pdf 6 See also the OECD Guidelines for Micro Statistics on Household Wealth (2013) http://www.oecd.org/statistics/OECD-Guidelines-for-Micro-Statistics-on-Household-Wealth-Chapter7.pdf
20
Percentile or dispersion ratios, such as the ratio between the income of the richest 10% of the
population and the bottom 10%.
The Gini coefficient for a set of developed countries shows that the gap in income distribution has
increased over the past thirty years. This measure illustrates the relative evolution of income distribution
over time, and to allow for a comparison between countries where data is available.
Figure 1: Gini coefficient of a set of developed countries, 1985 and 2010
Source: OECD
Globally, inequality has been growing at a steady rate. As Christine Lagarde, Managing Director of the IMF
said in early October, “There has been a staggering rise in inequality—7 out of 10 people in the world today
live in countries where inequality has increased over the last three decades. And yet, we know that excessive
inequality saps growth, inhibits inclusion, and undermines trust and social capital”7.
In the United States, the income gap is both increasing and higher than in other developed countries. To
better understand this tendency, we can look at the distribution of total income among the richest 1% in the
US economy. Data shows that current share of income going to the top 1% earners is similar to that
observed just before the Great Depression of 1929.
7 http://www.imf.org/external/np/speeches/2014/101014.htm
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
0.4
1985 2010
21
CDP is an international not-for profit organization providingthe only global system for companies and cities to measure,disclose, manage and share vital environmental information. CDPworks with market forces, including more than 822 institutionalinvestors with assets in excess of US$95 trillion, to motivatecompanies to disclose their impacts on the environment andnatural resources and to take action to reduce them. CDP nowholds the largest collection globally of primary climate change,water and forest risk commodities information and puts theseinsights at the heart of strategic business, investment and policydecisions. Visit www.cdp.net or follow us @CDP to find outmore.
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Project Leads: Diana Propper de Callejon & Bruce Campbell, with Gabi Blumberg
Project SummaryImpact Investors often rely on conventional term sheets to structure investments. This can create challenges and even potential conflict between capital providers and companies given that not all investments in social enterprises conform to traditional investment terms. To address these challenges, a number of investors have begun to test new models for structuring investments, and are adding entirely new terms to address impact. The changes and innovations that have been tried remain largely unknown to others in the market. Through interviews and group discussions with investors, entrepreneurs and other leaders in impact investing, this project’s goal is to develop an easily accessible on-‐line toolkit of innovative terms that will include new terms that are being piloted as well as new ideas that are at the conception stage.
Diana Propper de Callejon (www.linkedin.com/in/dianapropperdecallejon), Managing Director at Cranemere Inc., has 20+ years of sustainability investment experience and developed the term sheet project as a part of her Aspen Institute and Capital Institute Fellowships.
Bruce Campbell, (www.bluedotlaw.com/team/bruce-‐campbell/) Chief Happiness Officer at Blue Dot Advocates, has worked as a corporate finance lawyer for 15+ years and has an extensive track record structuring impact investments.
If you have any questions, comments or contributions, please contact [email protected]
September 14
Innovative Deal Structures for Impact Investments
Pi Investments
Background
Impact investors often rely on traditional term sheets to structure their investments. While familiar and well tested, they are not always the most effective way to structure investments into companies that are explicitly oriented towards social or environmental mission and profit.
First, conventional venture capital and private equity term sheets expect a financial return to come from an exit in the form of a trade sale, IPO or sale of the business to an institutional investor. While some impact enterprises may have the potential to attract a strategic acquirer or have access to the public finance markets, in other cases these paths to exit are either unrealistic or undesirable. This can be for a number of reasons, including the following:
- Growth rates and scale of the enterprise: the company’s business model reaches its growth projections over a period longer than 3-5 years and/or its ultimate size and scale may be limited by a smaller target market;
- Founder’s goals: the founder’s long-term goal may be to keep the company private to more easily preserve the company’s social or environmental mission;
- Returns: some mission-led companies may deliver concessionary returns.
For companies that are less likely to complete a traditional exit for their investors, alternative exit strategies must be utilized.
Secondly, conventional term sheets are silent on matters related to impact and thus fail to capture the full breadth of interests and goals of the investors and companies. Term sheets constructed with a new approach can, on the other hand, play a central role in aligning interests and behaviors related to the achievement and preservation of mission.
To address these challenges, a number of impact investors have begun to develop new models for achieving liquidity and integrating impact directly into deals. Much of this knowledge, however, remains fragmented with no central clearinghouse to gather and disseminate the new approaches and lessons learned.
Key Findings to Date
The team has interviewed almost 100 impact investors, enterprises, legal experts, and advisors from around the world. Our key findings, focused primarily on privately held, early-stage businesses, are summarized below.
Equity investors are using innovative approaches to achieve liquidity, including staged dividend payments and redemption based exits.
Equity based alternatives encompass the following approaches:
1. Dividend payments: Partial or complete liquidity is achieved through staged dividend payments toinvestors. The company is required to make payments until they achieve a specified cash-on-cash returntarget. These payments are variable – they are linked to a percentage of revenue or cash flow, and thus linkthe timing of liquidity to the health of the enterprise. Typically, returns are capped or have certain limits onthem, but sometimes investors have a mechanism to participate in a higher return if the enterprisesuccessfully completes a traditional exit.
2. Redemptions: At the investor’s option, an exit is achieved through the mandatory redemption of aninvestor’s equity stake in the business at a specified point in time. We have seen the redemption amountpaid to investors calculated in a variety of ways, including as a percentage of revenue, based on the fairmarket value of the company at a given point in time and as a pre-determined multiple on investment.Redemption provisions usually include some flexibility with respect to repayment in the event the companydoes not have adequate cash on hand to satisfy the redemption request.
These alternatives offer a solution to exit challenges by shifting the investor’s risk adjusted return perspective. By predetermining liquidity payments, investors trade the higher potential upside from a traditional exit, for more certain repayment terms and less risk. For most of these investments, investors we interviewed are targeting IRRs in the mid-teens (with a few even higher). These investments are better suited for investors looking to invest in companies that are likely to generate sufficient profits from operations in the relative short term from which to provide staged
24
liquidity payment to investors rather than VC-style investors that are willing to accept a high degree of risk for significantly higher return potential.
Debt investors are adapting traditional structures to increase flexibility and alignment with enterprises.
Debt based alternatives offer the following new terms and adaptations to traditional debt:
1. More flexible repayment: Like some of the equity structures, some investors are linking debt repayments toa percentage of revenues or cash flows. This makes the timing of the repayment contingent on thecompany’s performance, rather than fixed payments.
2. Longer time horizons: Investors have been willing to lengthen the term of the debt repayment, extendingpayments out as far as 10 years, or to offer longer repayment grace periods of 18-24 months and beyond.
3. Company friendly terms: Investors have included more company-friendly terms, including no pre-paymentpenalties and, in some cases, pre-payment discounts.
These structures can be advantageous for companies with return profiles that are not suitable for equity investment, but that also struggle to attain commercial loans due to unpredictable cash flows or a lack of security to offer as collateral.
Revenue share agreements offer investors an alternative liquidity structure.
Revenue share agreements offer investors a simple way to participate in the growth of a company without purchasing ownership, and therefore avoiding exit issues. These structures entitle the investor to an agreed upon percentage of a company’s revenue stream over a certain period of time. Typically, the revenue payments are limited by time or a capped multiple to the investor.
