I recently spoke on a panel about impact investing at the UNC Cleantech Summit, where 1,000 good souls joined to talk about opportunities and challenges in smart and connected communities, energy storage, grid modernization, sustainable farming, coastal resiliency, and energy innovation for economic development.
Fellow panelists included these smart folks:
- Tom Darden — Founder and CEO of Cherokee, an environmental private equity and angel investment firm that has raised $2B and invested in 500+ properties and 150+ companies
- David Kirkpatric — Managing Director and Co-Founder of SJF Ventures, one of the earliest and most well known impact investment firms that has raised $260M
- Josh Humphreys — President and Senior Fellow at the Croatan Institute, an independent, nonprofit research institute whose mission is to harness the power of investment for social good and ecological resilience by working at the critical nexus where sustainability, finance, and economic development intersect
- Pavel Molchanov — Senior Vice President and Equity Research Analyst at Raymond James & Associates
To begin our panel, we talked about the definition of impact investing.
If you can’t describe something, it’s hard to assess where it’s been, where it’s going, who’s involved, what the challenges are, what opportunities are most exciting, and…
[drum roll, please]
...whether impact investing delivers financial returns that are less than, equal to, or greater than other comparable investments in the market.
Starting from the broadest definitions and moving to the narrowest, here we go…
Impact investing = “Total portfolio approach”
This framing moves away from the magnetism of venture capital and instead points to the obvious: Every investment has some impact.
Accordingly, all bonds, stock, checking accounts, and savings accounts need at least a cursory review for positive and negative impacts, as well as other alternative investment classes such as hedge funds, real estate, infrastructure, and private equity.
In ImpactAlpha, William McCalpin, managing partner of Athena Capital Advisors, with $5.5B under management, put it this way: “Carving out $10M to do a few impact deals is no longer enough for many investors. Institutions want to drive this through their whole portfolio.”
To that end, the impact investment non-profit TONIIC has created its 100% Network, a “global network of high net worth, family office and foundation asset owners who have committed to deploying 100% of their investments in at least one portfolio in pursuit of deeper positive net impact. These investments are made across all asset classes, in alignment with each investor’s social and environmental priorities.” This initiative provides tools, lessons learned, and a community to share best practices.
Total market size:
- $200T (per TPG)
- 100% of all assets globally
Impact investing = “SRI (Socially Responsible Investing)”
Many of us associate SRI with negative screens — that is, public equity investments that screen against (and don’t invest in) “sin industries,” such as firearms, tobacco, gambling, and alcohol. (Though the latter, in moderation, is hopefully not a big sin, lest I need to repenteth.)
This approach to investing goes way back, like hundreds of years, like ancient history, like Biblical times, man. (Insert surfer voice.)
Investopedia will take you back in time to illustrate that SRI is not some newfangled innovation from know-nothing “hippie capitalists” (a term coined by my MBA friends years ago).
Centuries-old SRI includes Jewish law, from about 3,000 years ago in the Pentateuch (first five books of the Bible); Shariah law, from about 1,400 years ago in the Quran; and Methodists’ and Quakers’ beliefs and practices, from about 200 and 100 years ago, respectively, in the U.S.
Despite, or perhaps because of, this rich history, SRI has become an umbrella for many related themes of investor interest, including ““community investing,” “ethical investing,” “green investing,” “impact investing,” “mission-related investing,” “responsible investing,” “socially responsible investing,” “sustainable investing,” and “values-based investing,” per US SIF: The Forum for Sustainable and Responsible Investment.
Total market size:
- $23T (per JPMorgan)
- 11.5% of all assets globally
Impact investing = “ESG (Environment, Social, Governance), aka Responsible Investing”
SRI was version 1.0 of investing for financial and social or environmental motivations, while ESG is supposed to be version 2.0.
However, these two terms are still used somewhat interchangeably in many circles.
For me, ESG is about an active approach and a positive screening process to not just do less bad (e.g., sin industries) in a passive style as in SRI. This includes seeking out companies that excel in the management of social, environmental, or governance issues. The goal is to reduce risk (beta) and increase profit vs. benchmarks (alpha).
The United Nations Principles for Responsible Investment (PRI) may be the most popular group for defining ESG. (So, if you want to be one of the cool kids, you better, like, join now. I mean, totally.)
UN PRI counts 1,900+ signatories from the finance sector, representing over $89T in AUM. Before you get excited thinking that about 50% of the world’s assets are invested according to ESG principles, hold those horses.
These signatories apply ESG practices selectively, not across their entire portfolio.
However, according to the principles to which they publicly commit (see below), the plan is for an evolution to a more all-encompassing approach to Responsible Investing.
