"The ImpactAssets Handbook for Investors" offers an introductory overview for investors interested in generating financial returns with the creation of social and environmental impact. In addition to discussions of portfolio structure and strategy, the handbook offers an overview of due diligence necessary to assess potential investments, a discussion of communications and performance measurement issues and other factors key to managing capital for multiple returns. While not an “answer book,” "The ImpactAssets Handbook for Investors", with contributions from some of the field’s leading experts in impact investing, offers practical insights and presents critical questions every investor should consider in creating an investment strategy and executing the deployment of investment capital.
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About the Author
Jed Emerson, senior fellow at ImpactAssets, a nonprofit financial services firm, is an internationally recognized author and thought leader within the field of impact investing. He has led, co-founded and served on the board of directors of a variety of impact funds, social enterprises and family office investment committees. Originator of the concept of Blended Value, Emerson is coauthor of Impact Investing: Transforming How We Make Money While Making a Difference (2011), the first book on impact investing (and winner of the 2012 Nautilus Gold Book Award), and The Impact Investor: Lessons in Leadership and Strategy for Collaborative Capitalism (2014).
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Construction of an Impact Portfolio: Total Portfolio Management for Multiple Returns
Jed Emerson and Lindsay Smalling
Despite the growing media coverage of impact investing, and that coverage's increasingly sophisticated character, there continues to exist a widespread misperception that impact investing is a single type of investing and not a broad approach. It is easy for those considering impact investing to conclude it is similar to, say, venture capital investing — direct, volatile, high risk and a strategy available only to high net worth individuals. This perception was underscored when influential organizations initially made the mistake of labeling impact investing as an "emerging asset class," implying that impact cannot be achieved across all asset classes.
While understandable as a "way into" a discussion of how capital may be invested for financial return with the generation of social/ environmental impacts, such an approach initially segregated impact investing within a single category of capital as opposed to laying the foundation for exploring how investors might manage all their assets for impact across an entire portfolio. In point of fact, impact investing is broad and nuanced. One may look at impact investing as both a "sleeve," which is to say as a discrete strategy within a larger portfolio of investments, or as a "lens" through which one looks at an entire portfolio. For the purposes of this chapter, we will operate at a portfolio level and take the "lens" approach. When adopting such a total portfolio perspective, impact investors seek to achieve an appropriate financial return for any given investment instrument, fund or strategy under consideration within their portfolio while simultaneously asking,
What is the best way to think about the nature of impact within this particular investment or asset class?
When one takes this perspective, impact may be pursued across an entire portfolio with appropriate consideration of various risk, impact and financial return objectives for the allocation of philanthropic, near-market and market-rate capital. Developing this understanding of how best to incorporate impact within portfolio construction is especially timely for individual investors interested in taking a more holistic approach to their investment strategy as well as financial advisors who receive growing numbers of client requests to consider the social and environmental impacts of their portfolio as well as structure capital investments to advance positive impact.
Regardless of how much money you may have to invest, and while specific strategies may differ, it is increasingly possible to achieve positive impact across all one's capital investments. And every month sees investment products being brought to market that make impact investments available at lower minimums to a broad cross-section of investors at different levels of wealth. While not yet an "off-the-shelf" approach, impact investing is a growing option for many investors. This chapter is offered as an introductory guide to help investors and advisors construct portfolios that integrate impact appropriately across asset classes. We refer to this practice as Total Portfolio Management. Within such a Total Portfolio Management approach, all capital — philanthropic, near-market and market-rate — is managed to optimize financial performance across asset classes while maximizing the impact potential of each asset class you are invested within.
Emerging Practices of Total Portfolio Management
For financial advisors, engaging with a client in the process of portfolio construction offers an opportunity to understand and strategically respond to that investor's personal financial priorities and objectives. And for individual investors operating without an advisor, the process of exploring and identifying what investment options are available in which asset classes can be one of discovery and real excitement. As your investment objectives evolve to include social and environmental impact, the conversation between investors and advisors must weave considerations of impact throughout the portfolio construction process. Total Portfolio Management is an approach that seeks to optimize diversified financial returns while maximizing impact as appropriate for any given investment asset class. It is not reductive (asking, What do we remove from consideration from the investment universe?) but rather additive (asking, How do we take traditional investment practices and augment them with enhanced analytics and perspective to allow for consideration of both off balance sheet risk and impact investment opportunities?). In this way, when engaging in Total Portfolio Management, the fundamentals of traditional investment management still apply.
As discussed below, it is important to understand that Total Portfolio Management considers the full array of capital being deployed by asset owners: philanthropic, near-market and market-rate. Such an approach acknowledges charitable giving — by providing donors with tax benefits and other considerations — offers financial value while generating social and environmental returns. In this way, asset owners may bring a holistic approach to their consideration of how best to manage all their capital to pursue the full, blended value they seek to create as they manage and deploy their capital resources.
This chapter offers an introductory overview of these ideas and suggests some initial steps investors may take to envision, create and execute an investment approach that integrates financial considerations with social and environmental concerns.
