Tell me, what is it you plan to do
With your one wild and precious life?
—Mary Oliver, “The Summer Day”
Perhaps a philosophical start to a trusts and estates article. And yet, is this not the central question in all financial planning? One might argue that trusts and estates are the mechanisms through which this question is answered and the sharing of the hope of a life well lived with others.
The central topic of this piece is impact investing. So, what’s the connection? Three words come to mind: stewardship, integration and justice. (Confession: If I had written this two years ago, I would have only included the first two). Every human being has dominion over a tiny corner of the world during a tiny slice of time. Stewardship is recognizing this fact and doing what you can with the resources you have. Integration is, where possible, creating harmony between two or more seemingly distinct goals. And justice is a basic human right that all wealth holders should help restore.
Along the journey, if we become overinflated, let us humbly remember the words of the wise wizard Gandalf in “Lord of the Rings” that “Only a small part is played in great deeds by any hero.”
Definitions
Impact investing allows: (1) a philanthropist to expand their social impact by using more resources and tools, and (2) an investor to express values across their portfolio (not to mention a strong case for better long-term returns). An impact investor has the two-pronged goal of creating financial return and social impact. Key characteristics include the intention to achieve and the measurement of both bottom lines. Within this definition, there’s a broad spectrum of tools at the intersection of risk, return and impact characteristics—from environmental, social and governance (ESG) screens on public equities to low interest loans to nonprofits.
Most importantly to note is that all investments inherently have impact. Companies that anyone owns—directly or through funds—are out in the world doing things. They have supply chains, boards, customers and products/services that have social impact implications. The right question to ask isn’t “should I pursue impact investing?” but rather “what impact are my current investments making, and am I ok with that?”
Common Misconceptions
Now, what’s not true about impact investing. Here are the three most common misconceptions:
Fallacy 1: Considering impact or values in investment decisions violates fiduciary duty. A summary of interviews with policy makers, lawyers and senior investment professionals shows that “failing to consider long-term investment value drivers, which include environmental, social, and governance issues, in investment practice is a failure of fiduciary duty.”1 The Business Roundtable recently released a noteworthy “Statement on the Purpose of a Corporation” signed by 181 CEOs, shifting the focus from shareholders to broader stakeholders—customers, employees, suppliers, communities and shareholders.2
Fallacy 2: An inherent trade-off exists between impact and financial returns. Empirical evidence suggests otherwise. A meta-study3 of 2,000 individual studies finds a positive correlation between ESG considerations and corporate financial performance. To be clear, the data is still in its early days; the key is that no conclusive evidence indicates impact considerations inherently lower returns. A study by Nuveen TIAA finds:
no statistical difference in returns compared to broad market benchmarks, suggesting the absence of any systematic performance penalty. Moreover, incorporating environmental, social, and governance criteria in security selection did not entail additional risk.4
Fallacy 3: Impact investing is an asset class. Impact investing isn’t dependent on a particular asset class, investor structure, corporate form or investment tool. It can be applied across a portfolio.
Trends
The market size of impact investing has surged over the last 10 years. Using one of the broadest definitions of “impact investing” as defined by the U.S. Forum for Sustainable and Responsible Investment, sustainable and responsible investing from U.S.-based asset owners has grown more than 400% since 2012 to a current market size of $17.1 trillion, or one in every three investment dollars.5 Institutional investment management firms have noticed and are acting on this trend. All major banks are building significant teams and creating suites of related products. In the last two years, there’s been significant merger and acquisitions activity involving boutique and impact specialty managers and advisors. Leading providers of independent investment research and ratings now consider ESG factors a central concern for their offerings.
Significant drivers of impact investing will be the impending generational wealth transfer and the increased role and power of women in investment decisions. The next generation’s role will grow even more with $30 trillion changing hands to them.6 In addition, women now control nearly 60%7 of the wealth in the United States and continue to control more assets globally: from $34 trillion in 2010 to $72 trillion in 2020.8 Combining these two trends, “women will inherit 70% of the money that gets passed down over the next two generations.”9
How to Do It
The Impact Investing Handbook: An Implementation Guide for Practitioners10 directs an asset owner towards making their first impact investment or building a nuanced impact portfolio. See “Roadmap,” p. 72.
The core components along this journey provide another way to look at this roadmap. See “Most Relevant Components,” p. 73.
Case Study
To bring the roadmap to life, we’ll track alongside one asset owner’s journey as she, Sophia, and her family office develop and implement their impact investing strategy. For context, this asset owner sold her fashion business for $450 million and started a
$40 million foundation. Bothered by the fashion industry’s heavy water usage, she began with water-related grant making, but she eventually was frustrated by lack of scale. She set out on a journey to learn more after being introduced to impact investing. One key challenge is consensus building with her husband who holds a more traditional view of keeping investments and social good separate.
What: The asset owner should create a personalized definition of impact investing and begin mapping the resources she hopes to activate—including non-financial assets.
