What’s “impact investing?” Why do families make impact investments, and how do they do it?
“Impact investing” refers to strategies that actively incorporate social and environmental factors into investment decisions across asset classes. Impact investors intend to generate both financial return and measurable impact with their investments. The power of impact investing—and the confusion that it can inspire—comes from the creative tension that exists between the financial goals of impact investors and their non-financial (impact) objectives. Today, families and other asset owners use impact investing as a tool to create specific social and environmental outcomes in conjunction with their philanthropy and, in other contexts, as an investment approach designed to drive superior risk-adjusted financial returns. For the last five decades, the two-dimensional relationship between risk and return has shaped the culture and practice of wealth management. For a large and growing number of families around the world, the investment future will be shaped by the three-dimensional interplay of risk, return and impact.
Families play a unique role in the burgeoning impact investing market as collaborators, investors and ecosystem builders. Families are stewards of wealth; they think and act on behalf of future generations. Families are committed to building for the long term, but they’re also nimble, experimental, indispensable investors in emerging concepts, companies, managers and markets. Families lead some of the largest and most important enterprises in every sector and every market around the world, and they support the research, advocacy and network building that create vibrant market ecosystems. Families’ influences can be harmonized and leveraged to change the behaviors of market-shaping institutions such as banks and wealth management firms.
Here are 10 essential actions we see families take as they envision, develop, implement and refine their impact investment strategies. Families rarely move through these actions in linear fashion, but the actions shape and reinforce each other as families move through them.
Define “Guiding Lights”
Several distinct forces motivate families to make impact investments. Each of these motivating forces may inspire very different kinds of impact investments. A family’s impact investment strategy tends to be a function of the family’s motivation(s) and the entities out of which they’re making investments.
Establishing clear, unifying motivations enables a family1 to build or iterate on an impact investment strategy with purpose. Given that a family’s specific impact and financial objectives often stem from a deeper set of motivations, it’s important for families to be clear about why they want to make impact investments and what they hope to accomplish through their investment activity. Here are three major motivations that we see driving families to make impact investments:
- Aligning their investments with their mission, values and beliefs.
- Believing social and environmental factors are major drivers of investment risk mitigation and success—companies that proactively respond to critical social and environmental factors will outperform those that lag behind in addressing these issues.
- Believing in using the dynamism of business and the scale of capital markets to address specific social and environmental challenges.
Families have long used statements of mission or values to guide their decision making within the businesses they own and operate or in the context of their philanthropic giving. The management of family investments often existed outside the purview of these statements, resulting in some famously contradictory instances of, for example, family foundations actively investing in industries creating or perpetuating the social and environmental challenges that their grantees were working on to address. Families are increasingly interested in establishing holistic frameworks of purpose, mission and values that can apply across their enterprises: family businesses, investment assets and philanthropic giving. By knowing what they want to accomplish and why, a family can then build a strategy to use assets in the most creative and effective way to create their desired impact.
Build Family Consensus
Moving family capital towards impact investing often requires that family members align around a shared vision for their impact investing activity. This can be tricky for any family, especially complex, multi-generational ones. Many families encounter clear generational differences in how family members view the purpose of business, investment and wealth. Many Millennial and Gen Z inheritors view the creation of positive social and environmental impact as a fundamental purpose of investment, whereas their parents and grandparents view the preservation or growth of wealth and the creation of positive impact as distinctly different pursuits. These different viewpoints can easily become proxies for deeper family dynamics, especially inter- (and intra-) generational anxieties around role, credibility and authority within the family system. But opportunities for alignment on impact investing vision abound, even within complex families. Here are a few examples that we’ve seen:
- A four-generation family with substantial legacy holdings in fossil fuel-related industries aligning on a shared concern about the long-term financial risks that climate change poses to their asset base transitioning their public market portfolio to low carbon companies while making proactive venture investments in early-stage clean technology companies.
- A family patriarch embracing his children’s interest in investing in sustainable food and agriculture start-ups as a way to inculcate the entrepreneurial values he feared the family might lose once he had created substantial wealth.
