OPINION | The momentum behind the impact investing market is undeniable, despite a number of persisting growing pains.
Impact investments aim to generate measurable, beneficial social or environmental impacts alongside a financial return. Philanthropic investors and development finance institutions have driven growth in this area over the last few years, attracting the attention of global institutional investors.
For institutional investors, however, any impact must be understood in the context of risk and return. There is often a complex but crucial relationship between impact outcomes and financial outcomes, particularly for instruments such as social impact bonds. And not every impact investment offers an appropriate risk-return trade-off, just as not every mainstream investment opportunity is attractive.
As a result, two questions linger in the minds of institutional investors:
- Do impact investments, as a group, have enough homogenous characteristics to form a new asset class?
- Do impact investments offer sufficiently attractive characteristics to earn a place in a diversified portfolio?
Crunching the numbers
In a recent Brightlight Impact Advisory research paper titled “Impact Investing in the Context of a Diversified Portfolio”, we attempted to answer both questions, using empirical data and qualitative review of key characteristics of impact investments. We looked at return drivers, diversification and scale, to see if they meet the definition of an asset class.
That paper was published in the November/December 2016 edition of the Investment Management Consultants Association’s (IMCA’s) Investments & Wealth Monitor magazine. It is still timely to reiterate some of our key findings in relation to return drivers, diversification and scale.
Return drivers: On the one hand, impact investments do often share characteristics such as participation by government (or other not wholly financial stakeholders), exposure to disadvantaged or low-income populations, and the application of capital to solve social and environmental problems that philanthropic capital alone cannot solve. On the other hand, impact investing also carries a high degree of idiosyncratic risk, with inconsistencies in deal structures, deal pipelines, and exit opportunities.
Diversification: Analysis of Christian Super’s portfolio shows impact investments have a low correlation with all other asset classes in the portfolio (more on this below). This makes intuitive sense. Most impact investments take one set of risks (market risk, etc.) and replace it with another set (geopolitical, idiosyncratic, currency, illiquidity, exit).
Scale: The impact investments field has certainly suffered from a lack of scale. Few deals have been of a size that would attract institutional investors. But this has been changing. It may not be big enough yet to accommodate the largest institutional investors, but there is certainly enough to allow for allocations in the hundreds of millions of dollars.
Jury still out
Our conclusion is that the jury is still out on the question of whether this disparate set of assets is homogenous enough to be called an asset class.
A review of Christian Super’s eight-year track record of investment in more than $140 million worth of impact assets was useful in determining impact investments’ ability to add value to a diversified portfolio. The analysis showed that the impact portfolio outperformed its CPI + 4 per cent a year benchmark over the seven-year observation period to December 31, 2016.
The portfolio also showed low correlation (less than 0.2 on the scale from -1.0 to +1.0) with other asset classes. Christian Super’s portfolio, as at the end of 2016, had exposure to eight industry sectors, across more than 20 different countries, comprising 18 funds and direct investments.
There is still a great disparity within the impact investing sector and we expect the sector to continue to have growing pains in the medium term. However, the empirical evidence presented here, and seen globally, indicates it is beginning to warrant further consideration by institutional investors who have both financial and social or environmental objectives.
Tim Macready is the managing director of Christian Super’s Brightlight Impact Advisory, where Simba Marekera is a portfolio manager and head of research.