Impact investing grows to address problems raised by pandemic

Sometimes a crisis can help bring positive change. For impact investing, the COVID-19 pandemic and the inequities it exposed are boosting its outlook.

Impact investments are made with the intention of generating positive and measurable social, economic and environmental outcomes as well as a financial return. Asset owners and managers put them under various asset and strategy buckets, including ESG or sustainable investing — and note that the one shorthand definition to differentiate ESG from impact is that ESG tends to be more about risk management, while impact investments are specifically intentional.

Measuring comprehensive returns remains elusive. Among respondents in the Global Impact Investing Network's 2020 annual investor survey, 67% said they pursue competitive, market-rate returns. They also reported that portfolio performance overwhelmingly meets or exceeds expectations for both social and environmental impact and financial return, with just 12% reporting underperformance. When asked about impact, 78% said it met expectations and 21% said it exceeded them.

Still, as work progresses on standards and metrics, investors are leery of greenwashing. They “are more concerned that you actually deliver on what you promise,” said Nicholas Hegarty, senior vice president with global private markets investment manager Partners Group AG in New York. The firm has $109 billion under management, of which $4.2 billion is managed or advised under a dedicated impact fund methodology.

More broad-based acceptance of impact investing is “moving along incrementally in a positive way. We are still in an education phase and ‘prove it’ phase. It’s going to take some time,” he said.

Fran Seegull, executive director of the U.S. Impact Investing Alliance in New York, an organization building an impact investment ecosystem of asset owners, managers and service providers in the U.S., said the market’s response to the pandemic and its unequal impact across society helped investors, “especially pension funds, understand that there are systemic risks from climate change, income, wealth and racial inequality. I do think there has been a rising awareness of these risks among asset owners,” Ms. Seegull said.

Pension fund officials are increasingly hearing from beneficiaries who want reassurance about the world they will retire into, said Dean Hand, research director for the Global Impact Investing Network in New York. “We are hearing this more and more, that the cost of not doing (impact investing) is actually much larger” and it raises the question of fiduciary duty.

“I think pension funds are trying to figure out how to respond,” Ms. Hand said.

Deadlines help, too. The 17 U.N. sustainable development goals officially adopted by 193 member countries to address big problems like inequality, climate change, health care and education have a 2030 deadline. The goals are lofty and non-binding, but are increasingly being used by institutional investors as they integrate ESG into their overall investment strategies, industry sources said. Added to that are several deadlines for complying with climate action targets in the Paris Agreement, the international treaty calling for countries to limit greenhouse gas emissions to achieve a climate-neutral world by 2050.

As ESG investing becomes the norm for asset owners and managers, “some are growing their impact investing out of that,” said Jane Bieneman, a senior adviser at Tideline Advisors LLC, an impact investing consultant in New York.

Ms. Bieneman became involved in impact investing in 2007 as momentum was building before being derailed by the global financial crisis. “It really feels different to me this time, with the (investment) infrastructure being built out. And there is a real sense of urgency around environmental and social issues that weren’t there before,” she said.

The Global Impact Investing Network’s 2020 annual investor survey, the most recent data available, notched the largest number of respondents in the report’s 10-year history — 294 global impact investors with a collective $404 billion of impact investing assets under management. The estimated $715 billion total size of the impact investing market globally is based on GIIN’s database of more than 1,700 impact investors.

Those investors — 54% in developed markets and 30% in North America, reported that the global impact investing market is maturing, with increased sophistication of impact measurement and management practices contributing to growth. Top sectors for their capital allocations were energy and financial services, excluding microfinance.

Then there are investors that may not have a specific impact investing bucket but share the goals. “It shows up in language differently,” said GIIN co-founder and CEO Amit Bouri in New York. Some will use it to contribute to specific SDGs or to target priorities like climate solutions, but it is all done through the lens of risk mitigation. “There is a migration path that investors are going through, to think about risk and solutions,” he said.

“Pension fund managers see the writing on the wall. They are stewards of long-term capital. We see much greater interest in how they can use capital to drive change,” Mr. Bouri said.