Innovative investment structures may present challenges and trigger potentially disadvantageous tax issues.
These approaches have only begun to be tested recently (some have yet to be used) and none have been through a full investment cycle. We have no data as yet to conclude that these terms will successfully lead to the targeted financial outcomes or create better values alignment between investors and companies.
We have found that these innovative investment structures require careful tax analysis. If investors are not well informed about the tax aspects of these investments, they may end up paying more taxes than they expected and paying those taxes before the investment has realized a cash return. See the recent blog from Blue Dot Advocates for more on the tax considerations for these types of investments: www.bluedotlaw.com/innovative-financial-structures/.
Impact investors are incorporating impact considerations into deals
Investors and companies are integrating impact considerations in a variety of ways:
1. Mission definition: Investors require the mission of the enterprise to be articulated as part of the term sheet,By-Laws and Articles of Incorporation.
2. Use of funds to invest in impact: Some investors restrict the use of funds to business operations that driveimpact outcomes.
3. Impact governance: Impact governance is integrated at the Board level, including the appointment of atleast one board member who has oversight of impact.
4. Linking returns to impact outcomes: Investors link their financial returns to the impact that the enterpriseachieves. In some cases, they are inversely related, such that the investor accepts a lower return if thecompany achieves certain target outcomes. In other cases, they are positively related, such that the higherthe impact, the higher the return to investors (e.g. Pay for Success model).
5. Mission preservation at the exit: Different approaches include providing founders with veto power to blockan exit if they believe it to be in conflict with the enterprise’s mission. Alternatively, the fiduciary duty ofthe Board can be redefined through an alternative entity such as the Benefit Corporation or through theoperating agreement of a limited liability company to allow it to give equal consideration to impactpreservation when evaluating an exit for investors.
25
The new IRR: Impact, Risk and Return
YVONNE BAKKUM Managing Director, FMO Investment Management
A NEW 3-D WAY OF LOOKING AT INVESTMENTSThere is no such thing as a free lunch. Or, when talking about long term investing, no return without risk. In the Netherlands, a debate is going on about the risk appetite of pension funds. To what extent does regulatory pressure limit their ability to generate sufficient returns? The CIO of one of the largest pension fund openly questioned the Dutch Central Bank’s policy to freeze the risk profiles of some pension funds whose asset value had sunk below the required coverage ratio. He argued – rightfully so - that this would be counter effective. In the current low interest rate environment, a conservative investment policy emphasizing traditional fixed income instruments will yield low returns hence will not help to improve coverage ratios.
Investment decisions tend to be based on the internal rate of return (IRR) of an investment opportunity. IRR is the annual rate of return on an investment considering its original cash outflow and its ultimate outcomes in terms of cash inflow over time. IRR analysis is a commonly used method to compare investment opportunities and support (or even lead) investment decision making. Much has been written about the limitations of this method, and I will happily stay away from too much detail here.
But this wouldn’t be an article about a new IRR if I wouldn’t address at least one of the limitations of the old one: the uncertainty or volatility of return. If the future cash inflows cannot easily or reliably be quantified, IRR analysis will not work and an investment may not even be considered. As a result, many investments are never made nor considered. Uncertainty becomes a disqualifier – while in fact all financial outcomes are uncertain! And as mentioned before, no return without risk.
And then there is another issue in my view: the definition of return. Cash inflows and the assumed cash associated with a residual value are included in IRR calculations. But what about non-financial or indirect forms of return?
THAT’S WHY I ADVOCATE FOR A NEW IRR: LOOKING AT EVERY INVESTMENT TAKING INTO ACCOUNT ITS IMPACT, RISK AND RETURN. All investments have an impact. At FMO, the Dutch development bank, the impact we are looking for is the positive impact that successful private enterprise can have on emerging market
26
economies, on people and on the environment they live in. In 2014 alone, our new investments were expected to create and support at least 500,000 jobs, touching the lives of millions of people. By focusing our new investments on renewable energy projects and other ‘green’ initiatives, greenhouse gas emissions avoided amount to the equivalent of a million tickets from Amsterdam to Nairobi.
All investments carry some degree of risk. And as a reward for taking that risk, investors want to realize a commensurate financial return.
SO HOW DO IMPACT, RISK AND RETURN COME TOGETHER? In my view, they are interlinked concepts and should be seen in relation to each other. Many investors associate impact investing with high risk products such as venture capital or private equity. In the Netherlands, where regulatory pressure is highest in relation to illiquid investment categories, mainstream institutional investors are hesitant to pursue impact investing. In other cases investors struggle with apparently conflicting mandates:
“please build an impact investing portfolio, and please stay away from illiquid investments...”. However, as impact investing offers opportunities across asset classes, different products exist to meet risk-return requirements of different investors.
If you are wondering what types of impact investing options are available, let me just mention a few:
A LOW RISK OPTION: Green bonds offer impact investment opportunities with substantial liquidity. The market for green bonds is developing very quickly. Critical investors have driven increased transparency and consistency in the use of proceeds by the issuers, leading to improved realization and reporting of impact. FMO and others offer green or sustainability bonds on a regular basis.
A MODEST IRR OPTION: Emerging markets loans are another interesting impact investment theme. Especially through pooled vehicles, the risk profile is relatively modest while return potential is much more attractive than traditional EMD products. By selecting the right vehicle the impact can be very positive: creating jobs for many, improving labour conditions and promoting ‘green’ businesses.
A HIGHER IRR OPTION: Private equity funds-of-funds in general offer a highly diversified form of private equity investment. In emerging markets, private equity funds tend to focus on growth equity which has tremendous impact as it allows entrepreneurs to grow their business. This focus on growth equity also lowers the risk, as you are not exposed to the typical leverage risk associated with private equity in the US and Europe. So when looking at higher risk products, dig deeper to understand the true risk profile which may not always be as high as you think!
Clearly, investing for impact is not a privilege available to high risk seekers only, nor is it only suitable for the more philanthropically oriented investor. Every investor should be able to find impact investing opportunities that fit their specific risk appetite. I sincerely hope that the notion of this new IRR will help people realize there is more to investing than return optimization only. It’s a new 3-dimensional way of looking at investments.
Anna van Saksenlaan 71
2593 HW The Hague
The Netherlands
+31 (0)70 314 96 96
www.fmo-im.nl
FMO Investment Management offers professional investors access to FMO’s expertise in
responsible emerging market investing. We match investors’ appetite with FMO’s experience
in selected sectors, products and regions. The resulting fund propositions each aim for a
diversified portfolio, where each investment we make should generate an attractive financial
return and meaningful development impact. Our offering builds on more than 45 years’
experience resulting in a portfolio of EUR 8 billion portfolio spanning over 85 countries. FMO
Investment Management is part of FMO, one of the larger bilateral private sector development
banks globally.
27
Outcomes
Repayment
ExpansionCapital
Non-profitinterventionprovider
Privatefunders/impact
investors
Governmentpayor
We design public-private nonprofit partnerships, structure social financing solutions and manage performance to ensure shared goals are met.
77 Summer Street, Boston, MA 02110 | 617-939-9900www.socialfinanceUS.org
Founded in 2011, Social FInance is a501 (c) (3) nonprofit organization.