Sophia agrees with the Global Impact Investing Network definition and wants to activate her
$500 million portfolio, her $40 million foundation, her $5 million donor-advised fund, her fashion expertise, her experience as a female business leader and an important relationship with a trusted family attorney.
Who: Sophia should identify her position in the impact investing ecosystem of players, with particular attention to the capital chain or flow of capital from herself to intermediaries to enterprises to customers and beneficiaries.
Sheidentifies key stakeholders as a close family attorney, her husband, regulators, affiliate groups, peers and the whole capital chain. Her husband has the most influence on the portfolio, so she’ll keep him in mind as she moves forward.
Why: Sophia should develop a theory of change that identifies both investment and impact goals, leading to a logic model of how her resources will be activated to achieve the portfolio’s goals.
She aligns as much of her portfolio with a “do no harm” mentality by first understanding what she currently owns, prioritizing impact themes of water, climate and the arts. Where possible, she would also like to overlay a gender lens. She’s seeking a diversified portfolio with an allocation to less liquid, impact-aligned opportunities towards a risk-adjusted rate of return of a 5% payout plus inflation.
How: To arrive at an investment policy statement (IPS) and impact investment statement (IIS), Sophia should add specific tools and structures to the theory of change. Then, she should identify specific products that may give expression to each segment of her portfolio.
The IPS likely includes:
- Roles and responsibilities of the board, family, and investment committee;
- Role of advisors, including level of discretion;
- Overall investment goals and objectives;
- Risk appetite;
- Liquidity requirements;
- Diversification goals;
- Investment limitations, including specific assets and transactions;
- Tax considerations, as applicable;
- Asset-allocation strategy;
- Time horizon;
- New cash investment guidelines; and
- Financial reporting.
The IIS may contain the following elements:
- Mission, vision and values;
- Views on fiduciary duty;
- Definition and boundaries of impact investing;
- Role of impact investing;
- Impact investing approaches;
- Theory of change;
- Impact goals;
- Impact tools and structures;
- Product examples, if desired; and
- Approach to impact evaluation.
Sophia identifies priority tools and structures including ESG screens on positive climate and water considerations, cash transferred to a community bank, venture capital to promising water and arts startups and a gender lens across the entire portfolio.
So what: Sophia should follow the three-part process to build her approach to impact management and measurement: (1) Why is she measuring? (2) What is she measuring? and (3) How is she measuring? First, she must decide on which parts of the portfolio she plans to evaluate and segment the evaluation approach accordingly.
Sophia’s motivation to measure is a balance of proving past impact, improving impact for future decisions and personal learning. She’ll commit to the International Finance Corporation’s Operating Principles,11 track the percent of assets screened using negative and positive ESG criteria, categorize investments according to the Impact Management Project’s ABC Framework,12 align to Sustainable Development Goals 5 and 613 as outlined in the “2030 Agenda for Sustainable Development” adopted by all United Nations Member States in 2015 and track progress on worker health and safety, pay equity and board diversity.
One Small Step
All in all, this is a nuanced, dynamic field that evolves each day. The best starting point is for the asset owner to take one small step with the part of the portfolio that they know the best, and go from there. Ask peers for advice and practical guidance along the way. Whether driven by a moral imperative, client demand or long-term financial returns—here’s to a fruitful journey.
Endnotes
1. Rory Sullivan, Will Martindale, Elodie Feller and Anna Bordon, Fiduciary Duty in the 21st Century, at p. 9, www.unepfi.org/fileadmin/documents/fiduciary_duty_21st_century.pdf (2019).
2. “Business Roundtable Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All Americans,’” Business Roundtable (2019).
3. Gunnar Friede, Timo Busch and Alexander Bassen, “ESG and Financial Performance: Aggregated evidence from more than 2000 empirical studies,” Journal of Sustainable Finance & Investment, www.tandfonline.com/doi/full/10.1080/20430795.2015.1118917?scroll=top&needAccess=true (December 2015).
4. Amy O’Brien, Lei Liao and Jim Campagna, “Responsible Investing: Delivering Competitive Performance,” Nuveen TIAA Investments (2017), at p. 2, www.tiaa.org/public/pdf/ri_delivering_competitive_performance.pdf.
5. US SIF Foundation, Report on US Sustainable and Impact Investing Trends (2020).
6. “The ‘Greater’ Wealth Transfer: Capitalizing on the Intergenerational Shift in Wealth,” Accenture (2015).
7. “Financial Facts for Women’s History Month,” The Quantum Group (2017).
8. “Investment by Women, and in Them, Is Growing,” The Economist (2018).
9. Lisa Stern, “Why Wall Street Is Wooing Women and Their Future Wealth,” Money (2014).
10. For more details (180 pages worth), please refer to the full Handbook I co-authored with Steve Godeke, www.rockpa.org/wp-content/uploads/2020/10/RPA-Impact-Investing-Handbook-1.pdf.
12. https://impactmanagementproject.com/impact-management/how-investors-manage-impact/.