Authors Steven Godeke and Raul Pomares seek to provide an investment strategy that can combine social impact with financial returns.
SocialFunds.com -- Published in November 2009 by Rockefeller Philanthropy Advisors, the monograph Soluti ons for Impact Investors: From Strategy to Implementation asserts that the “sharp dichotomy between profit-maximizing financial investment and ‘give-it-away’ charity is gradually losing its edge.”
Authors Steven Godeke and Raul Pomares choose the term “impact investing” to describe a dual investment goal of producing a socially beneficial impact while seeking an appropriate investment return as well. Although investment strategies among impact investors may differ—the range of strategies can extend from those that seek to optimize financial returns to those that prioritize social or environmental benefits—a “well-considered investment strategy and a rigorous execution process” is essential for success, whatever the investment approach.
Central to the authors’ prescription for a successful impact investing strategy is the development of an impact investing policy. Before such a policy can be developed, however, the impact investor must establish a strategy. The strategy includes an articulation of values, in which the impact investor determines the issues to be targeted, the people or organizations that will implement the strategy, and the impact investor’s tolerance for risk.
The authors provide examples of successful articulation of values in an impact investing strategy by referring to the efforts of three established organizations.
RSF Social Finance is a nonprofit financial services organization with over $130 million in consolidated assets. Its three investment options whose funds support innovative social enterprises in food and Agriculture, education and the arts, and ecological stewardship.
KL Felicitas Foundation maintains an investment strategy that it terms Sustainability, Mission, and Social Investments (SMSI), in which sustainability metrics like workplace, community, and the environment are evaluated. According to the Foundation, its investment strategy seeks “financial returns approximating the average risk adjusted returns of similar investments made without regard to sustainability, mission or social considerations.”
The Calvert Foundation, a nonprofit organization, uses investment capital to make community investment an option for investors seeking to make a positive social impact.
In each of these three cases, the authors write, the organization developed an impact investment mission, chose its partners and advisors, and used this groundwork to apply such tools as asset allocation and portfolio theory to its investment process.
Central to the development of an impact investing policy is asset allocation, in which a portfolio is constructed of investments in different asset categories. The categories include stocks, bonds, and cash, as well as alternative investments. “By diversifying investments across several asset classes,” the authors write, “Investors may reduce risk and volatility while pursuing their return objectives.”
Asset allocation can be as diverse for the impact investor as it is for mainstream investors. In an example provided by the author, the environmental impact of investing in public equities can be tempered somewhat by the fact that most large companies maintain multiple business lines. Some groups within a corporation contribute more to greenhouse gas (GHG) emissions than others, and while investment in large companies may reduce risk, doing so could also reduce the effectiveness of the environmental impact sought by the investor.
On the other hand, investment in clean tech venture capital offers the opportunity for much greater purity of expression of an investment theme, but exposes the investor to the far greater risk associated with investment in illiquid and/or early stage companies.
For the most conservative investor who considers even public equity exposure to constitute too great a risk, appropriate options for addressing climate change may be green bonds, or cash deposits in green banks.
In any case, the authors state, opportunities for impact investing throughout all asset classes have grown in recent years, and can be expected to continue to do so.
In addition to asset allocation strategies, components of an effective investment policy statement should include a statement of purpose, the roles of those responsible for impact assessment—especially if, according to the authors, “external resources will be utilized in generating deal flow, due diligence, portfolio recommendations and reporting”—and documentation of performance benchmarks.
Once an impact investing strategy has been designed, the investor then implements and maintains an investment strategy. As with asset allocation, the authors see the generation of deal flow as an evolving process in which new “offerings to harness the scale and power of capital markets to deliver solutions to the social and environmental challenges faced by society” are being developed.
Following the generation of deal flow, the due diligence process addresses the impact risks of potential investments, as well as the mitigation of those risks. Important considerations include the mission-alignment of management and the governance structure of the fund or company in which investment is contemplated.
Finally, relevant impact assessment systems that can be compared to other investors’ performance should be created, because at present investors have too little data with which to assess and compare the non-financial performance of funds and companies.
In conclusion, the authors state, “Impact investing is not charity. It requires and demands every bit of the same disciplined approach currently being applied to traditional investing if it is to succeed.” Whether the intent of the investor leans toward financial returns or social impact, better standards of investment management best practice must be developed.
That said, opportunities for impact investing are growing in all asset classes. “Impact investing,” the authors write, “For all its challenges, may ultimately prove to be the most prudent form of investing.”