Step One: Establish Goals and Objectives
As every skilled investor knows, the first step in professionally managing assets is to define your core goals and objectives. These typically cover such issues as:
date of future retirement,
potential college or other education expenses, and
wealth preservation for future generations and so on. The next step is to take stock of the unique cash flow needs, risk tolerance and time horizon of the individual asset owner. All of this information is taken into account when engaging in a traditional investment approach or crafting the asset allocation, investment policy statement (IPS) and investment portfolio in a more customized manner.
These factors are considered when developing a traditionally managed portfolio of investments and are equally important for effectively constructing an impact portfolio. However, in addition to standard "financial only" discussions that inform the creation of an investor's profile, the process of creating an impact portfolio also includes simultaneous exploration of the investor's expectations and objectives with regard to the generation of social and environmental impact.
It is important to understand the "right" answer as to what should constitute the impact agenda of any given portfolio differs for each and every investor. For example, one family may be generally interested in making sure they are not invested in "bad" companies while having a broad interest in issues related to women and girls. Another investor may be spending her professional career focused on combating climate change or protecting the environment, and so will most likely not feel comfortable with financial returns generated largely from significant investments in fossil fuel production. And yet another investor may have a deep connection to his community or region and find tremendous value in identifying investment opportunities in regionally specific local food systems or area affordable housing.
Regardless of the ultimate goal and set of investment strategies, exploring your core values and expectations is critical to attaining a broader understanding of your definition of the purpose of your capital in order to create a strategy that best advances toward your goals.
Step Two: The Investment Policy Statement
The Investment Policy Statement (IPS) is a document that outlines the overall vision and goals for the investment strategy. For those working with an investment advisor, the IPS outlines how the client's investments will be managed over the course of a year or more. The reader will find this topic referenced in the following two chapters as well, from the perspective of investment advisors. However, even if you are not working with an advisor, having a single memo outlining your vision, goals and objectives as well as detailing how you want to allocate your investment dollars across various strategies and asset classes is a good document to have. Either way, the IPS serves as a guide star for family members, advisors and, if you have one, your investment committee — even if it consists only of you and your partner or pooch!
While important for all types of investing, for clients seeking to intentionally integrate impact across their entire portfolio the IPS is critical. Ad hoc impact divestment or investment is not a sustainable strategy for impact. The IPS provides a framework for evaluating current holdings, exiting investments that are not consistent with the evolved investment strategy and assessing new investment opportunities. It is the framework to be used in evaluating the total performance of a portfolio that seeks to generate financial returns with social and environmental impact.
Crafting an IPS with consideration of impact can be a challenge for advisors taking their first step into impact investing with a client. Although there is substantial evidence to support the position that impact investments may deliver market-rate returns for any given asset class, many financial advisors and investment committees are resistant to change, mistakenly believing investing with an impact orientation might threaten the fulfillment of their financial fiduciary responsibilities. Since the IPS is the foundational agreement between an advisor and client, explicit goals and practices outlined in the IPS should address investment committee concerns, detailing how any given asset owner defines their fundamental fiduciary obligations.
It should also be understood that the IPS is not a static document but rather a dynamic one that should be revisited annually, with its assumptions reaffirmed or modified based upon any number of factors. Such factors might include significant shifting of the overall market context or evolving investor intent — but should not be revised in efforts to try to "time the market." At the same time, while any changes to the IPS should certainly not be undertaken lightly, the IPS offers "guard rails" to guide and direct investment practice, not "train tracks" to lock in an investment committee regardless of where the train appears to be headed!
It comes as no surprise that various investors will handle the specifics of this investment process differently, but it is in the IPS where investors outline what is referred to as an impact thesis. This will entail drafting of an investor-specific understanding of impact and broadly defining how you view the integration of impact and financial performance. Some investors will feel it important to include several pages of narrative on how they understand the nature of the impact they seek to create through their portfolio while others will simply address it in a few paragraphs or sharply stated sentences. Either way, it is critical the IPS explore this question with enough definition to guide both the individual investor operating on her own, as well as an investment committee and/ or wealth advisor who may be working with individuals with larger portfolios and assisting the asset owner in their decision-making process.
Setting a leading example, The F. B. Heron Foundation wrote their IPS to reflect the "intent to balance the social and financial return on all assets, and to select opportunities for deploying capital, whether as grants or as investments, so as to maximize the combination of both kinds of return within each." You will find their full IPS on their website and other examples may be found in the web pages included in the resources section of this handbook.
Step Three: Asset Allocation
With an understanding of your financial and impact performance objectives, as well as risk tolerance and time horizon, investors should now establish the initial structure of the portfolio; this is done through a process of asset allocation. Since each asset class has its own risk, return and impact profile, investors may customize a portfolio to fit their specific objectives by varying the level of investment in each asset class.
For example, additional risk taken on in private equity may be balanced by a larger fixed-income allocation. There are sophisticated asset allocation strategies used to optimize the classic risk-return trade-off upon which traditional portfolio construction is based, and these strategies may be adapted to include consideration of impact across asset classes. An investor or advisor who seeks to thoughtfully integrate impact within a portfolio will evaluate where impact is redundant, complementary, or catalytic in relation to the ultimate objectives of the investor as needs to be expressed through your portfolio.