For the $299.8 billion California State Teachers’ Retirement System, West Sacramento, the objective of making impact investments is to secure the future of its pension beneficiaries.

“We happen to think that there’s opportunity to do that with positive impact,” said investment officer Nicholas Abel, who co-manages CalSTRS’ sustainable investment and stewardship strategies, where the investment policy adopted in March allows for up to 5% of pension fund assets to be invested in public and private portfolios.

“Our success is tied to global economic growth and prosperity,” Mr. Abel said. “We are recognizing that the world around us is changing. We think that’s creating an opportunity. We are very excited.” His team’s goal is to place an initial $1 billion and over the next few years a total of nearly $2 billion in impact-related investments like affordable housing and low-carbon approaches.

Turner Impact Capital LLC CEO Bobby Turner, whose Santa Monica, Calif.-based firm has $1.4 billion in committed capital for social impact investing in education facilities, multifamily housing and health-care facilities, said “the pandemic has been a blessing and a curse. The blessing is it has absolutely highlighted the limitations of government to solve these problems.”

The downside is that “now it is very fashionable to be an impact investor. I think there is still a lot of confusion how to define it,” he said. “Foundations are often more fleet of foot; pension funds tend to be the last, but they also have the most money. I do think they will come to the table eventually but they will need (proof),” Mr. Turner said.

Impact products are increasingly being launched across asset classes, including private equity, fixed income, real assets and credit, said Ms. Bieneman of Tideline. She also expects more co-investments, like the $254.8 billion New York State Common Retirement Fund’s $50 million commitment in late 2020 to 57 Stars Global Opportunity Fund 5 Direct Impact, a fund of funds focusing on emerging markets opportunities in Europe.

On the public equity side, increasing levels of shareholder activism, in part due to more engagement hires by asset owners and managers, are also expected to boost impact-related activity. “It will help deliver positive change and create shareholder value,” said Casey C. Clark, managing director and global head of ESG investments and portfolio manager at Rockefeller Asset Management in New York. “Ten years ago, clients just wanted alpha. Today they want alpha and outcomes, and it’s being led by European investors.”

Rockefeller has $12 billion in AUM as of May 31, including $4.1 billion in ESG strategies.

Maria Kozloski is senior vice president for innovative finance with the $5 billion Rockefeller Foundation, which recently created an asset management platform to aggregate and manage capital from like-minded partners to help build the infrastructure needed to grow the impact investing field. “We are getting calls on a constant basis from institutional asset owners asking, ‘How do I think about impact investing as an asset class?’”

“I think we are at a pivotal point,” said Ms. Kozloski, a former public and corporate pension investment official based in Washington. Most investors consider ESG investment “at minimum from a compliance standpoint. It becomes almost a mainstream due diligence point. And now as we start to think about impact, it is just a broader lens on ESG,” she said. “There is certainly demand for a deeper set of products.”

More asset owners now have dedicated impact teams, and more are setting up specific mandates, said Rekha Unnithan, managing director and co-head of private markets impact investing at Nuveen in New York, with $7.4 billion in public and private impact investments under management. “That’s an important first step.”

One year after the pandemic started, “I am happy to say I think the focus on impact investing has renewed energy. The story on impact has been a really good one, a resilient one,” she said.

Andrew Kuper, founder and CEO of LeapFrog Investments in Sydney, manages the first impact investing fund to reach $1 billion in commitments and has since doubled with a second fund. He sees impact investing as “headed in a much more commercial direction” as the world’s biggest asset managers get involved.

While impact investing was initially led by insurance companies and investment banks, “in the past three years, it has really started to change,” he said. “Now I think people are desperate to get exposure or fear falling behind,” he said. Just from the perspective of risk-adjusted returns, “I think in due course people might be seen in violation of their fiduciary duty if they don’t” consider impact investments, Mr. Kuper said.

Rapid growth could also bring the risk of impact washing, the practice of overstating or falsely claiming the benefits of an investment, in the absence of clear metrics for investors.

