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Welcome to the fourth instalment of Horizons’ major series on impact investing: “Invest like it means something”. This week, Dr. Falko Paetzold analyses impact investing on a practical level by discussing the most common barriers, and how they can be overcome. To read the first release of this series, click here.

Summary:

  • ·Practical barriers: Challenges include defining a sound strategy, conflicts in the investment agency chain, and questions regarding monitoring and evaluating investment performance. It is very helpful to work with specialist advisers, engage in networks, and be clear about expectations.
  • ·Family barriers: Differences in the understanding of impact across and within generations can be overcome, and turned into relational capital, by working with specialist advisers, specifically by mandating family members who are interested in the theme to take the lead, and be diligent in questioning assumptions.

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“Every generation has its challenges to face, its own battles to win. Why should yours be any different? Running away from your responsibilities won’t solve anything”

Luke Skywalker’s force ghost to Cade Skywalker, Star Wars: Legacy.

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Impact investing is a relatively new theme, and is multi-dimensional as it includes financial as well as ethical objectives. Today, Next Gens often rather naturally learn about the theme as part of their exploration of finance. Older generations might wonder about the necessity of the new approach, and how it relates to the “common wisdom” of finance, separating investing from real-world impact. Such aspects can lead to barriers that Next Gens and their families face when they engage with the theme. This section therefore outlines common barriers that families face in their orientation towards impact investing, and how they can be overcome.

 

Practical Challenges

 

To move towards a sound strategy, it is highly advisable – but often ignored – first to develop a comprehensive impact investing policy statement. Such a policy statement clearly defines, within a few pages, the values, goals and investment themes that the family aims to focus on, the asset classes that are considered, the desired financial return together with impact, and how investments are sourced and investment decisions made. Such a thought-through, agreed-upon policy statement provides a valuable filter and guide to implement a strategy thoughtfully. Do decide which types of investment to engage in, and which not.

From the start, a key aspect for Next Gens to consider is that the different actors along the investment agency chain are needed to implement an impact investing approach for the family. However, families often struggle to find suitable advice. In particular, amongst mainstream private banks and family office investment staff, sustainability and impact often are poorly understood, and frequently are rejected as not “real” investment. It is highly advisable to seek specialised advisers for the different steps of impact policy statement development, strategy development, request proposal (RfP) process definition, and strategy implementation. Such experts can be found by attending conferences and by reaching out to impact networks and other families.

Also, due to the limited availability of knowledgeable advisers, sourcing investment opportunities can be difficult for wealth owners. This generates increased “search costs”. This can be mitigated by signing up to databases such as the GIIN’s ImpactBase, lists such as ImpactAsset 50, attending conferences such as the annual SOCAP gathering in San Francisco, and joining invester communities such as Horizons, The ImPact, Toniic, GIIN, or PYMWYMIC.

In addition, investors that actively speak at conferences, support initiatives, and therefore actively position themselves in the impact community, such as Blue Haven Initiative, report great success in being approached regularly with interesting investment opportunities.

Importantly, investers will have to be clear about their expectations, in particular in regard to aspects such as the expected availability of historic performance data. Impact opportunities are often innovative solutions, with sometimes short track record, new teams, and are active in new industries or operate new business models. Again, such expectations should be clearly defined throughout the process of developing an impact investing policy statement, which then serves as a guideline, and helps, for example, to engage more consciously in some of the many first-time impact funds.

Further, structuring investments that combine financial return and impact can be new territory for some investors, and it is advised to work with specialised experts and rely on evolving standards.

Impact monitoring and evaluation is sometimes inhibited by overly idiosyncratic interpretations of what types of indicators are “worthy”, while investments usually report indicators based on standardised measurement sets. Notable is the Global Impact Investing Rating System (GIIRS), which is based on Impact Reporting and Investment Standards (IRIS), a set of measures that provides a common reporting language to describe social and environmental performance, and that ensures uniform measurement and articulation of impact across portfolios.

Lastly, the incentives for and communication between advisers and family office staff often require the explicit integration of impact-related targets, based on qualitative and, optimally, also quantitative measures, in order to avoid the frequent biases that can occur otherwise with traditional models. As put by an US-American Next Gen: “Our CIO used to push back and question why he should deviate from long-term established measures and compromise his incentives by spending time learning about impact if it might yield the same return. We had to really include measures on the minimum share of impact-related investments in order to ensure a re-alignment with what we actually wanted to see in our portfolios. It was a learning journey for us all”.

 

Family Challenges

 

Beyond practical challenges, a number of common themes can come up within families.

Status Quo: Members with significant power compared to Next Gens might not be willing to engage in a process that may challenge the status quo of existing investment processes. In such a situation, it can be helpful to develop the understanding that impact investing is not, really, a very different approach to what most families historically have been doing, particularly when it comes to managing their firms and foundations. It is more of a logical progression in being more explicit in considering how one can do good ethically and well financially. Further, it can be helpful to point younger generations to the specific appeal of impact themes such as financial inclusion, water, energy efficiency or food. A great opportunity lies in engaging them in family investment decisions by giving them the specific mandate to explore the impact theme on behalf of the family. For example, the argument of having the younger generation engage in impact allowed Antonio Moraes, a Brazilian Next Gen, to raise a family-internal cousins fund. The cousins fund laid the groundwork for him founding Vox Capital, one of the first and largest impact investing funds in Brazil:  “Without that angle of us cousins working together, the older generation would perhaps not have been that open to this new model. But that way they saw a reason to give the young generation a specific mandate and let us run off and see what we could come back with; and they ended up really liking it”.

Mindsets: Family members, even within generations, have different views on what their family legacy and stewardship is. Some family members can develop entrenched and personal positions regarding risk and impact. Some believe solving societal and environmental problems is done with philanthropy; they do not have an “integrated” belief system that impact and financial return can be pursued at the same time. Here again, specialist advisers can be of outstanding help. In the process of mediating these different positions, advisers can help families develop a greater understanding and trust for each other. Further, it can be helpful to focus not on investment opportunities that are specifically branded as impact investments, but rather that look and feel like plain-vanilla mainstream investments, while also having a positive impact. Such investments can gradually introduce the notion of impact investing, and over time prove a valuable impact proposition. For example, microfinance products often have very interesting and simple risk-return profiles, together with impact, and can serve as such a “gateway drug” for families and investment managers that are new to the impact investing theme. Next Gens can strategically introduce such solutions first to their other family stakeholders, and then slowly build up the appreciation for impact investing.

Risk-Reward Perceptions: Much related to the above point, impact investing can be regarded as too risky due to the frequent activity of such investments in emerging markets and new business models. In such a situation, it can often be helpful to be diligent in exploring the actual risks, both on an absolute level, and in relation to the risks of the many mainstream investment propositions that have turned out to be more risky than they had initially seemed. It can be helpful to outline the often strong underlying business rationale and trends that drive many impact investments, such as the need for renewable and decentralised energy, innovative financing models for low income communities, or the increasing demand for health food.

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Dr. Falko Paetzold is the Initiator and Managing Director of the Center for Sustainable Finance and Private Wealth (CSP) at University of Zurich and a co-founder of the peer-to-peer Next Gen Impact Investing programme taught jointly at the CSP and the Initiative for Responsible Investment at Harvard University. He was a Post-Doctoral Fellow at theSustainability Initiative at MIT Sloan School of Management. He is also the founder of the global network GreenBuzz that enables several thousand intra-preneurs in different cities to drive sustainability ahead within large firms.