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Feb 17, 2014

Impact Investment Can Yield Competitive Returns

One of the hurdles in expanding social enterprise investment is the worry of investment managers that they must forego competitive returns.  The lack of comprehensive or consistent data makes it difficult to allay that worry.  Newly released, however, is a detailed 68 page report by Sonen Capital of the 7-year investment results of the impact portfolio they designed for the KL Felicitas Foundation.  Compared with traditional investment benchmarks, its portfolio outperformed by 89 basis points over 5 years by reducing risk during the volatile 2008-10 period, while it underperformed by only 20-45 basis points during the recovery years 2010-12.

At its extreme, social impact investments sacrifice market returns in order to achieve significant social benefits.  Sonen Capital chose to seek market returns and explored how much social impact could still be achieved.  To do this it identified four investment filters, ranging from a modest to a larger trade-off between financial and social return.

Socially Responsible Investing (SRI): “negative screening of investments due to conflicts or inconsistencies with personal or organizational values, non-conformity to global environmental standards, adherence to certain codes of practice… or investment activity [with] a social or environmental component in its strategy.”

Environmental, Social, and Governance (ESG): risk factors that are integrated into core investment decision-making, such as environmental risks like more stringent regulation, social risks such as worker safety or child labor, and governance risks such as bribery or corruption or illegal incentives.

Thematic: investments that have a focus on one or more impact themes, such as clean water, deforestation, community development, or food security.

Impact First: investments that seek to optimize a social return without regard for attaining a competitive market-rate return.  This category includes most social enterprises as well as program-related investments (PRIs).

In constructing this portfolio, the impact orientation initially directed only two percent of assets.  By 2012 over 85 percent of assets were allocated through impact criteria while at the same time achieving index-competitive risk-adjusted returns.

Cash equivalent investments were most often guided by thematic criteria, particular community development, microfinance, and financial services to low-income populations.  Fixed income investments were focused on ESG criteria and on the microfinance theme.  Publically-traded equities were most often guided by ESG criteria while hedge fund investments were thematic, particularly for water, agriculture, and energy.  By 2012, ten percent of the portfolio was devoted to the lower return-higher social benefit of Impact First investments.  Of the 17 investments in this category, 15 were PRIs.

Sonen Capital concludes, “the impact characteristics of investments seem increasingly more valuable in the investment decision-making process.”  Their report suggests that the SRI and ESG factors allowed them to capture enhanced return by exploiting market inefficiencies, the thematic investments allowed them to capitalize on long-term social or environmental trends, and the Impact First investments reduced overall portfolio volatility by giving them a significant allocation to less-correlated investments.

This quick summary cannot cover the wide range of issues of concern to an investment manager which Sonen Capital’s 68 page report covers.  And one must be cautious in generalizing from the results of one portfolio over seven years.  Nevertheless, sacrificing 45 basis points to reduce volatility and align a foundation’s investments with its values and purpose seems highly appealing.  Click here for  more monographs by Sonen Capital on impact investing.

If you have a foundation or donor-advised fund, have your investment advisors and managers read the Sonen report and see if you can do well by doing good not just through your grants, but also through your investment portfolio.  It would be a win-win for the foundation, the community, and the nonprofit sector.  If you are a Ohio or Central Ohio foundation or donor-advised fund, consider the Community Investment Network of Central Ohio as one way to get exposed to impact investing.