3.2 Building Impact-driven Investment Portfolios
By Clara Barby, Partner and Head, IMPACT+, and Emilie Goodall, Director, IMPACT+, Bridges Ventures
- Bridges Ventures’ impact-driven investment approach follows a three-stage process: select high-impact investments; engage with investees to manage impact risks as well as identify opportunities to create additional societal value; and track progress to inform portfolio management decisions and investors.
- Each investment is reviewed using four criteria: target outcomes – the investment’s intended societal impact; ESG – managing environmental, societal and governance practices to protect and enhance value; alignment – between an investment’s ability to generate impact and its ability to deliver competitive risk-adjusted financial returns; additionality – whether target outcomes will occur anyway, without the investment.
- For each of the four criteria, Bridges scores both impact return and impact risk. It uses an indicative scoring guide that poses analytical questions for each of the four criteria. Pre-investment, the scoring summarizes the investment team’s recommendation to provide a basis for discussion. Post-investment, it acts as a portfolio management tool.
Founded in 2002, Bridges Ventures is a specialist fund manager with close to $800 million in assets under management, dedicated to using an impact-driven investment approach to create superior returns for both investors and society-at-large. We call our investment approach “impact-driven” because we use impact as a lens to select and engage with our investments. By doing so, we seek to generate superior returns – both for investors and for society. What does this mean in practice? Our impact approach is based on 12 years of experience investing for impact. We hope that breaking down the various dimensions of our analysis will prove useful to others.
Our methodology and tools, while not perfect, help us to make informed decisions within the bounds of what is practical (both proportional and affordable) and useful (allowing us to select and manage investments to create social value on a day-to-day basis). Our approach has three key elements: a specialist focus (“Thematic”), a consistent process (Bridges “SET”) and clear criteria (Bridges IMPACT Radar).
This article provides an overview of our process and criteria today but our intention is to improve continuously – to keep learning from our work, as well as through collaboration with others.
A Thematic Approach
While our investments range from fast-growth SMEs to property to social enterprises, we have a thematic focus that cross-cuts all fund types. Each theme represents a cluster of societal outcomes that we are learning can be efficiently delivered through investable models. Over time, we have developed an investment “sweet spot” where our themes overlap: high-impact products or services that combine quality, access, affordability and efficiency, making them ideally suited to address the needs of underserved markets.
Across our funds, we consistently follow a three-stage “SET” process, which integrates impact analysis into the full investment cycle. As an impact investor, we select for impact: identifying investments whose product, location or business model will deliver our thematic outcomes. In addition to generating our specific target outcomes, we also support our portfolio companies to manage impact risk as well as optimize their wider ESG practices. We view this as a commercial-social “win-win”: businesses that operate in a more sustainable way not only generate incremental impact but can also protect and enhance their commercial performance – be it through better energy management, progressive employee or customer engagement, or improved governance practices.
Bridges IMPACT Radar
Over the last decade, we have learned to focus on four key criteria. While we tailor our approach to each type of fund, certain criteria are common to all Bridges’ investments and provide a holistic view of an investment’s ability to generate positive societal change.
Impact risk and return
We consider it as important to understand the impact risk of an investment (the probability that our impact performance will be different than expected) as to understand its potential for impact return (the positive impact we can claim if things go well). We therefore consider impact returns and impact risks as they relate to each of our key criteria to generate a risk/return profile for each investment. We also do this at the portfolio level to understand the overall impact risk/return profile of each fund.
How does Bridges use the IMPACT Radar?
Below are our risk/return questions for each of the key criteria, along with our Scoring Guide for mapping a potential investment. Our scoring approach is subjective and indicative, rather than categorical. Pre-investment, we have found that it usefully summarizes our investment team’s recommendation to provide a basis for discussion. Post-investment, it acts as a portfolio management tool so we can monitor the impact risk/return profile of each investment (and therefore of each fund) on an ongoing basis.
Target Outcomes: Effective solutions to pressing societal needs represent significant growth opportunities
From an impact perspective, we view each investment as a strategy to address a societal challenge. Our “Target Outcomes” analysis therefore begins with identifying who is being affected by the problem (target beneficiary), what they need, the barrier to improvement and what the current response is.
