Investment strategy influenced by altruistic intentions – broadly, impact investing – has long held sway in a small number of portfolios. Historically, impact investing has failed to gain significant traction with the fiduciary-minded institutional investors as these investors believed that impact would offset financial returns. Impact investing in recent economic history can be traced back to efforts like the Sullivan principles in the late 1970s and early 1980s and faith-based socially responsible investment. Beyond such investment mandates, impact-oriented activities were principally the domain of foundations’ grant-making arms.
The term itself – impact investing – captures a broad spectrum of investments. At one end reside the more philanthropically oriented mandates that solely focus on impact outcomes versus financial return. At the other end of the spectrum sits a range of investment activities – exclusion approaches (such as Socially Responsible Investing, or SRI, negative screens), integration (where investors evaluate Environmental, Social and Governance factors to reduce risks and improve performance) and lastly, a more appropriately defined “impact investing” (investments designed to generate appropriate risk adjusted financial returns and measurable impact). Even within this last impact investing bucket, one can find different subsectors targeted including environmental sustainability, healthcare, education, and local impact. The transparency provided by private markets focus on fully controlled companies versus shareholder interests via public equities lead many investors to believe that the most concrete and measurable impact can be found in the private markets.
Increasingly, foundations and other institutional investors are seeking to leverage their investment activities to drive impact – while still prioritizing an ability to deliver returns – through a combination of exclusion, integration and impact approaches. Such approaches could provide the ability to amplify an investor’s mission, satisfy constituents, or seize on secular trends while seeking to deliver appropriate risk-adjusted financial returns. This latter point – the fiduciary need for investments to deliver an appropriate risk-adjusted financial return – is an important qualifier as market-rate returns for investments are typically a non-negotiable hurdle for an institutional investor.
The Global Impact Investor Network (GIIN) noted the growth of capital flowing to the space in their Annual Impact Investor Survey 2019 observing that respondents’ impact investing assets rose from $37 billion to $69 billion over just four years, representing over 16% annualized growth. This growth is not limited to the grant-making arms of foundations. In recent years, a growing number of foundations have begun to incorporate impact investments into their endowment’s investment mandate. In 2015, the Kresge Foundation announced it would invest $350 million by 2020 into impact investments – roughly 10% of its capital pool at the time – to “work alongside grantmaking” efforts for its six program areas.
One important subset of impact investing is focused on environmental considerations. This trend toward impact-oriented investment increasingly intersects broader institutional interest in environmental sustainability, driven by concerns around a range of issues including climate change, the food/agriculture/water nexus and broader resource efficiency. In the 2019 GIIN survey, energy combined with food & agriculture accounted for 25% of all impact capital allocations. Equally significant, nearly half of all respondents are targeting energy going forward. Two-thirds of the respondents were principally seeking risk-adjusted, market-rate returns – affirming that investors are frequently targeting both impact and financial return targets.
Additionally, recent data supports that these impact investors are generating attractive realized financial returns. In the same survey, investors’ gross median realized private impact return was approximately 17% with an upper decile return of 45%.
The maturation of markets and technologies in sustainable real assets may be contributing to interest in environmental sustainability. For example, global policy makers have sought to establish frameworks to support the dramatic growth of renewables. According to IHS Markit, wind and solar has grown from 4% and 1.3% of total installed global capacity respectively in 2010 to an expected 10% and over 7% by 2018. Such growth has been driven by both policy and the burgeoning economics of these technologies. The cost of production has fallen dramatically – research by Lazard saw the levelized cost of solar power fall by close to 90% in a decade from $359/MWh in 2009 to roughly $40/MWh in 2019. We have seen these market dynamics – falling costs and supportive policy frameworks – translate into investment opportunities in the private markets, from wind project development companies to distributed solar generation operating platforms.
One of the key criteria for impact investments involves the ability to concretely measure one’s impact. The interest in environmental sustainability may also be driven by the volume of concrete measurable metrics versus other impact investing areas. For example, it’s straightforward to measure the reduction of carbon by generating electricity from solar versus coal. The dramatic decline in the cost of that same solar power offers the potential to support market-rate, risk-adjusted returns. Such opportunities are being pursued by a growing number of institutional investors seeking the potential to do good – and do well.