Mobilizing Capital To Drive Social Progress
ADDRESSING A RANGE OF COMPLEX SOCIAL ISSUES
SERVICES TO MEET THE NEEDS OF THE EMERGING FIELD OF PAY FOR SUCCESS
ADVISORY
Feasibility StudiesConsulting AssignmentsProof-of-ConceptDemonstration Programs
MANAGEMENT
Performance & FiscalManagementAccounting & ComplianceInvestor Relations
DEVELOPMENT & EDUCATION
Financial StructuringCost-Benefit AnalysisMetric & Evaluation DesignCapital RaisingContract Execution
CRIMINALJUSTICE
EARLYCHILDHOOD
CHILD & FAMILYWELFAREEDUCATION HEALTH
Helping Energy Innovators Succeed Financing | Project Development | Government Relations
Patent Protection | Acquisitions | Green Bonds | Fund Formation
Mintz Levin has been representing leading energy technology entrepreneurs and investors since
the earliest days of the industry. Our passion is working with companies to achieve their goals, and since
2006 we’ve assisted hundreds of clients close more than $7 billion of transactions to help them on their way.
As a firm that cares about environmental and social issues, Mintz Levin commends you for thinking about
the impact your investments make. Your thoughtful investments are safeguarding
our future goal of sustainable economic development.
Contact Mintz Levin for cutting-edge advice and guidance.
Tom Burton, Chair, Energy Technology Practice | 617.348.3097 [email protected] | EnergyTechMatters.com | @TomBurtonIII
Sahir Surmeli, Co-chair, Energy Technology Practice | 617.348.3013 [email protected] | EnergyTechMatters.com | @EnergyCleanTech
Boston | London | Los Angeles | New York | San Diego | San Francisco | Stamford | Washington www.mintz.com 5023
SOCIAL IMPACT INVESTMENT TASKFORCE
Established under the UK’s presidency of the G8 September 2014
ALLOCATING FOR IMPACTSubject Paper of the Asset Allocation Working Group
30
EXECUTIVE SUMMARY
Despite increases in aggregate global wealth, levels of inequality and environmental degradation in many countries continue to rise. To help tackle this, impact investment1 aligns the positive power of private capital with the social and
environmental needs of society at large. This makes impact investment a critical tool for the policymaker, bringing cost-effective solutions and incremental capital to some of our most intractable societal challenges, from life-saving vaccines to affordable housing.
It also provides investors with a compelling opportunity: to align their investment strategy with their societal values, to spot areas of rapid growth (supported by a favourable policy environment) and even to identify potentially less correlated investment propositions.
To solve problems on a global scale, we need global capital pools to respond. This means that, alongside the pioneering investors already allocating for impact, we need impact investment to find its formal place within institutional portfolios.
This will happen when Chief Investment Officers and Investment Managers recognise that a diversified and thoughtful allocation to impact investments can fit with their fiduciary responsibilities, and when governments use well-designed policies to encourage and support such allocations.
This paper presents a series of frameworks to help both investors and policymakers do just that.
In Chapter 1, we describe the various features that make impact investment an attractive proposition, for both governments and investors.
In Chapter 2, we clarify the various terms used in the market and position the investment choices available. This chapter aims to help investors identify the opportunity set that can best meet their societal and financial goals. It also provides policymakers with a view of the impact investment universe, which they can influence and incentivise to meet their development agendas.
In Chapter 3, we propose a framework for including impact investments across a balanced investment portfolio, without compromising the financial goals and fiduciary responsibilities of Chief Investment Officers and investment managers. This chapter is clearly relevant for investors but it is also aimed at policymakers, since it lays the groundwork for later policy recommendations.
In Chapter 4, we assess the key barriers to making impact investments for a wide range of investors and intermediaries. These barriers fall into three main categories, relating to conflict of duty, to the nascent stage of the industry and to increased risk factors.
EXECUTIVE SUMMARY
Impact investment aligns the positive power of private capital with the social and environmental needs of society at-large. It is for this reason that this report has two key audiences: both investors and policymakers.
1 Throughout this report, the terms ‘impact’ and ‘societal’ encompass both social and environmental impact 31
EXECUTIVE SUMMARY
Finally, in Chapter 5, we present a series of actionable policy recommendations that can address these barriers, illustrated through examples of equivalent policies already at work around the world. These recommendations call for governments to act in three key ways:
1. MARKET STEWARD
• Clarification of fiduciary duty
Use of fiscal incentives
• Requirement for regulated financial institutionsand foundation endowments to articulate theircontribution to impact investment
• Requirement that impact investment be includedas an optional percentage of pension fundofferings
• Requirement that banking institutions lend topriority sectors
2. MARKET PARTICIPANT
• Issuance of Requests for Proposals to encouragedevelopment of impact investment products
• Stimulation of the intermediary market toproduce more bundled/ multi-asset productsat-scale
• Provision of catalytic capital, such as matchinginvestment, first loss protection or guarantees
3. MARKET BUILDER
• Support for placement and distribution platforms
• Support for an impact investment rating system
Taken together, we hope that the various frameworks and policy recommendations presented in this report have the potential to unlock the financial power of global portfolio investors, bringing widespread solutions to some of our most pressing societal challenges.
About the authors
This report is the product of a series of discussions by the Asset Allocation Working Group of the Social Investment Taskforce, established established under the UK’s presidency of the G8 (see Acknowledgements for details).
The Working Group is chaired by Harvey McGrath of Big Society Capital.
The report’s lead authors are Clara Barby of Bridges IMPACT+ and Mads Pedersen of UBS.
Please direct any feedback or further enquiries about this report to:
[email protected] and [email protected]
32
www.jpmorganmarkets.com
Global Social Finance04 May 2015
Eyes on the HorizonThe Impact Investor Survey
Social Finance
Yasemin Saltuk
(44-20) 7742-6426
Ali El Idrissi
(44-20) 7134-6938
J.P. Morgan Securities plc
Global Impact Investing Network
Amit Bouri
(1-646) 837-7203
Abhilash Mudaliar
(1-646) 837-7168
Hannah Schiff
(1-646) 837-7152
33
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Executive Summary
This report presents the findings of the fifth annual impact investor survey conducted by The Global Impact Investing Network (GIIN) and J.P. Morgan. We have maintained core questions on investor activity and perspectives, and also included additional specific topics such as loss protection, technical assistance, impact management and measurement, and exits. Throughout the report, we complement the survey questions with some of our own desk research presented in “Zooming In” sections. Below, we present a summary of the survey’s key findings.
Sample characteristics
The sample size this year is 146, a 17% increase from last year.
Seventy-eight percent of respondents have their headquarters (HQs) in NorthernAmerica and WNS Europe. However, 48% of current assets under managementare in emerging markets, even though 90% of capital is managed by DM-HQinvestors.
The sample is about half fund managers (57%). The rest of the sample is assetowners, with foundations making up 18%, diversified financial institutions/banks7%, and development finance institutions (DFIs) 5%.
Just over half of the sample (55%) principally targets “competitive, market ratereturns”, with the remainder of the sample split between “below market ratereturns: closer to market rate” (27%) and “below market rate returns: closer tocapital preservation” (18%).
Investment activity and allocations
As Table 3 shows, the group reports having committed USD 10.6bn in 2014 andintends to invest 16% more – USD 12.2bn – in 2015.
Table 3: Number and size of investments made and targeted
In 2014 2015 target
Number(n=146)
USD, mm(n=146)
Number(n=145)
USD, mm (n=144)
Mean 37 72 44 85Median 7 10 8 14Sum 5,404 10,553 6,332 12,241
Source: GIIN, J.P. Morgan.
The 82 organizations that responded both last year and this year reported a 7%growth in capital committed between 2013 and 2014 and a 13% growth innumber of deals.