When taken together, each of the specific investment allocations contributes to the Total Performance of the portfolio, generating financial and impact returns across various asset classes, including philanthropic. Accordingly, the impact goals sought through any given investment should be appropriate to that investment opportunity just as the financial returns expected of any strategy will differ based on the investment approach of that particular asset class. Said another way, one should not expect microloan impact from a socially responsible mutual fund, just as one does not expect private equity returns from a fixed-income product. In this way, impact and financial returns may differ across individual asset classes within any given portfolio, but you should seek to structure the total portfolio to best manage your capital in a manner that seeks to generate financial and impact returns in alignment with your specific goals.
Manager Search, Due Diligence and Selection
After the asset allocation is established, the process of you and your advisor researching managers, conducting due diligence on those managers and selecting possible investments for consideration may begin. Chapter Seven of this handbook explores various aspects of due diligence in greater detail, but for now you should know a good starting place for your research are the socially responsible and impact investing communities that have compiled resources for identifying investment products with social and environmental criteria. Refer to our appendix sections for more on this information.
As with all other investment products, specific diligence requirements differ with asset class or deal structure. However, it is always important to take a close look at the background and experience of the people managing the investments, the philosophy behind their approach, the process they use for selecting investments and the total performance (meaning assessment of both impact and financial returns) they have achieved over time. The evaluation of performance for an investment in an impact portfolio includes measurable, demonstrated and reported impact that is aligned or complementary to the portfolio objectives. Therefore, it is critical those considering various managers analyze their impact reporting capacity and practices as well as their traditional financial management and reporting practices.
If you find you're especially interested in an investment that doesn't quite fit the agreed upon criteria for that asset class, this can be thoughtfully accommodated by taking a Total Portfolio Management approach. For example, you may want to pursue an investment that takes on greater risk in relation to the expected financial return because it generates a particular type of demonstrated impact. Alternatively, an investor may choose to unconventionally risk-balance a portfolio to permit pursuit of high-innovation impact opportunities that offer an elevated probability of failure not due to their impact DNA but simply due to their innovative structure. And as discussed below, savvy portfolio construction may compensate for many different forms of risk — execution, liquidity, credit, innovation, start-up, and so forth — through complementary investments within each asset class, shifting your own monitoring and engagement practices or by adjusting the overall asset allocation.
Excerpted from "The ImpactAssets Handbook for Investors"
Copyright © 2017 Jed Emerson.
Excerpted by permission of Wimbledon Publishing Company.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
List of Contributors; Introduction, Jed Emerson; 1. Construction of an Impact Portfolio: Total Portfolio Management for Multiple Returns, Jed Emerson and Lindsay Smalling; 2. Total Portfolio Management: One Practitioner’s Approach, Matthew Weatherley-White; Case Study 1; 3. Seed Stage Investing: High Impact, But Not for the Faint of Heart, Tim Freundlich, Jed Emerson and Lindsay Smalling; 4. Choosing Your Impact Investment Advisor, Brad Harrison and Stephanie Cohn- Rupp; Case Study 2; 5. Targeted Impact: Donor- Advised Funds and Impact Investing, Jointly authored by senior staff of ImpactAssets, RSF Social Finance and Tides Network; 6. Transformational Giving: Philanthropy as an Investment in Change, Kris Putnam-Walkerly; 7. Assessing Your Opportunities: The Challenge and Key Practices of Engaging in Investor Due Diligence, Sandra Osborne; Case Study 3; 8. The Measurement Challenge, Sara Olsen; 9. Communicating Impact: Frameworks for Messaging, Amy Hartzler; 10. A Journey to Impact: Initial Steps toward Impact Investing, Jennifer Kenning; Case Study 4; 11. Getting to Impact, Jed Emerson; 12. Concluding Thoughts on Mobilizing for Impact, Jed Emerson and Tim Freundlich; Appendix: Impact Investing Resources; Notes on Contributors; Index.
What People are Saying About This
“A much-needed guide for investors seeking to both understand the impact investing landscape and engage their own portfolios for impact. Full of examples and resources to provide guidance and insight along the journey.”
Ron D. Cordes, Co-founder, Cordes Foundation
“The ImpactAssets Handbook for Investors takes a sledgehammer to the fossilized mind-set that financial returns are all that matter. Jed Emerson and his coauthors give color and texture to an approach to investment and business that is changing our economy more effectively […] than government.”
Seth Goldman, Co-founder and TeaEO Emeritus, Honest Tea
“For investors who are serious about tackling social and environment issues, and considering making impact investments, this book is highly recommended. It is grounded in practical information, pragmatic advice and persuasive examples. Jed challenges traditional thinking, debunks myths and misperceptions about this powerful model of social change and makes impact investing accessible to an ever-widening circle of investors determined to change the world.”
Amit Bouri, Chief Executive Officer and Co-founder, Global Impact Investing Network