3.4 Impact Investing Across Asset Classes
3.4 Impact Investing Across Asset Classes
Investors interested in understanding how to begin allocating capital to impact investments will first need clarity about which asset classes are most relevant for impact investing. While the notion of impact investing may have originated in private equity and venture capital, many other asset classes offer impact investment opportunities; however in most cases, systematic measurement of social and environmental impact has only begun to emerge in areas outside of impact private equity and microfinance. Most infrastructure investors, for instance, may not be able to systematically assess how much clean water and low-carbon energy has been provided (a notable exception is obviously sectors where development finance institutions are active as they employ very stringent targets regarding social and environmental objectives).
Impact investors need to ask themselves, ‘What bucket does this fit into?’ It is a key question that must be asked in order to help mainstream investors understand which asset class the investment aligns with.
David Chen, Co-Founder and Principal,
Equilibrium Capital Group, USA
This report sets out to assess the impact investing landscape and help mainstream investors understand the sector and investment opportunities that it offers; select examples of impact investments across asset classes are described below.55
Cash/Cash Equivalents: Investments of cash assets (such as certificates of deposit, savings accounts, and money market accounts) into community banks and local financial institutions that make investments specifically into organizations that are intentionally seeking social or environmental objectives. For example, Triodos Bank offers a range of liquid offerings to individual, business and institutional customers and “only lends to and invests in organizations that benefit people and the environment”.56
Fixed Income: Bonds with maturities ranging from short term (less than one year) to long term (five to more than 30 years) issued by governments, corporations or financial institutions that result in capital flow to impact enterprises or projects that address social or environmental challenges. These include traditional and untraditional bond structures. The International Finance Corporation (IFC)’s green bond, an example of a traditional bond structure, is a US$ 1 billion three-year AAA rated green bond with an interest rate set at three-year US treasury rates. The IFC uses green bonds to finance projects that result in reduced greenhouse gas emissions in developing countries.57 Unlike the IFC’s green bond, social impact bonds (SIBs) offer a fairly untraditional bond structure, and are actually more similar to structured products than bonds.
Investment Funds (Private Equity and Venture Capital): Investments made into third-party managed funds that make debt and equity investments into impact enterprises. Private equity is the most common investment instrument used by impact investment funds (see Figure 13).58 However, institutional investors often find the direct deal sizes to be too small (see Section 4 for more information), so will thus invest through investment funds. There are approximately 250 impact investment funds listed in ImpactBase, which presents offerings across asset classes, sectors and geographies. For example, LeapFrog Investments makes equity investments into impact enterprises that provide financial services to low-income populations. It has a diverse set of investors including large-scale institutional investors (e.g. TIAA-CREF), development financial institutions (e.g. IFC), investment banks (e.g. JP Morgan) and philanthropic investment firms (e.g. Omidyar Network).59 LeapFrog is just one example that illustrates the diversity of fund offerings in ImpactBase.
Public Equities: Investments made into impact enterprises that are publicly traded. Given the early stage of the sector, few publically listed organizations exist that intentionally seek and measure social outcomes in addition to profits; however, notable exceptions do exist. London’s Social Stock Exchange (SSE), introduced in Section 3.2, lists 11 publically listed companies that meet its criteria to be considered a “social impact business”.60 An additional 12 companies are currently pending admission into the SSE. Although the number of publically listed impact enterprises is currently quite small, mainstream investors will have greater ability to find liquid trading opportunities of impact enterprises as retail demand increases and new social stock exchanges are created (such as IIX launched in Singapore in June 201361).
Real Estate: Investments made into sustainably managed properties, or properties currently in development in regeneration areas or among low-income populations, and in which social and environmental objectives are intentionally sought, such as smart growth, green buildings, urban regeneration, and affordable housing. For example, Vital Capital has committed over US$ 200 million to build 40,000 affordable houses in six provinces throughout Angola. The investment seeks to not only provide affordable housing units for the local population, but also provide a full spectrum of the necessary elements for a vibrant life, including clean water, sanitation, power, education, social services and health services. These combine for better employment opportunities, cohesion and empowerment in an integrated community environment. In addition to measurable improvements in the quality of life of the residents, the IRR is on track to achieve the +20% target.
Infrastructure: Investments into the facilities and structures required for the effective operation of an economy and society, usually involving the provision of essential physical structures and services to populations at the bottom of the economic pyramid. For example, with financing from a group of investors and the Kenyan government, the AfDB financed a €115 million investment in wind power in Kenya’s Lake Turkana region. The project provides clean energy, reduces energy costs to consumers and connects landlocked regions to the rest of the country through improved infrastructure.62 Impact investments in infrastructure appeal to institutional investors given the size and scale often associated with these transactions.
Other Real Assets: Identifiable and tangible assets, whose value is derived from physical properties, managed to produce long-term value to society and the environment, as assets are not depleted or damaged, such as sustainable forestry and agriculture. For example, Equilibrium Capital manages US$ 500 million and invests exclusively in real assets (e.g. croplands, forestry, and agricultural and food waste). The firm applies a “sustainable alpha” strategy in which assets are stewarded over the long term and considerations across the entire ecosystem (e.g. community and environment) are included in the investment decision-making process.63
Remaining Asset Classes: The most commonly targeted asset classes for impact investing are described above; intentionally omitted asset classes include commodities, direct private equity/venture capital, and hedge funds. These asset classes are less common impact investment targets by mainstream institutional investors. Commodities involve investments made into basic resources that are used in the production of other goods and services. While opportunities may exist for trading of sustainably produced commodities, it is unlikely to occur in the near future. Direct private equity/venture capital64 is a common asset class for impact investment funds to target, but the deal sizes are usually too small for most of the mainstream capital providers described in Section 3.2. Hedge funds involve complex investment strategies of publically traded companies; given the limited number of public listings of impact enterprises, there are currently limited opportunities for hedge funds in impact investing.
Spotlight on Social Impact Bonds
Social impact bonds (SIBs), introduced in Section 3.2, are a pay-for-success contract in which a private investor provides the investment capital to fund an intervention to address a social challenge, typically related to behavioural change (e.g. recidivism, homelessness, childhood obesity, etc.). The investor is paid a financial return based on the savings actually achieved as a result of a successful intervention (e.g. fewer people in prison save the government money; the government pays the investor out of these savings). SIBs are often structured such that a private foundation guarantees a portion of the initial principle invested by the investor, allowing philanthropists an opportunity to leverage their balance sheet for more impact (they only pay if the intervention is unsuccessful). SIBs have gained momentum in recent years because they offer an opportunity to translate socially desirable goals into measurable economic returns; cash flow is generated as a direct result of a social outcome. In this regard, SIBs are highly structured products that require a sophisticated and stable legal framework over a long time frame and thus can be challenging to implement in frontier markets, making SIBs an extremely unique form of fixed income. Furthermore, they are difficult to scale and typically have high transactions costs.
Source: GIIN, J.P. Morgan (2013)