Collectively, our respondents are managing a total of USD 60bn in impactinvestments today, 35% of which is proprietary capital and 65% managed onbehalf of clients.4
Fund managers manage 63% of this total AUM while DFIs – who make up just5% of our sample – manage 18% of total assets (Figure 1).
4 Total impact investment assets under management represents 145 respondents and not the total 146 due to one respondent not providing this data.
34
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Figure 1: Total AUM by organization type
n = 145; AUM-weighted average; Total AUM = USD 60bn
Source: GIIN, J.P. Morgan.
Investments directly into companies represent a much larger proportion of assetsunder management (74%) than do indirect investments (20%).5
Capital is diversified across regions, with about half invested in emergingmarkets and half in developed markets (Figure 2).
Housing accounts for 27% of respondents' assets under management, as doMicrofinance and Financial Services (excluding microfinance) combined. Afurther 10% is allocated to Energy, while Healthcare and Food & Agricultureaccount for 5% each (Figure 3).
Figure 2: Total AUM by geographyn = 145; AUM-weighted average; Total AUM = USD 60bn
Source: GIIN, J.P. Morgan. See Table 2 for region codes used in the text.
Figure 3: Total AUM by sectorn = 145; AUM-weighted average; Total AUM = USD 60bn
Source: GIIN, J.P. Morgan. NB: Some of the “other” categories reported include forestry, land
conservation, sustainable agriculture, arts & culture, and manufacturing
5 A small group of respondents chose "other" to denote investments in structures that are neither companies nor funds (these respondents specified, for example, real assets and NGOs).
63%
18%
9%
6%
2%
2%0.01%
Fund manager
Development finance institution
Diversified financial institution / Bank
Foundation
Other
Pension fund or Insurance company
Family office
40%
14%11%
10%
8%
6%6%
3% 2%0.2%
Northern America
SSA
LAC
EEC
WNS Europe
ESE Asia
South Asia
Other
MENA
Oceania
27%
17%
16%
11%
10%
5%
5%
2%
2%2%
1%
1%1%
0%
Housing
Other
Microfinance
Financial services (excluding microfinance)
Energy
Healthcare
Food & agriculture
Education
Information and communication technologies
Manufacturing
Infrastructure
Habitat conservation
Water & sanitation
Arts & culture
35
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Private Debt and Private Equity are the most prominent instruments, accountingfor 40% and 33% of assets under management, respectively. Eight percent isallocated to Equity-like Debt while less than 1% is allocated to Pay-for-performance instruments (Figure 4).
Most capital managed today – 91% – is invested in companies post-venture stage,with 28% allocated towards companies at the Growth Stage, 52% in Mature,Private and 11% in Mature, Publicly-traded companies. Nine percent iscommitted to Seed/Start-up companies or Venture Stage businesses (Figure 5).
Figure 4: Total AUM by instrumentn = 145; AUM-weighted average; Total AUM = USD 60bn
Source: GIIN, J.P. Morgan.
Figure 5: Total AUM by stage of businessn = 145; AUM-weighted average; Total AUM = USD 60bn
Source: GIIN, J.P. Morgan.
Planned asset allocations going forward
The region to which the highest number of respondents plan to increase theirallocations is SSA (29 respondents), followed by ESE Asia (28 respondents) and LAC (27 respondents). A relatively low number of respondents plan to increase allocations to MENA, WNS Europe, EEC and Oceania (Figure 6).
The sectors to which the highest number of respondents plan to increase theirexposure are Energy and Food & Agriculture (38 respondents each), followed byHealthcare (37 respondents) and Education (33, Figure 7).
Figure 6: Change of allocation planned for 2015, by geography Ranking by number of respondents who chose "increase”
Source: GIIN, J.P. Morgan.
Figure 7: Change of allocation planned for 2015, by sectorRanking by number of respondents who chose "increase”
Source: GIIN, J.P. Morgan.
40%
33%
8%
6%
5%3% 3%2% 0.2%
Private debt
Private equity
Equity-like debt
Public debt
Public equity
Real assets
Other
Deposits & cash equivalents
Pay-for-performance instruments (e.g., social impact bonds)
3%6%
28%
52%
11%
Seed/Start-up stage
Venture stage
Growth stage
Mature, private
Mature, publicly-traded
(10)
(5)
(1)
(4)
(7)
(1)
4
6
6
4
2
6
4
1
8
10
16
19
30
21
23
21
23
29
3
4
9
12
14
22
27
28
29
(10) 0 10 20 30 40 50 60 70
Oceania
Eastern Europe, Russia, & Central Asia
Middle East & North Africa
U.S. & Canada
Western, Northern, & Southern Europe
South Asia
Latin America & Caribbean (including Mexico)
East & Southeast Asia
Sub Saharan Africa
Decrease Begin to assess Maintain Increase
(2)
(1)
(1)
(9)
(4)
(1)
(1)
(3)
(2)
4
6
3
3
6
18
1
8
3
6
9
6
4
9
14
12
11
14
18
20
20
31
25
23
28
19
5
9
12
13
15
16
20
21
23
33
37
38
38
(10) 0 10 20 30 40 50 60 70
Arts & culture
Habitat conservation
Manufacturing
Infrastructure
Information and communication technologies
Water & sanitation
Microfinance
Housing
Financial services (excluding microfinance)
Education
Healthcare
Food & agriculture
Energy
Decrease Begin to assess Maintain Increase
36
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Market development and pipeline
Respondents indicated progress across the board on several key indicators ofmarket growth, including: collaboration among investors, availability of investment opportunities, usage of impact measurement standards, and number of intermediaries with significant track record. Compared to 2013, respondents seemed to see more progress in 2014 on the availability of investment opportunities at the company level.
However, certain challenges remained consistent in investors’ views. “Lack ofappropriate capital across the risk/return spectrum” ranked first among a set ofchallenges this year, and “shortage of high quality investment opportunities withtrack record” ranked second (Table 4).
Table 4: Challenges to the growth of the impact investing industry today
n = 146; Respondents ranked top three
Rank Score Available answer choices
1 193 Lack of appropriate capital across the risk/return spectrum
2 174 Shortage of high quality investment opportunities with track record
3 115 Difficulty exiting investments
4 97 Lack of common way to talk about impact investing
5 87 Lack of innovative deal/fund structures to accommodate investors’ or portfolio companies’ needs
6 76 Lack of research and data on products and performance
7 67 Inadequate impact measurement practice
8 57 Lack of investment professionals with relevant skill sets
Source: GIIN, J.P. Morgan. See scoring methodology in the Methodological and Analytical Notes section on page 3.
When evaluating potential government policies, respondents indicated that themost useful policies would be those that improve the risk/return profiles ofinvestments, either through credit enhancement or tax credits or subsidies.
About two-thirds of respondents perceived the market for impact investments tobe at least somewhat competitive, with most citing a limited number of investableventures or scalable business models as the chief source of competition.
At the same time, nearly 9 out of 10 respondents indicated that co-investors areeither important or critical to their investment decisions.
Indeed, referrals from co-investors or portfolio companies were identified as themost effective sources of identifying potential deals.
Performance and exits
Survey participants reported that their portfolios are performing mostly in linewith both their impact expectations and financial return expectations (Figure 8).
Twenty-seven percent of respondents reported outperformance against theirimpact expectations and 14% reported outperformance against their financialreturn expectations. Conversely, only 2% reported underperformance on impact,while 9% reported financial underperformance relative to expectations.