- A three-generation family foundation board experimenting with both program-related and mission-related investments in areas aligned with their historic grant making as a means to significantly amplify the total resources the foundation could mobilize towards the social issues it exists to address.
Build an Investment Team
For many families, investment approaches resemble an old political cliché: “personnel is policy.” Most families or individuals don’t manage their impact investments directly—whether and how the family is able to develop and implement an impact investment strategy depends on the knowledge, experience and perspectives of the professionals they employ to support them. As each family is unique and may be at a different point in their impact investing journey, the range of approaches families take to build their teams differs widely. According to Omidyar Network, there’s no one-size-fits-all approach—the right team will depend on the family’s context as well as financial and impact goals and constraints.2
Some families may work entirely with institutional service providers such as wealth management firms, a growing number of which have dedicated (and in some cases, extensive) impact investing teams. Other families rely on independent advisors or consultants whose sole responsibility is to serve the family’s impact investing strategy. For families with large-scale assets and the interest in developing a deep impact investment portfolio, it can make sense to build a dedicated in-house team within their single-family office. Many families end up creating hybrid systems, in which certain impact investment functions (such as screening for environmental, social and governance factors when constructing public equity portfolios) are managed by large institutions, while private markets investments are handled by an in-house team or specialist advisor. Across these approaches, families may need to recruit the relevant impact talent or leverage existent talent. The structure of their teams would also evolve over time as the family’s impact investing approach matures. See “Team Structures,” this page.
Map Assets
To understand the impact of all of their assets, families must first map their assets to know what they own, including:
- How assets are owned within the family—the structure of legal entities that define ownership within the family.
- The portfolio or fund-level holdings within each entity.
- The security-level holdings of every portfolio or fund.
- The activities of each security-level holding and the alignment of those activities with the individual or family’s defined impact vision.
Multi-generational families’ investment portfolios have tended to grow extraordinarily complex over the last several decades. Diversification standards have increased exponentially—a 10-stock portfolio held by a family a generation ago might now be a portfolio of 10 pooled funds, each holding dozens (if not hundreds) of underlying assets. Inheritors who view their money choices as an extension of their values or identity into the world increasingly demand to understand what they own and why. Answering these questions is onerous in the context of a complex portfolio, but often serves as a launching point for a family’s impact investment journey (especially when family members discover that, unbeknownst to them, they’ve been holding significant investments in assets deemed out of alignment with the family’s values or mission).
For families with operating businesses, knowing what you own can also mean understanding deeply the operations of the business. Once a family knows all that it owns, it can move assertively to assess the impact of its assets and align all of its investments with its values.
Build Impact Into an IPS
An investment policy statement (IPS) is the document within which an individual or family defines its investment beliefs, objectives and constraints. According to the CFA Institute, “The Investment Policy Statement provides the foundation of the portfolio management process.”3 An effective IPS makes three things clear:
- The personal or family objectives and constraints that guide the investment professional’s deployment of the assets.
- The roles and responsibilities of all parties involved in the governance and successful management of the assets, including individuals with fiduciary duties, other relevant stakeholders and the standards by which all stakeholders will be assessed in the performance of their roles.
- The investment strategy employed to achieve objectives within constraints.
By incorporating impact considerations within an IPS, a family elevates the discussion of impact investing from the level of “investment product” to “investment policy or approach.” It helps the family make explicit its beliefs and goals about impact investing and creates clear expectations and requirements around decision making for the wealth managers and investment professionals who will act on the family’s impact goals in addition to financial objectives. As such, it’s essential for a family to clarify its motivations and intent as an impact investor, as these factors directly influence the investment objectives in an IPS. In instances of conflict and when there’s no common consensus, the IPS also establishes either who makes the final decision or the process by which the decision is made.
Weave Impact Into Due Diligence
To incorporate impact into investment decisions, families must incorporate impact factors into their assessments of individual investment opportunities: the due diligence process. This can be done for investments across asset classes, sectors, return profiles and impact strategies. The goal of any due diligence process is to determine the potential value an investment could create and identify the risk factors that may prevent the investment from creating that value.
