Last week saw the gathering of 1200 global impact investors and professionals in Amsterdam for the 10th annual Global Impact Investing Network Forum. The forum, where a wide range of impact investment topics are tabled, began with barely a hundred attendees. Now, ten years later the growth seems to be directly related to various areas garnering societal attention – The UN’s global goals, global inequalities, and climate change, to name a few.
Impact investments have the intrinsic ability to not only support these areas but also help investors and businesses become more responsible. This is achieved by placing an increased focus on non-financial risks and objectives through a measurable approach.
Non-financial risks and objectives cannot be ignored anymore
The view that non-financial risks and objectives can no longer be ignored was one shared by many of the speakers and panelists at the event. The core thinking behind impact investing is not to force investors to make an impact but rather to ensure that the investments match and align with the investor’s intentions.
This means that investors are increasingly considering non-financial objectives and risks when evaluating their current and future portfolio compositions. One example that many agree on these days is climate change risk, a topic that is attracting increasing attention in many different contexts.
Ross Piper, CEO of Cristian Super, an Australian superannuation fund with 28,000 members and more than $1.6 billion in funds under management, agrees that climate risk is something that is more widely considered. “There’s a case in Australia where a member of a pension fund is suing the board for failing to take into consideration climate risk in the risk profile of their portfolio.” This is not an isolated incident, fourteen UK funds were warned by their lawyers that they risk legal action and US funds have also been urged to be more climate-sensitive.
Ever-evolving risk and perceived risk
The appetite for various other areas of non-financial risk has also been evolving and various developments in finance structure, like blended finance, have led to increased security and confidence.
According to Patrick Goodman, co-founding partner of Innpact, “Perceived risk often tends to be higher than the actual risk when it comes to unrated investments.” When investors need to rely on their own due diligence for private debt or equity, rather than ratings on bonds and stocks, this makes the risk and return calculation more complex.
In the current low rate environment, investors are looking for returns and are willing to assume slightly more risk. “After structuring blended finance deals, we often have investors come back to us and say that they would be prepared to assume more risk and have a smaller percentage of their capital protected.” Goodman continues while stressing that it is, therefore, important to carefully consider the structuring of your funds with the investors you want to attract in mind.
Measurement is becoming increasingly possible
The outcome of investments is the actual purpose or “the why” behind impact investing. For this reason, the desired or expected outcome needs to be clearly defined, measured and reported on as part of the overall investment’s reporting. For example, as Loïc de Cannière, CEO at Incofin, puts it, “If the impact is defined as improving the living standards of people affected by a particular investment, the management needs to actually measure the living standards.”
In theory, this sounds simple. In practice, various factors make it more complicated. One of the frequently discussed challenges is that of defining which effects to measure and how to do this. This also includes the practical and cost considerations involved in executing this measurement. The second, possibly more difficult hurdle is ensuring that you can get the required data over time.
For early-stage investors with a more substantial stake, it’s generally easier to have the management of the company being invested in collect and supply this data. However, in later funding rounds where an impact-first investor’s stake might get diluted, this becomes increasingly difficult. For this reason, we’re seeing various funds taking innovative approaches to how they ensure that they can maintain ongoing measurement.
One example is the approach taken by Crevisse Partners. This Korean impact startup venture fund includes a budget in the investment for external partners to handle the assessments. According to Executive Director, Wonyoung Kim, “It is also important to word the shareholder agreements in such a way that you can ensure reporting will take place but that there’s flexibility around the actual metrics that might be measured in the future.”
Metrics will change
With the advent of evergreen investment vehicles that can get involved during various investment rounds, it might become easier to maintain consistency in the reporting. At the same time, this evergreen relationship could place increased attention and focus on the importance of alignment with your partners.
This in itself could be difficult as we’re still in the early days when it comes to impact metrics and measuring what matters. As we get more data-points, the measurement and definition of metrics will become easier and better. It is, therefore, essential to ensure that there’s the ability to change what’s measured in the future.
Again, investor descriptions will play a significant role to ensure mutual understanding between the investment and the investor and ideally provide a values-based match that will make it possible for long term relationships and alignment between companies and their investors.
The commercial value of using impact as a differentiator
For all firms, an impact focus can be a strong differentiator. This is especially true for those playing in the financial sphere who could still use impact to position themselves and attract new customers. There is still a lot of ground available to attract better investors that are more aligned with what will matter in the future, or like Mark Grier, former vice-chair of Prudential puts it, “Everything matters over time.”
Even though impact as part of a broader portfolio may or may not be directly comparable in terms of financial performance, it is the longer view that matters here and the belief that whatever impact area is being addressed, is something that might, in future, see the right amount of attention and value.
What will shift the dial?
Wealth transfer from one generation to the next is a consideration that will continue to grow in importance as more wealth moves From Baby Boomers to Gen X, Gen Y, and Gen Z. With every generation, a new context will shape behaviors and consumption. With the new generation consuming ethically and valuing transparently, we’re moving beyond the idealistic materialism of previous generations.
This also paves the way for the rise of the awakened consumer, who questions the status quo, and demands more accountability from companies. Right now, some of the compromises that need to be made to offer both financial and impact returns might seem high, especially to family offices and private investors. This is, however, something that cannot be ignored without risking a very disconnected next generation. Remembering that future generations have a very different time horizon will help guide the decisions along with the trust that, over time, this will deliver even better returns.