Impact Investing Primer
This article briefly introduces Impact Investing but then, in order to appreciate how financial considerations are intertwined with environmental and social aspects, reviews an informative case study in some detail on a successful impact fund. This is a market expanding in scope and depth, providing investors the opportunity to make a global impact, but from which extracting market rate returns requires expertise beyond just competence in financial markets.
A. Impact Investing – Overview
Impact investments are investments made not only for a measurable, positive and sustainable ESG (Environmental, Social and Governance) impact but also to generate a financial return. This contrasts with the conventional position that social and environmental issues should be addressed only by philanthropic donations, whilst market investments should focus exclusively on achieving financial returns. Moreover, the difference should also be noted between impact investing and sustainable investing. Whereas sustainable investing allows investors to ensure they are not investing in companies with a net negative impact, impact investing, on the other hand, aims to make a net positive impact.
Impact capital is helping to address the world’s most pressing challenges in many sectors – healthcare, education, sustainable agriculture, renewable energy, conservation, microfinance, amongst many – and this capital comes from a wide range of investors, both individual and institutional. This includes Fund Managers, Development finance institutions, Diversified financial institutions/banks, Private foundations, Pension funds and insurance companies, Family Offices, Individual investors, NGOs, Religious institutions, who invest through a number of different asset classes that include cash equivalents, fixed income, venture capital, private equity and real assets.
According to a UBS article (Sustainable finance – Ten trends for 2021), 63% of Global family offices have invested in education, 50% in healthcare, 40% in climate change, 30% in economic development & poverty alleviation, 28% in waste Management & recycling.
B. Financial Performance – In GIIN’s 2020 Annual Impact Investor Survey, investors get a range of returns, some intentionally investing for below-market-rate returns, in line with their strategic objectives, whilst others pursue market-rate returns, sometimes required by fiduciary responsibility. Most investors surveyed strive for competitive, market-rate returns.
Source: GIIN Annual Impact Investor Survey
Particularly in the active space of impact investing, again according to UBS, “a 2020 study by Morningstar of more than 700 European sustainable funds showed that over one, three and five and ten years the majority of those funds outperformed non-ESG funds”.
C. Status and Outlook
– Market Size – The GIIN estimates that over 1,720 organizations managed USD 715 billion in impact investing AUM as of the end of 2019.
– Impact investing has grown in depth and sophistication over time
– Impact measurement and management practices have matured, but need refinement.
– Impact investors hold a positive outlook for the future and are optimistic that an international effort currently underway will promote the development of a high-functioning market that supports impact investing with increased scale and efficiency. Growing regulatory pressure is increasingly driving institutional client demand, particularly in the EU.
D. Is it possible to achieve return and impact at large scale?
It is informative to drill down. The remarks below are based on a case-study in the LSE Business Review July 26th 2019, “Impact investing: can funds achieve both social impact and returns at scale?” by Feng Li, Gianandrea Giochetta and Luigi Mosca, which highlights TGIF, a global impact fund, as an exemplar for successful impact investing.
TriLinc Global Impact Fund (“TGIF”), is an impact-investing fund managed by California-based TriLinc Advisors, LLC (TriLinc), ranked 9th in the Global Banking and Finance Review’s top 100 impact companies in 2019.
To quote from the article:
“TGIF has made over $1 billion in loans to 82 businesses in 36 countries since 2013, delivering a consistent unlevered net annual return of 7% to 9% per cent to investors and with a measurable impact using established international standards.”
“As of December 2018, its portfolio companies created over 18,500 jobs, achieved 100 per cent compliance with local environmental, labour, health, safety and business laws, standards and regulations, and all have committed to working towards implementing international environmental and health and safety best practices. Seventy-seven per cent of portfolio companies also demonstrated positive impact on their local communities through services or donations; and 91 per cent implemented environmentally sustainable practices.“
As the article points out, this performance required special leadership skills, professional expertise and an organisational setup to identify and seize suitable opportunities.
TGIF’s achievement reveals the many dimensions of Impact Investing:
– Investing only in fixed income – the largest capital market, bringing a huge potential for scaling up impact investments.
– Employing private, US dollar-denominated short-term notes such as trade finance or term loans, financing to undercapitalized SMEs in selected emerging economies for their expansion projects – a simple yet actionable strategy
– Seeking to generate employment growth and supporting local communities with sustainable growth that can be directly aligned with the business objectives.
– Teaming up with an institutional-class local partner in each country, who has local knowledge and presence on the ground, for opportunity identification, making an investment and monitoring throughout the entire life cycle. TriLinc remains involved in all key decisions and activities.
Returns vs Impact
– Focusing on less efficient emerging markets, with greater arbitrage opportunities.
– Investment strategy – engineered from the ground up to maximize both financial and impact objectives.
– Attributing equal weight to impact and financial considerations – assessing the merits of all deals from both financial and impact perspectives. A loan is only made when both sets of conditions are met.
– Selecting target countries using a proprietary macroeconomic analysis platform that takes into consideration a number of variables, including growth, stability and access.
– Enhanced risk management through ad-hoc structuring and collateralisation.
Impact Measurement & Reporting
– Employing five core impact metrics for every investment – job creation, wage increase, increased revenue, profitability improvement and increased company taxes paid, holding each portfolio company accountable for its own impact objectives through key performance indicators.
– Employing IRIS – the generally accepted impact accounting system that leading impact investors use to measure, manage, and optimize their impact – to track and report impact activities at both the fund and borrower levels.
E. In Summary
The capability to achieve market-rate returns while at the same time making a measurable social or environmental impact challenges the prevailing view that financial criteria alone determine these returns. The evidence in the returns chart, together with the TriLinc case study, suggests that quantifiable, non-financial features can be accommodated without loss of financial performance. However, exploiting this space requires managerial, economic and organizational expertise alongside financial skills and a focus on specific market niches, especially for large-scale projects.
With regard to the future, to quote UBS, a “clear focus on sustainability objectives and tangible impact is what will, in our view, define and differentiate sustainable investing in the coming years. Investor interest, regulatory initiatives and the development of products and measurement tools, as well as broader industry efforts, all point to these areas being in focus going forward. We expect to see increased targeted investment in the areas of climate, resource scarcity, diversity, food and agriculture, and healthcare, among others, as society rebuilds post-pandemic and investors seek return opportunities through solutions to these large-scale challenges”.
MarketCurrents Events will host an Impact Investing Event on March 31st, 11 AM EST. Click here to learn more.