Whereas conventional investors tend to assess return and risk primarily in financial terms, impact investors add analysis of the social and environmental value an investment can create, as well as the social and environmental risks inherent to the investment’s products, services and operations. Families may also include an assessment of experiential return and risk to their due diligence, assessing the value they may derive from the learning experience afforded by the investment opportunity and the potential reputational risks associated with a particular investment.
Due diligence is a multi-stage process; during each stage, investors gather progressively more detailed information that can support a decision on whether to invest in a fund or company. The details of an investor’s due diligence process vary depending on context, region and market within which the company or private fund that’s being assessed operates.
This action is a clear “raise the ceiling, raise the floor” opportunity—families can start with simple practices and become more precise or sophisticated over time as they clarify and iterate on their investment objectives and impact measurement methodologies.
Build an Impact Portfolio
Weaving impact into due diligence enables families to build an impact portfolio that’s in accordance with their IPS. This process of building a portfolio usually involves five distinct actions: (1) sourcing investment opportunities, (2) performing due diligence, (3) making investment decisions, (4) structuring investments, and (5) monitoring a portfolio and providing ongoing support, such as technical support, governance and follow-on investments, to the investees. See “Building a Portfolio,” p. 79.
Building a robust, diversified impact portfolio may require families to build networks to source investments and identify aligned partners to collaborate on due diligence. Portfolio monitoring, especially for private investments, often requires careful analysis of investees and the development of risk management frameworks to guide investment decision making. Families may also face difficult decisions related to making follow-on investments or determining whether and when to exit investments.
Develop Measurement Methodology
Having defined their guiding lights and an impact investment strategy, families monitor the mission or values alignment of the portfolio as a whole and the impact of individual investments. Here, families also clarify how they measure and assess impact alongside financial performance evaluation.
An impact measurement methodology defines how social and environmental impact will be measured and reported on each investment level: security-level, fund-level and portfolio-level. Impact measurement methods will likely need to differ at each of these levels and for each individual investment made. To develop an effective measurement and reporting system, an individual or family should first clarify their impact objectives as part of their guiding lights so that measurement is tied to intended outcomes.
Engage Institutions
Families should engage the institutions that support the deployment of their assets on their impact investment strategy. For many families, fully implementing an impact investment strategy requires the support of an institutional wealth manager or asset management firm. Many families feel loyal to or stuck with these firms but want more from the firms in terms of impact investment service offerings or values-aligned business practices. Most families aren’t experienced with exercising their voices as clients to advocate for more impact offerings and higher standards. By proactively engaging their wealth managers, families can increase the likelihood that their own needs and desires are met and be a part of larger systemic change.
Some families also work collectively to influence the behavior of institutions to raise standards for sustainable investment activity throughout the market. By identifying common impact investing products and standards of service that they would like to see and engaging their financial institutions, families can collectively be a powerful catalyst for that change. Such collective action aggregates and more clearly communicates wealth owners’ needs, increasing families’ abilities to advocate for more impact investment offerings and higher operational standards.
Support “Impact Ecosystem”
Impact companies and funds are just one part of a wider ecosystem. Research is necessary to study the impact and financial performance of market players and to identify verifiable solutions to social and environmental challenges. Networks play an essential role in distributing opportunities and driving changes to the culture and practice of business and finance. Investment markets can’t function without this wider ecosystem, and the ecosystem relies on private capital (money, time and talent) to grow and thrive.
Together, families can build a future in which the measurement and management of social and environmental impact are the norm for investors and for companies, and families align all of their assets with their values. By making impact the market norm, not the exception, families will help unlock the trillions of dollars of capital needed to address the world’s most pressing social and environmental challenges.
Endnotes
1. Though we refer to families throughout, the “critical path” is equally applicable to individuals within a family.
2. https://omidyar.com/wp-content/uploads/2020/09/Building-an-Impact-Investing-Team.pdf.
3. John L. Maginn, Managing Investment Portfolios: A Dynamic Process (John Wiley & Sons, 2007).