Impact investing

1. Impact investing P.V. Viswanath

2. Learning Goals • What is Impact Investing? • Why should we be interested in Impact Investing? • What are Impact Ratings? • How can a socially responsible investment be created and managed?

3. Why Impact Investing • There are positive and negative externalities that need to be internalized in some fashion. • Impact Investing can be a partial solution to such internalization, by making it valuable for companies to be socially responsible – in this way, the conflict between shareholder wealth maximization and social wealth maximization disappears. • Government Policies Matter • Social Attitudes Matter • Impact Investing can raise social consciousness about the impact of government policies and social attitudes.

4. Income Inequality: Factors • The Census Bureau reported in 2012 that the median white household held a net worth of $110,729 in 2010, while the median black household held a net worth of just $4,995. Here are some of the factors: • Homeownership • White households are 28 percent more likely to own their home than black households, according to the study. • Income • The average white person's income was $29,401 per year in 2011, while the average black person's income was just $18,357, according to the Census Bureau. • Unemployment • The black unemployment rate was 13.8 percent in January, while the white unemployment rate was only 7 percent, according to the Labor Department. • College education • Roughly 29 percent of whites age 25 and older held a bachelor's degree or graduate degree between 2006 and 2010, compared to only 18 percent of blacks in the same age group, according to the Census Bureau. • Inheritance • Whites were five times more likely to receive an inheritance than blacks between 1984 and 2009, according to the Brandeis study.

5. Underlying factors requiring policy action: Home ownership • Opportunities and barriers in workplaces, schools and communities that reinforce deeply entrenched racial dynamics in how wealth is accumulated. • Homeownership has a huge racial component. Racial segregation by government design and often enforced by federal agencies like the FHAlowered demand for homes in black neighborhoods, reducing the equity black homeowners could accrue. • Because whites are five times more likely to inherit money than blacks, or otherwise help family members with down-payments, whites on average bought homes and started building equity eight years earlier than African-Americans, generally with lower lending costs.

6. Underlying factors: education • Factors that should help everyone helped whites far more than blacks. For example education: "Similar college degrees produce more wealth for whites." • A number of factors contribute to this, including the fact that African-Americans are more likely to graduate college burdened by debt. • Solutions: • We can enforce lending standards and fair housing policies to lessen the effects of segregation and predatory lending. • We can help low-income families and families of color attend college and graduate without massive debt. • We can use the minimum wage and equal pay provisions to reduce the income gap, and strengthen employer-based retirement plans.

7. Impact Investing vs Socially Responsible Investing • Impact investments aim to solve social or environmental challenges while generating financial profit. • Impact investing includes investments that range from producing a return of principal capital (capital preservation) to offering market-rate or even market-beating financial returns. • Impact investing is a kind of "socially responsible investing." However, impact investors actively seek to place capital in businesses and funds that can harness the positive power of enterprise. • In contrast, socially responsible investing often involves negative screening, which focuses primarily on avoiding investments in "bad" or "harmful" companies.

8. Need for Social Impact Ratings • Philanthropy and socially responsible investing work differently from investment for financial profit. • In the case of investing for financial profit, the capital market provides signals as to the desirability of the investment, to the extent that the capital markets are efficient. • In socially responsible investing, investors need to obtain signals of how good a given company is from the point of view of its social impact. • Furthermore, different donors might care about different social issues – one donor might worry about the environment, another about poverty eradication, a third about health. • Social Impact Ratings provide a way to enable efficient capital allocation in the non-profit and socially responsible investment sector

9. Social Ratings for MFIs • Because an MFI is often a non-profit institution, and even if it is a for-profit institution, its business is inextricably tied up with social issues, MFIs have a double bottom line. • Hence, MFIs, as well as their donors/investors need to have information about the MFIs social ratings. is that • One such system of ratings is that of Microrate; it has a system of social ratings for MFIs, similar to its financial ratings. • MicroRate’ssocial ratings measure the social performance of microfinance institutions (MFIs). A social rating not only provides an independent analysis of an MFI’s social performance but goes deeper to evaluate an MFI’s social results and social commitment within its context. (Microrate website). • However, impact investors target a variety of investments, not limited to MFIs. Hence a variety of rating services have come up that evaluate the social impact of any organization, including for-profit corporations. In this case, the corporation itself might not have any explicit social objectives. However, its activities might lead to a high or low social impact, which would be of interest to impact investors.