From this background analysis, we can plot a Theory of Change: the series of theoretical stages necessary to address the challenge. To understand how an investment will convert theory into action, we then lay out the investment’s specific steps (the Logic Model) to deliver each stage of the Theory of Change. This process enables us to analyse the investment’s potential impact in terms of scale, depth and systemic change (which signals potential “impact returns”). It also allows us to pressure test the causal links in the investment’s logic model – in other words, to question to what extent the “recipe” is understood and the causality is evidenced (which signals the level of “impact risk”).
A. Depth: While scale can typically be measured, depth is more subjective: what is fundamental to one person may be less important to another. In the absence of an objective definition, we find that duration and leverage can be useful “proxies” for depth: Is the outcome long-lasting (duration)? Does the outcome catalyse many positive changes in a person’s life (leverage)? For example, one could argue that a successful adoption creates positive change for the rest of a child’s life (as does, for example, a life-saving operation), while it has also been shown to generate a wide range of other positive benefits for a child, such as improved physical and mental health and reduced likelihood of becoming a person classified as not in education, employment or training.
B. Inclusivity: Within Health & Well-being and Education & Skills, we apply an additional “inclusive” lens to ensure that the investments we make are, at a minimum, creating positive change for the population-at-large rather than for the wealthiest segments of society only. Our Social Sector Funds go further, typically backing models that focus on underserved beneficiary groups.
C. Systemic change: In addition to the direct outcomes of an investment – the graduates who go on to enjoy sustainable livelihoods or the elderly receiving improved quality of care – we also look to create wider or systemic positive change through our portfolio, such as additional cost-savings to society, a positive influence on policy or a “ripple effect” in the broader market (including price disruption and copycat models).
ESG: Active management of our impact on key stakeholders both protects and enhances value
While we select companies that will generate our intended outcomes (through the high-impact products or services that they provide, or the economic growth that they generate in underserved communities), we also recognize that every investment has the potential to generate other societal outcomes, both positive and negative. We take these outcomes – the ESG factors – into account to understand an investment’s total (or “net”) impact.
Prior to making an investment, our investment team works with the management team of the prospective portfolio company to identify ESG risks. To guide this discussion, we have developed an in-house risk assessment screen based on global best practices but adapted to fit the needs of investees operating in our areas of thematic focus. Our emphasis is on making this ESG risk screen as practical as possible – on making it a conversation about operational excellence. We use a materiality lens to grade each risk as a high, medium or low priority and record the results on a risk register. For each material risk, we propose a mitigation plan in the Investment Committee paper, so that our investment decision is made with a holistic view of projected impact, and a 100-day plan can be developed immediately post-investment. Thereafter, ESG issues are reviewed regularly at board meetings with investee companies, as well as at our own firm-level portfolio review meetings. Once a year, each investee provides a snapshot of any new or outstanding ESG issues, as well as progress against targets, through a pre-agreed IMPACT Scorecard.
We call ESG opportunities “win-wins” because they improve social or environmental performance in ways that also improve business performance. While each investment has its own range of relevant ESG opportunities, our specialist focus on themes (and sub-sectors within themes) has allowed us to develop “rules of thumb” for recognizing where opportunities might lie – for example, maximizing quality of care for patients through independent clinical advisory boards in our healthcare companies, creating employment access through apprenticeship schemes in our businesses in underserved markets or minimizing energy and water usage across our property (and property-backed) investments. While some ESG opportunities can be defined pre-investment, many emerge during the investment period, through a process of regular interaction and learning with the company and its stakeholders. We create an ESG matrix for each investment to capture how ESG factors and business success factors go hand-in-hand.
Alignment: A platform of distinct fund types allows us to match opportunities to the financial and impact expectations of a wide variety of investors
The various funds which Bridges has developed are shaped differently: while all deliver impact alongside financial return, the funds differ in terms of the types of business models they back and the level of risk-adjusted financial returns they generate. By developing this platform of distinct fund types, we have sought to “align” each fund carefully with the financial and impact expectations of different investors, allowing us to draw a wide variety of asset owners to invest for impact. This approach also means that, increasingly, asset owners are allocating across our various funds, from different parts of their portfolio.
Over the last 12 years, we have learned there are a wide variety of social or environmental needs that create commercial growth opportunities, with the potential to deliver positive impact alongside market-rate, or market-beating, financial returns. For example, in the face of rising unemployment, we have backed training colleges, like Babington Business College, which are equipping the next generation with the skills to compete globally – an increasingly attractive proposition for both government contractors and private-pay customers.