Figure 8: Performance relative to expectationsNumber of respondents is shown under
each category; some respondents chose
“not sure” and their responses are not
considered here.
Source: GIIN, J.P. Morgan.
27%14%
71%
78%
2% 9%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Impact expectations Financial expectations
Outperforming In line Underperforming
n=139 n=139
37
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Private equity impact investors reported on their most recent exits, totaling 77exits in our sample, 61 of which happened since 2012. Seventeen exits were inMicrofinance, and nine each in Financial services (excluding microfinance),Healthcare and Food & Agriculture (Figure 9).
Twenty-one of these exits were in South Asia, while 11 each were in SSA andWNS Europe.
The majority of these exits took place by selling either to a strategic or financialbuyer, and most exits took place more than five years after investment.
In order to mitigate exit risk, over 50% of private equity investors include “tagalong” and “drag along” clauses in their investment terms.
Risk and loss protection
"Business model execution & management risk" once again emerged as thelargest contributor of risk to respondent portfolios, as shown in Table 5.
Table 5: Contributors of risk to impact investment portfolios
n=146
Rank Score
1 288 Business model execution & management risk2 132 Liquidity & exit risk3 115 Country & currency risk4 106 Market demand & competition risk5 98 Financing risk6 91 Macroeconomic risk7 34 Perception & reputational risk
Source: GIIN, J.P. Morgan.
In order to manage downside risk, 34% of respondents participated in atransaction with a loss protection feature, such as a first-loss reserve or aguarantee, over the last year.
However, the majority of respondents see loss protection as something that’seither a “nice to have” or necessary only in certain cases, but not critical tomaking impact investments.
The risk of mission drift at exit is important to impact investors, with 61% takingmeasures to mitigate this risk, either by selecting an investee in whose missionimpact is embedded and/or by selecting an acquirer that will protect the mission.
Impact performance management
Ninety-nine percent of respondents measure the social/environmentalperformance of their investments, through a range of standardized and proprietary metrics and frameworks, with the majority aligning with IRIS.
Most respondents seek to achieve impact by investing in organizations that eithersell products or services that benefit a target population or provide employment totarget populations.
Respondents generally put high importance on measuring outputs and outcomes,while they are less focused on putting a dollar figure on impact.
While the vast majority of respondents track impact performance because it ispart of their mission, nearly two-thirds also believe the business value of suchinformation to be of high importance.
Figure 9: Sample private equity exits by sectorn = 76 exits
FS= Financial services excluding microfinanceICT= Information and communication technologies
Source: GIIN, J.P. Morgan.
1
2
2
2
4
8
9
9
9
13
17
0 5 10 15 20
Manufacturing
Education
Energy
Habitat
conservation
Housing
ICT
FS
Food &
agriculture
Healthcare
Other
Microfinance
38
Global Social FinanceEyes on the Horizon
04 May 2015
Yasemin Saltuk(44-20) [email protected]
Only 20% of respondents have a standalone team for impact measurement; two-thirds rely on their investment teams for this.
About one-third of respondents explicitly target gender equality as an impacttheme, while just over half target environmental conservation as an impact theme.
Technical assistance
Seventy-three percent of respondents provide technical assistance to investees,either in-house and/or through third parties.
The most common use of technical assistance is general management support,followed by assistance with accounting and financial systems, industry-specificskills enhancement and impact measurement.
While most respondents who provide technical assistance do so during theinvestment period, a notable proportion does so pre-investment as well.
The intermediary market
The fund managers that participated in our survey reported having raised USD4.7bn in 2014 and target raising USD 7.1bn in 2015 (Table 6).
Fund managers reported current impact investment assets under management ofUSD 38bn, 32% of which comes from Diversified financial institutions/Banks,19% from Pension funds or Insurance companies and 18% from Developmentfinance institutions.
Table 6: Capital raised for 2014 and targeted for 2015
Raised in 2014 (n=52) Target raise for 2015 (n=65)Mean 90 109Median 22 50Sum 4,702 7,082
Source: GIIN, J.P. Morgan. Note: excluding funds that did not answer or reported “0” for the
calculation of mean and median
Figure 10: Primary investors in terms of percentage of total capitaln = 80; AUM-weighted average; Total AUM = USD 38bn
Source: GIIN, J.P. Morgan.
32%
19%18%
13%
8% 6%
2%1% 1%
Diversified financial institution/Bank
Pension fund or Insurance company
Development finance institution
Family office/HNWI
Retail investor
Foundation
Fund of funds manager
Endowment (excluding foundations)
Other
39
EPICExcellence. Passion. Integrity. Caring.
Lincoln, MA | New York, NYwww.athenacapital.com
Investment Advisory & Management | Estate & Wealth PlanningAdministration & Reporting | External Chief Investment Officer
Athena Capital Advisors is intensely focused on offering exceptional service and customization to meet our clients’ particular needs. As an established wealth manager, our core strength lies in the depth of our due diligence, risk management and portfolio management processes, into which we seam-lessly integrate impact goals for interested clients. For almost a decade, we have been helping individuals, families, and endowments incorporate their values into their investment portfolios.
These are our values. What are yours?
Governance: A Critical Aspect to Impact Investing Success
At Slocum, in our work as a generalist investment consultant, we are helping many of
our clients explore impact investing for the first time. We are also working closely with
clients with longstanding SRI or ESG programs who are looking to expand or deepen the
alignment between their investments and their mission. This organizational movement
can be spurred from various directions. In some cases it is due to a forward thinking
President or Executive Director. In others, it is led by interested staff or board members.
Sometimes, influential donors or student groups provide an external initial push into this
area. Regardless of how impact investing is introduced, it challenges existing decision-
making processes and governance structures.
Conventionally, investments and programmatic work are neatly separated. They have
different staffs and are governed by different board committees. In many institutions,
there is little to no overlap between the activities of these two functions. Impact
investing requires a different paradigm – the goal is to enhance both the investments
and the mission of the organization by building alignment between them. This
objective clearly has its merits, and we see the interest in it growing. In many cases,
however, the push into impact investments is frustrated by governance questions – or it
moves ahead without addressing them, which can cause problems later.
Governance can be a complex and tricky concept, and good governance is often
defined by ‘you know it when you see it.’ Fundamentally, good governance means
that decisions are being made by the right people, at the right time, with the right
information. In the case of impact investing, we believe there are three key decisions:
Should we make mission-
related investments?
•To align our investment process withour mission?
•To convene capital and extend ourinfluence?
•To enhance our brand?
Which investments are
aligned with our mission?
•Are we trying to impact aparticular region or issuearea?
•How do we think abouttrade-offs between differentimpacts?
What tradeoffs should we be
willing to make?
•Financially?
•In managertenure/AUM?
•In staff time?
41
Should We Make Mission-Related Investments?
There are several different ‘reasons’ that an organization can have for embarking on a
mission-related investment program – and many times, more than one are at play. For
some institutions, there is a driving belief that the mission of the institution should be
expressed in all of the choices that the institution makes, not simply in the grantmaking
portfolio. Other institutions believe that there is philanthropic benefit to applying a
profit-driven model to social or environmental problems; it can convene capital and
catalyze sustainable solutions. And for some groups, moving into impact investing can
be a critical component of their brand positioning.
In all cases, the decision to move into mission-related investments should have the
support of the board.
Why Are We Moving into Mission-Related Investments?
Which Investments are Aligned with Our Mission?