UN PRI -- Signatories’ Commitment
“As institutional investors, we have a duty to act in the best long-term interests of our beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate governance (ESG) issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, asset classes and through time).
We also recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to the following:
- Principle 1: We will incorporate ESG issues into investment analysis and decision-making processes.
- Principle 2: We will be active owners and incorporate ESG issues into our ownership policies and practices.
- Principle 3: We will seek appropriate disclosure on ESG issues by the entities in which we invest.
- Principle 4: We will promote acceptance and implementation of the Principles within the investment industry.
- Principle 5: We will work together to enhance our effectiveness in implementing the Principles.
- Principle 6: We will each report on our activities and progress towards implementing the Principles.
The Principles for Responsible Investment were developed by an international group of institutional investors reflecting the increasing relevance of environmental, social and corporate governance issues to investment practices. The process was convened by the United Nations Secretary-General.
In signing the Principles, we as investors publicly commit to adopt and implement them, where consistent with our fiduciary responsibilities. We also commit to evaluate the effectiveness and improve the content of the Principles over time. We believe this will improve our ability to meet commitments to beneficiaries as well as better align our investment activities with the broader interests of society.
We encourage other investors to adopt the Principles.”
To learn more about the segments within ESG and SRI, you can view some great graphics and summary PDFs by by US SIF.
Total market size:
- Unclear due to ambiguities in market definitions for SRI vs. ESG
- Unknown percentage of all assets globally, but growing quickly
Impact investing = “Measurable social or environmental impact alongside financial returns”
For this definition, I’ll reference a leading impact investing sector non-profit association, the Global Impact Investor Network, GIIN.
[And if you’re remembering my prior reference to another impact investing industry association, TONIIC, and asking yourself whether investors in this sector actually do love “sin” industries like alcohol (gin + tonic), the answer is...I don’t know. But the more interesting question is this: Does the impact community have a stronger sense of humor relative to other financial sectors?]
In their annual survey of impact investors (n = 229), they report a 13% increase year-over-year in impact investments globally, with total assets under management at about $228B.
Here is a summary of the most popular sectors as determined by the percentage of impact investors investing in each:
- 57% food and agriculture
- 49% healthcare
- 48% energy
- 45% financial services
- 45% housing
- 41% education
GIIN stresses that impact investments should have intentionality (i.e., positive outcomes cannot be accidental) and should require impact measurement (e.g., show me your KPIs).
Now, I love metrics as much as the next guy or gal steeped in finance and science. However, as I experienced when I was co-leading sustainability at a $2B private equity fund, measuring social or environmental impacts is tricky.
To that end, Andrew Beebe, Managing Director of Obvious Ventures — a VC firm “on a mission to help fuel startups that combine profit and purpose,” aka, #worldpositive companies — had this to say about metrics.
[Note: This may be the longest quotation I’ve every used in an article, but bear with me. It’s worth it.]
“We don't require hard metrics in sustainability or impact from our portfolio company for specific reasons. First, it's super hard. When you ask a vegan cheese company, "Please tell us your positive impact each month," how do you figure that out? Is it how many cows didn't have to get milked? Is it how much methane from each cow that didn't get produced? But then, of course, you'd have to offset that with the emissions from your delivery trucks. It's just too hard. That's the practical reason, but there's also a strategic reason: Companies will pivot. And when they change, you have to rejigger all of those impact measures. What we do is simply ask the question, is this company likely — regardless of pivot and because of the value of its leadership — going to continue to have a positive impact on the future of humanity? On the human potential? After that point, our decisions are economically driven.” (Source: Greenbiz)
As for whether impact investors are seeing real impacts from their allocations, 97% of the GIIN respondents report that they are meeting or exceeding their impact goals.
As further validation of this type of measurable impact investing, TPG, one of the world’s largest private equity firms with over $100B in AUM, launched its Rise Fund in 2016 with $2B in AUM. That’s serious amount of capital from a very serious investor, who has no interest in below-market returns.
Combining their deep investment experience with partners champions like U2’s Bono, impact investment experts like Elevar Equity, and nonprofit strategy advisor Bridgewater Group, fundraising has been fairly easy. In fact, they are now raising a second fund targeting $3.5B.
The Rise Fund website provides more detail on the opportunity, the societal need, and their rigorous approach to impact measurement:
“It will take more than $2.5 trillion per year to meet the United Nation’s Sustainable Development Goals...We have defined 30 key outcome areas, aligned with the United Nations Sustainable Development Goals, in which impact is both achievable and measurable through evidenced-based, quantifiable assessment. For each potential investment, we calculate an Impact Multiple of Money (IMM)™, part of our proprietary assessment methodology that allows us to estimate a company’s potential for positive impact.”