“The need for authenticity, and for scaling with integrity, is paramount at this point as the trillions begin to flow in,” Mr. Kuper said.

Todd Cook, managing partner at the Bain Capital Double Impact unit at Bain Capital LP in Boston, said: “There is clearly a lot of momentum within the investor community to obtain exposure to impact strategies.” Raising $800 million for a second fund twice the size of the first “doesn’t change our approach. The trends we are investing behind are durable and long-term themes,” which are health and wellness; education and workforce development; and sustainability.

The funds “are consistent with our commitment to scale mission-driven companies that have lasting impact,” he said. “We wanted to prove we could drive positive change without giving up returns. We feel good about that trajectory,” Mr. Cook said.

He attributes some of the increased demand to generational shifts and changes in consumer beliefs. “Investors are at various stages of the impact journey, but we believe an investment has to deliver something beyond a product or service.”

Investment consultants are expected to play a key role in helping public pension funds and other asset owners understand and participate in impact investing.

A Cambridge Associates LLC 2020 survey of institutional clients, the majority being foundations and endowments, found more than half “doing something or taking a big active step toward sustainable or impact investing,” said Managing Director Tom Mitchell in Arlington, Va. who deals with impact investing. “The consultative part is really driving it. It’s having a discussion about the true north of an organization, its purpose, priorities, principles.”

Client questions about a trade-off for performance “is an easier conversation now. People are seeing the importance of resilience, the importance of acting, and transition risk,” Mr. Mitchell said.

“Pension plans no longer need to fight the perception that they are compromising their duty to beneficiaries when investing in a thematic manner,” said KC Connors, St. Paul, Minn.-based partner and philanthropic practice director at NEPC LLC.

“Institutional investors now have the data and education to understand that they do not have to compromise investment return. In many cases, responsible investing can help mitigate risk and has even resulted in higher returns,” said Ms. Connors, who expects some elements of impact investing to become standard parts of portfolios and due diligence best practices.

“We are seeing a significant increase in both pension funds and broader institutional clients in impact or thematic investing. There has been a palpable shift in the last year to focus on measuring the portfolio’s exposure to different themes and to setting quantifiable goals.”

NEPC consultants are seeing increased investments across all philanthropic segments, and more discussion and education in the corporate pension and public pension space. “If pension behavior mirrors what we have seen in the philanthropic sectors, we anticipate an increase in investments over the next few years,” Ms. Connors said.

Regulators are also playing a role. Impact investing advocates are cautiously hopeful that the Securities and Exchange Commission will consider more stringent disclosure requirements of companies on issues like climate risk, diversity and human capital management, and that the Department of Labor will clarify some of the confusion about sustainable investing in retirement accounts to address sponsor concerns that it does not violate their fiduciary duty.

In the European Union, with new rules for sustainability‐related disclosures in the financial services sector, “regulation is behind some of the behavior you see there,” said Matt Christensen, Paris-based global head of sustainable and impact investing at Allianz Global Investors, with $1.18 trillion under management. “There is now a clarifying source that will help make the (impact investing) market clearer in Europe. There is no doubt in my mind” that it will start to have a ripple effect in the U.S., he said.

William Burckart is president and chief operating officer of The Investment Integration Project in New York, an applied research and consulting firm with a proprietary investor database of sustainable and impact investors and asset owners.

TIPP recently launched a road map for investors who want to address complex problems like income inequality and climate change on a deep, systemic level.

Along with using conventional investment tools, the road map encourages pension funds and other institutional investors to go beyond a portfolio focus to drive broader systemic change, with advanced techniques that include working with peers to put pressure on whole industries, supporting and informing government regulations and stewardship standards, and helping to create new financial markets that solve persistent challenges.

When it comes to impact investing in the U.S., he said, “we are now moving into marketplace building, and starting to form standards and best practices. We are building the runway as we are taking off.”

“The hope is that 10 years from now, it is just good investing,” Mr. Burckart said.