10. Social Impact Ratings for Companies • There are several systems/providers of social impact ratings • the Total Social Impact Foundation’s TSITM Ratings for S&P 500 companies (uses a numerical score up to 20) • Reputex Ratings & Research Services’ ratings for Australian companies (uses a letter category system ranging from AAA to D) • dotherightthing Inc. ratings for specific events involving a given company (use a numerical range from +5 to -5 • Other research providers offer a narrative assessment of a variety of social impact criteria for rated companies. http://www.ethicsworld.org/corporatesocialresponsibility/PDF%20links/Cosgrove%20paper%202.pdf

11. Social Impact Ratings for Companies • In September 2011, GIIRS, an impact ratings system was launched at the Clinton Global Initiative. GIIRS has been marketed together with IRIS, a set of metrics and PULSE, a tracking system. • GIIRS • GIIRS (which stands for the Global Impact Investing Ratings System) is a comprehensive and transparent system for assessing the social and environmental impact of companies and funds with a ratings and analytics approach analogous to Morningstar investment rankings and Capital IQ financial analytics • IRIS • IRIS is a set of standardized metrics that can be used to describe an organization’s social, environmental, and financial performance. • PULSE • PULSE helps track and benchmark financial, operational, environmental and social data to better demonstrate impact.

12. Social Impact Headings Used by IRIS

13. IRIS Environmental Impact Headings • Biodiversity conservation • Energy and fuel efficiency • Natural resources conservation • Pollution prevention & waste management • Sustainable energy • Sustainable land use • Water resources management

14. Portfolio Issues with Ratings • A Portfolio Social Impact Rating can be calculated simply as the weighted average social impact rating of the companies represented in the portfolio. • Some issues that could make this calculation more complicated are: • Should equity and debt investments should be treated in the same manner • Should short positions should offset long positions in calculating social impact ratings • How should derivatives be treated?

15. Building an Impact Portfolio • Organizational Structure • Separate team: Some impact investment portfolios are managed by a separate team operating alongside program officers responsible for grant-making (e.g. Rockefeller Foundation) • “Hub-spoke” partnership: The social impact aspect is an overlay to the portfolios they manage; there is a partnership between a centralized team and the individual portfolio management teams (e.g. TIAA-CREF.) • Whole institution: Many asset managers, have their entire institution dedicated to impact investments and split out the portfolios by instrument, sector or asset type(e.g. MicroVest, a US-based fund manager with portfolios separated by instrument type (debt and equity). Based on “A Portfolio Approach to Impact Investment” by YaseminSaltuk, JP Morgan

16. Impact Thesis • The impact thesis is the investment philosophy of the fund/organization. • This will usually include these elements: • A target population, which could be defined by income level, degree of inclusion or access, or other characteristics. Examples might be BoP, underserved areas, rural areas, specific countries etc. • A target business model of impact delivery, which focuses the investment opportunity set on certain business models • Target impact, which can be measured to determine the success of the intervention

17. Target Business Model Specification • For example, Global Easy Water Products is interested in energy and natural resource efficiency. Its business model involves a retail, low-cost for-profit approach that delivers technological advancements in irrigation directly to farmers. • GEWP is a for-profit social enterprise in India that focuses on developing and delivering low-cost irrigation solutions to small farmers who are often overlooked by technology advancements. GEWP’s mission is to distribute products that help smallholder farmers to increase their available income, improve their nutrition and earn their way out of poverty. The company’s portfolio contains over 50 different products primarily in drip tape, micro sprinklers, fertilizer tanks and flexible water storage tanks • Alternative business models might include suppliers or distributors from the target population in the value chain, such as utilizing informal retail franchises for distribution. • The investor might have preferences among these business models.

18. Target Impact Specification • Examples of target impact are: • Number of target population reached • Number of customers, e.g. LeapFrog Investments aims to reach 25mm low-income and underserved people worldwide • Percent of business reaching target population • Minimum percentage of customers in target population; e.g. The Africa Health Fund managed by Aureos has set development targets according to the percentage of BoP clients served by portfolio companies • Scale of outputs • Cost-effective expansion of product/service delivery; Shell Foundation aims to act as a catalyst in the very early stage by proving business models that can be replicated at a large scale • Quality of outputs • Improved quality of products/services available; e.g. D.Light provides energy and lighting solutions to households without access to reliable electricity • Pioneer • Addressing a gap in market for which there are few alternatives, e.g. Root Capital provides capital to "the missing middle” (enterprises underserved by either microfinance and commercial banks)

19. Combining risk-return and social impact • The investor then has to combine the standard risk-return dimensions with the social impact dimension. • For example, an investor might have the following profile: • Impact: targets businesses that deliver products and services to underserved communities while meeting a high-standard of employment and resource efficiency practices • Return: seeks to balance asset income and asset appreciation • Risk: seeks a balance between ecosystem risk and investment risk • One thing we see here is that there is an element of risk even in the evaluation of social impact. • While this particular framework puts social impact risk and investment risk in the same category, it may make more sense to create an efficient frontier for social impact that involves expected social impact and associated risk factors.

20. Other Issues • Other issues that have to be addressed regarding the recipients of funding are: • Mission Drift: There is also the risk that investees drift away from their intended mission without the approval of investors. This is a risk among traditional fund managers more generally since managers can be tempted to invest in sectors outside of their mandates when attractive opportunities arise or yields in their designated assets become less competitive. • Moral Hazard: because the investor is explicitly focused on helping the recipient of the funding, it will be even more difficult to enforce loan covenants or submit a claim on assets than would be the case for a traditional lender. • Instruments: Grants versus investment capital