Impact Investing for Institutional Investors

Impact investing is here to stay and going mainstream: Recent impact investing conferences like the Impact Summit Europe and the GIIN that feature the who’s who of the financial services industry don’t leave any doubt about that. A good set of investment managers have an experienced head start of several years and are creating differentiated positions for their companies in the market.  These savvy investors move beyond the simplistic impact vs. return debate, as Omidyar Network and FSG portray in the Beyond Trade-offs series published on The Economist digital hub, as well as in a set of newly-released podcasts on that same theme.

Here are some key take-aways for institutional investors:

1. Institutional investors—such as banks, insurances, and pension funds, for example—can explore their unique role within the impact investing market. These institutional investors can seek out the market segments where impact goes hand-in-hand with financial return, or even delivers impact alpha, i.e. excess return beyond market benchmarks. In impact investing, there is a broad range of viable impact investment profiles, some of which involve a choice between impact or financial return, and some of which do not. Therefore, fiduciary duty is only a mental hurdle—and not a fact-based hurdle—for involvement in the space.

From a thematic perspective, particularly financial services, clean energy/energy access and affordable housing have proven dual business models that achieve market rate returns in several geographies and customer segments (see e.g. Elevar’s experience and Lok’s microfinance funds).

Institutional investors can also pioneer new instruments in their quest to find ways to deploy capital for good. One of the newer additions to the impact investment spectrum is dubbed SDG or Shared Value investing. When institutional investors go beyond risk-avoiding ESG screens to explore the “right tail opportunity” of investments in purpose-driven multinationals, they can vastly expand the impact derived from their public market allocations, as Goldman Sachs explains in the Beyond Trade-offs contribution.

Front-runners like Philips already push investors one step further: They want to not just be selected as investment in a public market impact investing portfolio, but actively create investment solutions with the asset managers. They already have a $1B revolving credit facility with a bank consortium where interest rates are tied to their sustainability performance, and now look to impact bonds and special purpose vehicles to drive specific impact goals of their purpose-led corporate strategy.

2. An important learning from the front-runners is to not mute, but actually to lean into the tensions and concerns about impact investing one hears from colleagues and top management. Does it create real impact? Can it create market rate returns? Isn’t it inherently riskier? It is not helpful to hide below-market rate investments within a bigger portfolio and only report on the average outcomes. One of the key Beyond Tradeoffs messages is that investment officers need to understand the full risk-returns-impact continuum available and select different instruments, with transparency about what each of these vehicles can and cannot achieve. Asset class flexibility and a breadth of target impact outcomes have allowed Prudential to ensure a steady and diversified pipeline across their three differently positioned impact portfolios.

Often times the term concessionality gets carefully avoided around institutional investors, yet it is a fact that the full continuum of capital is essential to tackle the world’s pressing challenges. Prudential finds that transactions in their sub-commercial, “catalytic portfolio” routinely become future sources of alpha in their main “impact managed portfolio” (hear about the symbiosis here). Not all institutional investors have the means to play across the spectrum like Prudential, but they still shouldn’t be deterred by the fact that some impact investing market segments need catalytic capital. In fact, they can participate in developing these segments through blended finance deals: government backed development finance institutions take high-risk tranches to mobilize additional institutional investments for developing countries. The fund sizes are attractive to even the largest institutional investors: Climate Investor One, initiated by the Netherlands Development Finance Company FMO, recently announced its third close at USD 535 million, attracting bank and pension fund investments from all over the word to lower the cost of clean electricity in developing countries.

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