Except for different tax considerations, financial returns are universal. An investment
that returns 8%, returns 8% for everyone. Impact investments, on the other hand, are far
from one size fits all. On more controversial issues, investors may even have opposite
perspectives on what constitutes positive impact. Before making mission-related
investments, organizations must have a cohesive, shared vision of how their mission
objectives can be achieved through investments. This requires a clear definition of the
mission from the board, as well as a broad sense of the investment opportunity set,
based on input from investment committees, staff and consultants. Organizations
should define their impact investment activities by issue area and by geographic focus.
Economic development investments are very different if the mission is focused on
Detroit or in Africa.
To align our investment process with our mission
•Program staff andcommittees should beinvolved, alongsideinvestment staff andcommittees, in definingwhich opportunities bestfit the institution
•As much of theinvestable funds aspracticable, withoutsubjecting the institutionto undue financial risk,should be invested inaligment with the mission
To convene capital and extend our influence
•Investment opportunitiesshould be clearlydirected to specific issueareas and problems -and in many cases,investment opportunitiesmay flow out of existinggrantmaking work
•Partnerships with for-profit entitites and astrong communicationplan can enhanceimpact
To enhance our brand
•Strong communication iscritical
•Determining which areasto invest in should be aboard driven process, soas to align investmentswith the strategic goalsof the institution. Specificinvestments should thenbe vetted by investmentcommittees and staff
42
In many cases, specific investment opportunities can create tradeoffs between
different areas of impact. Increased employment can come at the expense of the
environment. Environmental improvements can come at the expense of economic
development. These tradeoffs are not always present, and investors can often help
managers think of creative ways to address them. But organizations should have a
view on how they want to address these tradeoffs, based on the goals and resources of
the organization.
What Tradeoffs Should We Be Willing to Make?
Impact investments have long been tagged as a tradeoff – more social return, less
financial return. Many investors are now finding that mission-related investing can be
win-win; they are finding opportunities to have significant impact and strong financial
returns. This isn’t always the case, and many investors have a desire to pursue impact
even if it does create a financial tradeoff.
Even where investment returns are equivalent, impact investments can pose additional
risks. Many business models in social entrepreneurship are new, creating opportunity,
but also increased uncertainty. Funds and firms in impact investing are often newer
and smaller than conventional asset managers. And impact investing – including
impact evaluation – can create additional administrative work.
Addressing these tradeoffs requires the participation of boards, investment committees,
and staff. Impact investing often means investing in something new – investment
committees are unlikely to take such a risk unless they feel they have the backing of the
board.
Addressing Governance Issues First
The promise of impact investments has many institutions jumping in feet first without
second thought – and has left others scratching their heads, wondering how and
whether to proceed. We strongly advise early consideration of governance issues,
including key questions such as: what decisions need to be made, who should make
them, and what information is needed? Different organizations will find different
governance structures that work for them, but regardless of what structure is ultimately
chosen, impact investing requires a new approach.
Slocum has seasoned experience working through these issues with a variety of
institutional investors since our founding in 1986. We have learned from this firsthand
experience what works well and what does not. Please email [email protected] with
any questions.
43
TOTAL PORTFOL IO ACT IVATION A FRAMEWORK FOR CREAT ING SOC IAL AND ENVIRONMENTAL IMPACT ACROSS
ASSET CLASSES
A paper published by Tides, Trillium Asset Management, and Tellus Institute has developed a novel framework for pursuing social and environmental impact opportunities across asset classes.
The study “Total Portfolio Activation,” by Joshua Humphreys, Ann Solomon and Christi Electris, provides concrete steps to help institutional investors begin working toward a fuller activation of their portfolio to advance their mission.
The basic insight that drives Total Portfolio Activation is that every investment across every asset class has social and environmental impacts—positive and negative. The paper provides both a framework and a set of analytical tools to help mission-‐driven investors understand the specific impact opportunity set that can be pursued.
In addition to wide-‐ranging research on the burgeoning field of sustainable, responsible, and impact investing, the authors relied on the advice and examples of numerous investors, investment officers, and fund managers who agreed to speak about their efforts to pursue investment impact, whether across their portfolios or within asset classes. With case studies of The Oneida Trust, Equity Foundation and Dominican Sisters of Hope among others, the report provides specific examples of investors who have begun to activate increasing allocations of their portfolios for deeper social and environmental impact.
Total Portfolio Activation outlines four related areas of activity where opportunities for impact can be readily seized within each asset class and ten key steps that investors can take in order to implement the Total Portfolio Activation framework.
Download the full report, Total Portfolio Activation: A Framework for Creating Social and Environmental Impact across Asset Classes http://croataninstitute.org/publications/publication/total-‐portfolio-‐activation-‐2012
The following is an excerpt from the paper:
nterest in investment that pursues social and environmental impact has exploded in recent years. Although opportunities for impact investing
have emerged across asset classes, most impact-‐investment activity has remained largely confined to a
I
44
limited array of private investments, touching only a small percentage of investor portfolios.1
For organizations and individuals seeking greater impact and better alignment between their investment activities and their mission or values, there remains a pressing need for tools to help investors identify and seize opportunities to activate more of their assets for social and environmental benefit.
To help fill this gap, this paper introduces a simple conceptual framework: Total Portfolio Activation.
“Total Portfolio Activation” is a framework for conceptualizing social and environmental impact investment not as an asset class, but rather as an approach to be pursued across all asset classes in a diversified portfolio. At a time when most "impact investment" has seemingly been confined to private equity and private debt investments, the basic insight that drives Total Portfolio Activation (TPA) is that every investment across every asset class has potential social and environmental impacts – both positive and negative. However, we lack a coherent framework for evaluating the opportunity for impact across all holdings in a diversified portfolio.
Specifically, the paper identifies four related areas of activity where opportunities for impact can be readily seized within each asset class in order to increase an investor’s potential for social or environmental impact:
1. Investment selection – incorporatingenvironmental, social or governance (ESG) issues and impact into investment review, decision-‐making and performance analysis. Investors will have specific criteria related to environmental or social issue areas or targeted geographies around which they structure their investment selection process and then monitor their impact.
2. Active ownership – exercising the stewardshiprights and responsibilities, voice and votes, that often accompany owning an asset. Investing in assets can often open opportunities to engage in activities as an owner, whether directly or indirectly.
1 Yasemin Saltuk, Amit Bouri, and Giselle Leung, “Insight into the Impact Investment Market,” J. P. Morgan and the GIIN, December 2011.
3. Networks – joining wider groups and coalitions ofstakeholders around common environmental and social issues of concern, in order to leverage collective power to generate greater impact than any single investor could on its own.
4. Policy – engaging in public-‐policy activities as aninvestor in order to tap government resources and incentives or encourage regulatory oversight and intervention in support of impact objectives. Policy activity acknowledges the potential role government support, regulation and intervention can play in the investment process to encourage positive social and environmental outcomes.
Each activity area can be applied within each asset class, and increasing portfolio activation can have significant leveraging effects on an investors’ potential impact. At the same time, the relative importance of each activity for increasing potential impact will vary within each asset class and depend on the investor’s specific social or environmental concerns or goals. The process of selecting an investment because of its impact attributes is key for every asset class, but we
45
have also found meaningful opportunities to increase the potential for impact in the other activity areas as well: by taking more active ownership of assets, joining with other stakeholders in networks of common concern, and using policy tools and strategies.
