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Impact Investing - A Market Matures

January 6, 2020  | by Daniel H. Connell, Ethan Levine

Investment Strategy | Market Commentary | Responsible Investing

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.

Authors

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Dan Connell is a member of the Real Assets and Sustainability team for Commonfund Capital.  Prior to joining Commonfund Capital, he worked as a principal investor on energy infrastructure with GE Capital’s Energy Financial Services, where he focused on both project finance debt and international equity.  Before his time with GE Capital, Dan worked in commercial development for Atlantic Power and served as an Intelligence Officer in the US Navy. He has a B.A. from Seton Hall University, an M.P.A. from Harvard’s Kennedy School of Government and an M.B.A. from MIT’s Sloan School of Management.
Daniel H. Connell
Director
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Ethan Levine is co-Head of Real Assets and Sustainability and a member of the Investment Committee of Commonfund Capital. His primary responsibilities include due diligence, manager selection and portfolio construction for the firm’s natural resources programs while also contributing to venture capital, private equity and distressed capital programs. Ethan originally joined Commonfund Capital in 2007 as a Senior Analyst in the Commonfund Capital Rotational Program. Prior to Commonfund Capital, Ethan specialized in energy markets at Charles River Associates, an economic and litigation consulting firm in Boston, MA. At Charles River Associates, he advised power and utility clients with their damages litigation, regulatory approval and business strategy forecasting. While at business school, Ethan also worked at Rockland Capital, a private equity firm, where he conducted due diligence on potential power generation asset acquisitions and helped manage existing portfolio investments. Ethan is a member of the advisory boards of several private capital limited partnerships. He is a member and prior chairperson of the Dartmouth College Hillel Board of Overseers. Ethan received a B.A., B.E. and an M.E.M. from Dartmouth College and an M.B.A. from the University of Chicago Booth School of Business.
Ethan J. Levine
Managing Director
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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.