Understanding Impact Investing Performance
Unlike conventional investment management, impact investors can benchmark their performance in social or environmental returns in addition to traditional financial returns. Investors in ESGthemed indices, ETFs, or equity can track financial returns using the same conventional benchmarking tools as other traditional investors. A discussion of financial benchmarking tools will not be included here as there is already a variety of literature on investment portfolio management.
Tracking social or environmental returns, however, is more difficult. Tools such as B Analytics (profiled in more detail in the Appendix) allow investors to manage their companies based on ratings derived from IRIS or GIIRS. Most of this information is only collected ex post facto and cannot be exhibited in real-time. Furthermore, most of the ratings are based on “scores” given to broader themes within environmental, social, and governance categories. This information is qualitative and therefore difficult to assimilate into economic returns, which are tracked in quantitative financial terms. Quantifying social and environmental returns remains a challenge for investors seeking more specific information on whether their “impact investments” are truly making a difference. One possible solution to this problem is the social return on investment (SROI) concept.
Social Return on Investment Social return on investment (SROI) as a benchmarking tool is unique to impact investing. It can be compared to the price/earnings ratio in terms of its potential for evaluating performance. These metrics are used to measure value creation, and the SROI specifically measures the amount of social impact generated on a specific amount of investment in a particular subject.
SROI is not a new phenomenon in the world of impact investing–there have been discussions on SROI in the 1990s–however, measuring SROI remains tricky. Emerson, Wachowicz, and Chun of the Roberts Economics Development Fund (REDF) concluded that social enterprises create value in a continuum that ranges from economic, to socioeconomic, to social value.45 Economic value is the traditional motive for most enterprises; common measurements include return on investment, price/ earnings ratio, and profit margin. Social value is created when processes and inputs are combined to create improvements in the lives of individuals or society as a whole. Emerson, Wachowicz, and Chun state that this is where most non-profits operate, and it is difficult to measure value in this space since most “products” are qualitative and not reducible to analytical terms.
Socio-economic value, on the other hand, includes economic and social value. An entity creates socio-economic value by generating economic value from its inputs, but also by creating social impact. For example, an initiative that provides job-training programs to unemployed people who currently receive public support would qualify as socio-economic value. This initiative develops professional abilities with the potential result of reducing unemployed workers dependent on government support.46
Socio-economic value can be quantified and calculated as SROI, which in turn can help investors evaluate investments before and after they invest. A study conducted by SVA Consulting in Australia on the impact of SROI and SROI reporting showed that the SROI analysis gave organizations a deeper and more analytical insight into their value creation.47 The study also found that the SROI report helped investors and organizations understand the true costs associated with delivering social impact, resulting in better strategic planning. However, SROI is not without its flaws. The study also noted that there were only two forms of SROI analysis: one that estimates social value creation in the past, and one that projects social value creation in the future. The study proposed a need for a third form – “baseline SROI” – that assesses SROI in the present.48
Despite these considerations, calculating SROI can be a powerful way to track portfolio performance. Guidelines on calculating SROI and isolating social cash flows are available in Emerson, Wachowicz, and Chun’s paper. The SROI Network also offers assistance in calculating SROI, social net present value, and sensitivity analysis.49
Market Performance
It can also be challenging for institutional investors looking to understand and benchmark their performance against the general impact investing market. At the time of this writing, there is still a significant lack of analytical research on the impact investing market. Although there have been numerous developments in qualitative frameworks, there is still a dearth of research on market performance and other retrospective benchmarks. Some of the reasons that contribute to this could be 1) the market is still nascent and time horizons are too short to make significant conclusions, 2) many funds or organizations do not release data on their investing performance to the public, and 3) not all actors in the impact investing market are familiar with investment research or analysis. Despite these challenges, the literature on impact investing is constantly evolving to fill new informational gaps.
Impact Investing Benchmark
The Impact Investing Benchmark (IIB) is the first comprehensive analysis of the financial performance of private equity and venture capital impact investing funds. Although it leaves out institutional investors such as sovereign wealth funds and pension funds, the IIB is still useful for any impact investor. To date, it is the only initiative that is produced similarly to analogous financial performance reports for traditional investment funds. In doing so, the IIB is paving the way for analysis of impact investments as an asset class.
Managed by Cambridge Associates and GIIN, the IIB is comprised of 51 private investment funds that were launched between 1998 and 2010. According to their 2015 inaugural report, the IIB found that these funds performed comparably well, despite the perception that impact investing may generate subpar returns.50 From 1998 to 2004, the IIB funds outperformed similar conventional funds, and over the entire 1998 to 2010 time period, underperformed conventional funds by about 1.5 percent. IIB also showed that funds that raised under $100 million returned a net IRR of 9.5 percent to investors – outperforming similarly sized conventional funds (4.5 percent). As with any other investment strategy, manager selection, due diligence, and risk management are still important factors to achieving high returns. The IIB provides much-needed information on impact investing as its own asset class. Its decision to focus on private investments shows that the impact investing strategy can be viable on a smaller basis as well. For institutional investors, this means that impact investing can be done without usurping many other fund resources.
Literature on Impact Investing Practices
While impact investing is not new, the recent exponential growth in the demand and diversity of this type of investing means that few widely established practices exist. An increasing number of organizations are producing both theoretical and practical advice for crafting a successful impact investment portfolio. For investors looking for qualitative information on how to manage an impact investment portfolio, several entities conduct their own internal surveys of institutional investor practices.
J.P. Morgan and GIIN conduct an annual impact investor survey that includes information on asset allocation and performance, portfolio management, and general perspectives on the impact investing market. Their latest edition, published in 2016, featured answers from 158 impact investors that allocated capital to a wide range of asset classes and industries.51
The Sovereign Investor Institute has also conducted surveys on institutional investors – many of whom are impact investors as well. The Institute’s polling reports feature perspectives on macro risks as well as the percentage of participating institutional investors that promote good governance in their portfolios.52
Other resources include the UK DFID, Rockefeller Foundation, and various academic institutions. For example, Rockefeller Foundation not only publishes articles on their investment performance, but also makes public their list of grantees and investments.
By Rachel F. Wang, Fellow, Bretton Wood’s Initiative.
Download her report at: https://na-production.s3.amazonaws.com/documents/Impact-Investing-for-Institutional-Investors.pdf
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