Specific asset classes are also better suited for generating particular kinds of impact, so investors with targeted issue areas of concern will need to place greater stress on the activities and investments that align with their impact objectives. Cash and fixed-‐income investments in community development financial institutions, for example, are particularly useful ways to support affordable housing in targeted, low-‐income geographies. Active ownership initiatives, by contrast, appear particularly germane to investments in public and private equity and real assets, though they take very different forms in each asset class, ranging from high-‐impact shareholder engagement with publicly traded companies, to directly influencing companies through a board seat in private equity, to sustainably managing timberlands in real assets.
Ultimately, each investor will need to assess the primary social and environmental issue areas that are core to its mission and then evaluate the activities within each asset class that are most appropriate for increasing its potential for impact in those areas. The framework of Total Portfolio Activation provides a clear process for identifying what we term an investor’s “impact opportunity set,” by assessing the impact activities and investment opportunities within each asset class of its portfolio that are most relevant to increasing potential social or environmental impact.
IMPACT OF EQUITY ENGAGEMENT (IE2):
EVALUATING THE IMPACT OF PUBLIC EQUITY INVESTING IN TOTAL PORTFOLIO ACTIVATION
Since the report’s release, increasing numbers of investors have been grappling with the place of public equity investments within impact investing. Given that public equity investments continue to constitute a substantial allocation of most diversified investment portfolios, the potential for increasing the positive impact attributes of public equity investments presents a major opportunity for the impact investing space.
At the same time, a growing group of investors have committed to becoming active owners of their assets and to engaging corporations on environmental, social and governance issues through networks such as the UN-‐backed Principles for Responsible Investment. Yet the impact of these engagement activities remains poorly understood.
A new multi-‐stakeholder initiative, known as the Impact of Equity Engagement (IE2), is exploring these issues and developing a new more robust, standardized framework for tracking and reporting engagement activities in order to document investor’s impact through engaged listed equity investments. Coordinated by Croatan Institute, a new sustainability research center, IE2 is being sponsored by the original lead sponsors of Total Portfolio Activation, Tides and Trillium Asset Management, with a wider group of engaged investors, including Calvert Investments, Boston Common Asset Management, NorthStart Asset Management, Inc., and Walden Asset Management.
Croatan Institute is also exploring other opportunities to deepen TPA in other asset classes, such as cash, fixed income, private equity and real property.
For more information, or to get involved in these initiatives, please email Joshua Humphreys [email protected] .
46
Impact Investing: A Primer for Family Offices 1p g y
Impact Investing: A Primer for Family Offices
December 2014
A report by the World Economic Forum
47
Impact Investing: A Primer for Family Offices
Contents Preface
Impact investing has become a popular topic of discussion, not only with
the mainstream media but also with mainstream investors. Yet while impact
investing has entered the mainstream mindset, many investors with the
enthusiasm and means to engage meaningfully in impact investing lack the
informational resources to do so. For most investors today, impact investing still
needs to be translated from a compelling concept into a sound strategy. This
situation is especially true for family offices.
Family offices can and likely will play a unique and important role in bringing
scale to the impact investing sector in the coming years. The reasons for this,
further detailed in this publication, include their desire to align family values with
investment decisions, the autonomy with which they can make decisions on the
deployment of capital and the overall volume of assets under management held
by family offices.
Impact Investing – an investment approach intentionally seeking to create
both financial returns and positive social impact that is actively measured –
has been lauded as an innovative investment strategy with the potential to
reconcile key structural shortcomings in traditional financial markets. Moreover,
with exogenous trends such as population growth, rising inequality, climate
change and resource scarcity gradually affecting investment markets, impact
investing offers a progressive approach to mitigating risk. While impact investing
continues to gain momentum, the sector remains small in the context of global
assets under management and faces systemic challenges, such as lack of
standardized metrics for social impact and the long investment horizons often
needed to prove the model.
Over the past few years, the World Economic Forum has conducted extensive
research on the opportunities and challenges of impact investing – first with
an objective assessment of the sector as well as the challenges holding the
sector back,1 second through curating, synthesizing and disseminating the
best practices of impact investing practitioners,2 and third through offering
customizable roadmaps with which institutional and private investors can define
a competitive strategy for impact investing.3
One of the most important insights we have gleaned is that while investors chose
to enter the impact investing sector for a variety of reasons, successful impact
investors are clear upfront about their intended impact as well as the metrics
they will use to measure it. Moreover, as it is an investment strategy and not
a rigidly defined asset class, impact investments vary widely not only in their
impact profile, but also in how the opportunity is sourced, selected and managed
for success. Investors’ motivations, operational contexts and goals for impact
investing are also highly diverse – there is no model that fits every investor. As
such, there is no science to being an impact investor; it is more of an art. With this
in mind, the location for this report launch is apt – during Miami Art Basel (and
at the World Economic Forum’s convening of next generation of wealth holders).
The goal of this report is to help family offices ask the right questions as they
contemplate their path into impact investing. It is important to recognize that
impact investing may not suit all investors. There will be family offices which
conclude impact investing is not appropriate at this stage for them.
While we are passionate about the potential of impact investing, we acknowledge
the best future for the sector is where each investor can make informed choices
about their own best interest. Each investor and investment institution needs to
evaluate if impact investing fits with its needs, interests and unique context.
It is with that in mind that we offer this report as a resource and tool that family
offices can use to begin the conversations internally, to craft and design their
own engagement strategy on impact investing with family members, advisers
and potential investees, as well as to ensure that not only is their wealth growing
in value, but also that their wealth can reflect their values.
We look forward to hearing about your interest in impact investing. Please share
your experiences and feedback with us at [email protected].
3 Preface
5 Introduction
7 Impact Investing in Theory and Practice
7 Definitional Breadth and
Investment Opportunities
9 Impact Investing
within the Context
of Sustainable and
Responsible Investing
10 Charting the Course for Your Family Office into Impact Investing
11 Step 1: Define Vision
12 Step 2: Determine
Engagement Strategy
15 Step 3: Develop
Investment Guidelines
15 Step 4: Execute
Investment Strategy
19 Step 5: Evaluate
Portfolio and Adjust
Investment Strategy
20 Conclusion: Unique Positioning of Family Offices to Grow the Impact Investing Sector
21 Appendices
21 Appendix A: Potential
Approaches to
Structuring Impact
Investing Strategy
23 Appendix B: Resources
to Engage in Impact
Investing
26 Appendix C: Examples of
Investment Opportunities
across Asset Classes
27 Endnotes
29 Acknowledgements
Michael Drexler
Senior Director
Head of Investors
Industries
World Economic
Forum USA
Abigail Noble
Associate Director
Head of Impact
Investing Initiatives
World Economic
Forum USA
48
Impact Investing: A Primer for Family Offices
Introduction
Impact investing4 is an investing approach that intentionally seeks
to create both financial return as well as positive social and/or
environmental impacts that are actively measured. In the past
year, impact investing has received increased attention within
mainstream audiences, including the G8 Social Impact Investing
Taskforce, Pope Francis and the World Economic Forum.
Despite the “buzz” surrounding impact investing, with an estimated
$50 billion of assets under management,5 the sector remains a
small proportion of the estimated $13.5 trillion of global funds
invested in sustainable and responsible strategies and an even
smaller percentage of tens of trillions in global assets under
management.6
While impact investing is becoming a more frequent topic of
discussion among global leaders, asset owners and asset
managers, few individuals or institutions have the expertise, tools
and understanding of how to put it into practice.