We also recognize, however, that there are many pressing social or environmental issues where commercial investment opportunities do not present themselves: the social mission requires a prioritization of impact over competitive financial returns, whether because of the enterprise’s structure (for example, a trading charity), its business model (such as a cross-subsidy model where all profits are reinvested), its target market (perhaps it focuses exclusively on disadvantaged consumers who do not represent a commercial growth opportunity) or the founder’s goals (perhaps the founder does not wish to pursue a commercial exit that may compromise the mission). To support these business models, we have developed our Social Sector Funds, which are able to offer flexible financing to suit the enterprise’s individual needs.
To illustrate where our funds are positioned within the broader impact investing market, we have developed a “map” of the capital spectrum, which indicates the new capital deployment paradigm and frames the increasing range of choices available to investors.
How do we assess alignment?
From a return perspective, we analyse the alignment between an investment’s ability to generate impact and its ability to deliver competitive risk-adjusted financial returns. Both the Bridges Sustainable Growth Funds and the Bridges Property Funds look for an investment’s impact and its competitive financial returns to be in “lockstep” – in other words, that impact will automatically scale as investors make attractive financial returns. The Bridges Social Sector Funds look for investments that are capable of generating impact alongside a sustainable, rather than fully commercial, financial return – from early-stage social ventures seeking social equity (requiring high risk capital but offering a below-market return) to established social enterprises whose business models (such as cross-subsidy schemes or cooperatives) need what we increasingly call “social mezzanine” financing (lower risk/lower return financing with an innovative exit structure that will preserve mission).
From a risk perspective, we analyse the underlying business model: the alignment between the model’s business success factors and the impact it seeks to create. While our funds differ in terms of the financial returns they generate for investors, all funds share a focus on spotting business models whose ability to generate impact creates a competitive advantage.
Additionality: Understanding the true value-add is key to both social and commercial performance
Our additionality analysis asks whether our target outcomes will occur anyway, without our investment. In this sense, additionality defines our impact, allowing us to tell our investors whether their funds are creating societal value.
Our additionality “return” analysis assesses the positive impact that we can claim if things go well, i.e. the positive societal outcomes that our capital can take credit for (we describe this as “investor-level additionality”). Our additionality “risk” analysis assesses the probability that our investment will lead to negative (or neutral) impact through the displacement of comparable societal benefits (i.e. stealing market share and destroying impact value, or simply creating no net benefit). We refer to this as “investment-level” additionality).
For our funds seeking market-rate returns, our additionality return analysis considers the extent to which Bridges is integral to the investment’s development and growth. For our Underserved Markets theme, our additionality lies in directing capital to investments in the most deprived 25% of the United Kingdom – to businesses that demonstrate strong links to their community through significant local job creation or supply-chain spend, or by serving local consumers as a target market. Today, over one-third of our Underserved Markets investments are in the most deprived 10% of the country. Our decision to focus investment on these regions was rooted in the belief that there was insufficient growth capital readily available to support businesses in these markets. In other words, investor additionality was the driving force for developing Underserved Markets as a theme in the first place. For our other themes, our investor additionality considers whether, at a minimum, Bridges’ alignment with the investee’s social or environmental agenda will create non-monetary benefits that generate additional social value. More often, our additionality is due to our integral role in structuring or even creating an investment from scratch: in each of our funds, we look to incubate a number of businesses in-house (in which case, our investor- and investment-level additionality become one and the same).
Our Social Sector Funds provide flexible capital to sustainable, often profitable, business models that cannot attract commercial capital due to their structure or target market, or both. In this sense, investor additionality is more readily assumed, since such investees could not rely on the mainstream capital markets to support their growth. However, in co-investment situations, we still consider the extent to which Bridges leads the development of the investment (and therefore the leverage of additional capital), which signals an even higher level of investor-level additionality.
At the investment level, our analysis assesses probability that the social outcomes generated by the underlying investment will create a positive net benefit for society (typically through improved quality or quantity of outcome, or both); or if, instead, the investment’s target outcomes are at risk of displacing comparable benefits.
Source: Bridges Ventures
*For Underserved Markets, a high additionality return is if Bridges’ investment is the driver for the launch of a business in (or relocation to) an area of very high deprivation
** An investment could be creating new positive outcomes or it could be preventing negative outcomes from otherwise occurring (e.g. saving jobs).
Our methodology is rooted in our day-to-day experience and based on over a decade of learning, combining idealism and realism. We hope it can serve as a useful contribution and welcome feedback.
(For more information, see Bridges IMPACT Report, 2014)