Total market size:
- $228B+ (per GIIN)
- 0.12% of all assets globally
Impact investing = “Filling a gap”
Finally, some industry professionals restrict the impact sector to investment opportunities that are thought to be unfinanceable — that is, ones that mainstream investors will not, or supposedly, cannot touch due to fiduciary duty, the responsibility to put financial returns above all else.
The problem with this definition is that the boundaries of what investors consider attractive, or not, is always changing.
Consider off-grid funding for small solar energy solutions.
The size of the need (only recently deemed a “market opportunity”) is immense: According to the International Energy Agency, roughly 1 billion people globally lack access to electricity.
I’ve been on the ground in Ethiopia and India doing work d.light and Greenlight Planet, two global leaders in this field, and I’ve seen how life-changing these microsolar products can be.
Five years ago, most investors would have viewed this field as being all about charity, led by foundations and government aid organizations.
However, today we see investments commitments such as these:
- Investment in Off-Grid Energy Access Totals $1.7B Through 2018 (Wood Mackenzie)
- Acumen Closes $70M Impact Fund for Clean Energy in Africa (Bloomberg)
- Engie Leads $20M Investment in Off-Grid Solar Startup Bboxx (Greentech Media)
- Off Grid Electric announces $45 million debt financing for distributed solar leasing to Africa (Solar Power World)
The other problem is that this definition severely restricts the size of the market. So, as a proponent of the sector, I don’t like it.
But if I put my cheerleading pom poms down for a second, constraining the market size also means that mainstream investors might miss out on emerging sectors, demographic, and geographies that represent new ways to place capital and generate attractive financial, environmental, and social returns in parallel.
Luckily, this is the least common definition of impact investing.
Total market size:
- Teeny tiny (that’s a technical term, so you might want to look it up)
- Far less than 0.12% of all assets globally
Financial Returns: Below or Above Market?
Ah, the most critical question and the most misunderstood: “Does impact investing require concessionary returns, a financial sacrifice in order to do the right thing?”
One of the most authoritative studies on the topic was conducted by Deutsche Asset Management and the University of Hamburg in 2016. They reviewed 2,200 reports to assess the linkage between ESG excellence and the financial performance of companies.
- About 90% of the studies showed a non-negative correlation
- Roughly 60% of the studies showed a positive correlation
For another perspective, we can look at the responses from impact investors in the 2018 GIIN report.
Here were their conclusions:
- 64% are seeking market-rate returns
- 91% report that their investments are meeting or exceeding their financial goals
Going one step further than the mainstream might be ready for, as he does so well, Al Gore is championing a new initiative called the Fiduciary Duty in the 21st Century Progamme.
Led by the UN Environment Program Finance Initiative (UNEP FI), UN PRI, and Generation Investment Foundation, it flips this discussion on its head.
Instead of seeing impact returns as being at odds with an investor’s fiduciary duty, it notes that “there are positive [fiduciary] duties to integrate environmental, social and governance factors in investment processes.” That is, to ignore ESG consideration may be akin to slacking on one’s duty to achieve the best risk-adjusted returns for investors.
To put some of this into practice, they have created roadmaps for institutional investors that “address fiduciary training, corporate reporting, asset owner interaction with service providers, legal guidance, the development of investment strategies, ESG disclosure and governance structures.”
For more on this topic, you can check out more research aggregated here by US SIF.
Why is this market not growing faster?
Because people too often act like ostriches burying their heads buried in the sand to avoid new impending realities?
(And, by the way, ostriches don’t really do this. You can trust my source: National Geographic Kids. “Ostriches don't bury their heads in the sand—they wouldn't be able to breathe! But they do dig holes in the dirt to use as nests for their eggs. Several times a day, a bird puts her head in the hole and turns the eggs.” OK, Fun Fact Time is now over.)
Below are a few barriers based on the reports referenced above and my own experiences in the sector:
- The belief that impact investing requires a sacrifice in financial returns
- Limited amounts of capital relative to market needs for impact companies to scale
- Lack of investment options across the risk-return spectrum of asset classes
- Misunderstanding of how to define and segment the sector
- Good investment opportunities with sufficient track record
- Too few professionals with the required skills and sector knowledge
- Excess passion for the mission versus hard-core focus on business execution
Impact investing is not going away. Instead, it will become mainstream.
I think it’s going to be like other niche fields that I’ve entered five years ahead of the masses — green real estate, solar power, energy storage — before the billions of dollars began flowing into sectors thought to be purely about mission, solely the purview of “hippie capitalists.”
If you don’t agree, then consider one more trend: An estimated $30T of wealth is expected to be transferred from Baby Boomers to Millennials over the coming decades. And research shows that this younger generation cares more about using their capital to make an impact, not just a profit.
Luckily, both are increasingly possible.