For a more in-depth discussion of the impact investing sector and
trends, download the World Economic Forum report:
From the Margins to the Mainstream – Assessment of the Impact
Investment Sector and Opportunities to Engage Mainstream
Investors.7
Family offices act as responsible stewards of the wealth of high-
net-worth and ultra-high-net-worth individuals, their families and
their heirs. Yet after wealth is generated by one generation of a
family, an estimated 60% lose that wealth by the end of second
generation, and a staggering 90% by the end of third.8 Many
multi-generational family offices are now exploring whether impact
investing is a way to unite families around values and positive
legacies, thereby more closely involving family members in
responsible long-term investing.
Impact investing enables families to be explicit about their
shared values and to reflect them in their investment and wealth
management decisions. In addition, an impact investing strategy
aligned with family values can help to engage a younger generation
in the leadership and management of a family office.
According to a 2013 Financial Times survey, family offices that
are already active in impact investing cite intergenerational wealth
transfer, contribution to sustainable economy, contribution to
community, family values, risk management and succession
planning as top motivations for engaging in impact investing.
On average, family offices allocated 17% of their assets under
management to impact investments with a broad spectrum of
exposure from 1% to 100% for some single family offices in the
US, UK and Switzerland.9
In light of the fact that some family offices are making impact
investments, there are still many more on the sidelines. However,
many investors and thought leaders believe that family offices are
well-positioned and necessary to influence the maturation and
success of the impact investing sector for a number of reasons.
First, family offices have greater discretion and independence in
investment decisions compared to other asset owners that may
be subject to policy regulation (e.g. pension funds, insurance
companies) or that have mandated trusts which limit decision-
making (e.g. large foundations). This means that family offices can
be flexible in their consideration of investments of varied sizes,
geographies and asset classes.
Second, family offices are guided not only by financial
considerations, but also qualitative factors such as their standing
in the community and inter-generational legacy. In many cases,
this makes the discussion about investing for multiple bottom lines
easier to have with family offices than with other asset owners.
Third, family offices can play a role in ecosystem building by
sharing knowledge, serving as role models and even financing
organizations dedicated to sector-building. Estimates show that
single and multi-family offices represent roughly $1.6 trillion in
assets under advisement in North America.10 In short, family offices
can play a catalytic role in the impact investing sector.
While impact investing may not suit all family offices, for those
that choose to become involved, there is a shortage of expertise,
tools and frameworks to enable engagement. As a result,
despite growing interest, many struggle with the initial steps of
engagement. One of the main goals of this primer is to help family
offices interested in impact investing to begin to understand how
they can put it into practice.11
The main target audience for this report is single family offices. It
offers useful frameworks and insights for multi-family offices, family
businesses, family foundations and high-net-worth individuals as
well as policy-makers and advisers. The goal of this primer is to
help interested family offices ask the right questions and take the
first steps as they contemplate their path into impact investing.
Each family office’s motivations, operational contexts and goals
for impact investing are unique – there is no standard course that
fits every family. While this creates a daunting array of potential
engagement opportunities, it also allows for a wide variety of
opportunities to engage in impact investing. Thus, rather than
prescribing a single approach, the primer offers high-level
frameworks and disseminates insights that are the result of
extensive conversations with family offices, family businesses,
family foundations and advisers.
49
Impact Investing: A Primer for Family Offices
Spotlight: Statistics and trends that may affect family offices’ entry into impact investing
Several demographic, business and socio-environmental trends will affect impact investing over the coming decades:
Rising wealth and increased demand from Millennials
• Increased wealth: Over the past 30 years, the wealth within the Forbes top 400 has increased from $125 billion $2.29 trillion
today.12 The number of high-net-worth and ultra-high-net-worth individuals has grown; between 2008 and mid-2014 there
was a 54% rise in the number of millionaires and more than double increase in the number of billionaires.13
• Among the ultra-high-net-worth individuals, a growing percentage are self-made billionaires: The composition among the
ultra-high-net-worth individuals has shifted from predominantly inherited wealth to self-made billionaires.14 Of the 29 people
listed on the Forbes under-40 billionaires list (which represent roughly $119 billion in net wealth), 13 people (slightly less than
half) are self-made billionaires.15
• Wealth transfer from baby boomers to Millennials: Over the next four decades, it is projected that the Millennial generation will
inherit an estimated $41 trillion from the baby boomer generation.16
• When wealth is inherited, the inheritee switches advisers: It is estimated that 98% of the time when the next generation
inherits wealth, he or she switches advisers.17
• Younger wealth holders are more socially and environmentally conscious: According to the 2014 Deloitte Millennial survey,
nearly 30% of Millennials believe the number one priority of business should be to improve society. They believe business can
do more to address society’s challenges of resource scarcity (56%), climate change (55%) and income inequality (49%).18
Nearly 40% of GenX/Y millionaires give more than $30,000 annually to charity versus 6% of the baby boomers.19
Increasing demand from women
• Among the ultra-high-net-worth individuals, a growing percentage are women: Women control almost half of all US estates
valued at more than $5 million.20 Of the $41 trillion in intergenerational wealth transfer over the next four decades, women will
inherit 70%.21 And, 45% of American millionaires are women and by 2030 roughly two-thirds of private wealth in the US will
be held by women.22
• Attitude towards investing among women: Roughly half of affluent women are interested in environmental or socially
responsible investments (compared to one-third of men).23 Social, political or environmental impacts in evaluating investments
were considered “somewhat” or “extremely” important by 65% of women, but only 42% of men.24
• Women making more investment decisions: 75% of female wealth creators say they are the primary decision-makers.25
• Attitude towards investing among female advisers: Female advisers report to be more interested than their male counterparts
in using sustainable investing funds by a margin of 59% to 34%.26
• When wealth is inherited, the inheritee switches advisers: When a spouse inherits wealth, 55% of the time he or she switches
advisers.27 Another study shows that 70% of women fire their financial adviser within one year of being widowed.28
The growth in impact investing opportunities
• Climate change makes environment a business imperative: UNESCO estimates that by 2030 the world will need 30% more
water, 40% more energy and 50% more food.29 The cost of climate change-related impacts on the environment, health and
food security could exceed $4 trillion by 2030. Climate change policy could contribute up to 10% to overall portfolio risk.30
• Rise of LOHAS consumers around the world represents growth sector for investment: Consumers want products reflecting
their values and positively influence society. The LOHAS (Lifestyles of Health and Sustainability) market, roughly $300 billion in
size, has grown over 10% annually since the early 2000s.31
• Government policies creating incentive and opportunities for impact investing: As governments design and implement
policies and programmes to incentivize capital to flow into socially and environmentally impactful programmes, such as
wetlands mitigation credits, the set of opportunities to invest with impact and available instruments increase.32 Such projects
can be attractive to investors based on expectations of market-rate returns and low correlation with other investments.33
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Environmental Stewardship
Workplace Community
To learn more about Rockefeller & Co.: John O’Hara
Senior Advisor and Managing Director212.549.5404 | JO’[email protected]
New York, NY | Boston, MA | Washington, DC | Wilmington, DE | Stamford, CT
Governance Products & Marketing
© 2015 Rockefeller & Co., Inc. All rights reserved. Does not apply to sourced material. Products and services may be provided by various subsidiaries of Rockefeller & Co., Inc.
Human Rights
Rockefeller & Co. relies on six fundamental pillars to evaluate companies for our Sustainability & Impact investment portfolios:
“Sustainability & Impact investing is an approach; it is about being intentional and paying attention. Investors need to select investments with clear intention toward social and environmental goals and follow through with acute attention to the process
that is followed to achieve those goals.” - Farha-Joyce Haboucha
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