wef impact investing december 2013

8/11/2019 WEF Impact Investing December 2013

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World Economic Forum

2013 - All rights reserved.

No part of this publication may be reproduced or transmitted in any form or by any means,including photocopying and recording, or by any information storage and retrieval system.

The views expressed are those of certain participants in the discussion and do not necessarilyreect the views of all participants or of the World Economic Forum.

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3From Ideas to Practice, Pilots to Strategy

Table of Contents 1. Preface

3 1. Preface

4 2. Introduction to the MainstreamingImpact Investing Initiative

7 3. More than an Idea: Creating the Casefor Impact Investing

7 3.1 Enhancing Financial Returns by Targeting Social Impact

9 3.2 Making Impact Investing anInstitutional Priority for AchievingSuperior Investment Performance

11 3.3 Evaluating Past ImpactfulInvestments to Create a FutureImpact Investing Strategy

15 3.4 The Current Limits and PotentialRole of Institutional InvestmentCulture and Fiduciary Responsibility

18 4. Building a Strategy: Integrating ImpactInvesting in the Mainstream InvestorsPortfolio

18 4.1 A Portfolio Approach to ImpactInvestment: A Framework forBalancing Impact, Return and Risk

22 4.2 Leveraging Exper tise across Asset Classes for an InstitutionalImpact Investment Mandate

26 4.3 Incorporating Impact Criteria inPortfolio Construction: From Policy toImplementation

29 4.4 How to Evaluate Impact InvestingFund Managers

32 4.5 Best Practices ofHigh-Performing Impact InvestingFund Managers

36 4.6 Achieving Portfolio Diversicationand Double Bottom Line throughInvesting in Underserved Markets

40 4.7 Impact Investing through Advisersand Managers who UnderstandInstitutional Client Needs

43 5. Innovations for Unlocking MainstreamCapital

43 5.1 Social Stock Exchanges:Democratizing Impact Investing

47 5.2 Commingling Funds: ScalingImpact while Protecting the Interestsof Diverse Capital Providers

50 5.3 The Social Impact Bond Market: Three Scenarios for the Future

53 6. Road Map: Next Steps forMainstreaming Impact Investing

55 7. Acknowledgments and Aboutthe Authors

From Ideas to Practice, Pilots to Strategy is both an attempt and an opportunity to disseminate the best practicesand lessons learned from the rst movers, early adopters

and bold innovators in the eld of impact investing, with thegoal of further advancing the sector.

When we published From the Margins to the Mainstream: Assessment of the Impact Investment Sector andOpportunities to Engage Mainstream Investors in September2013, we sought to add clarity to the eld through a realistic,current assessment. With over 10,000 people accessingthe report in the rst two weeks, it became evident that wetouched on a strong need. However, given the relativelysmall scale of impact investing, we realized that more thanclarication was needed. For active investors in the eld,to shift impact investing from a small part of their portfoliosto a full-edged strategy requires operational and practicalknowledge. New players in the impact investing space,looking to take it from a compelling idea to a real investmentapproach, need to know how to get started in this nascentand potentially rewarding sector. This codied know-howand repository of best practice is currently as embryonic asthe sector itself.

Readers of the Margins to Mainstream report reachedout from far and wide to ask for advice on how to start(or do even more) with impact investing. While we couldhypothesize and make suggestions, it is only experiencedimpact investors who can speak with authority about whatdoes and doesnt work, and why. With that in mind, wecurated this collection of short, action-oriented and insightfulthought pieces on how to put impact investing to work.

Because the sector is in a nascent stage and engagesdiverse individuals, organizations and societies, no onesolution will apply to every situation. Rather, this publicationcan serve as a trailhead and as a semi-trodden path for newpractitioners; but much more trail-blazing will be necessarybefore the sector can call itself mature.

We advocate learning by doing, failing fast, synthesizingfeedback and quickly re-engineering shortcomings intoa more informed approach. Above all, we believe thatintentions (and certainly good ones) matter with everyaction and step towards building a new sector. With theseprinciples in mind, we can collaboratively and proactivelyensure that the impact investing sector is on the best pathforward.

For the many key players whose wisdom and expertisecould not be represented here, we look forward to hearingfrom you and, where possible, including your perspectivein future efforts to help bring the impact investing sector tomaturity.

Contact us at [email protected]

Michael DrexlerSenior Director,Head of InvestorsIndustriesWorld EconomicForum USA

Abigail Noble Associate Director,Head of ImpactInvesting InitiativesWorld EconomicForum USA


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4 From Ideas to Practice, Pilots to Strategy

2. Introduction to theMainstreaming Impact

Investing Initiative

Target Audience for Ideas to Practice, Pilots toStrategy

This publications target audience includes three key groups:(1) investors looking to start impact investing; 2) activeimpact investors looking to expand impact investing froma limited part of their work to a full-edged strategy; and(3) intermediaries, policy-makers and development nanceinstitutions whose support is vital for the sectors growth.Since large investors often have a proportionally largeinuence on a sector, a key focus is on highlighting bestpractices or frameworks from large asset owners and assetmanagers.

Motivation and Scope of Ideas to Practice, Pilotsto Strategy

The reports goals are to show how mainstream investorsand intermediaries have overcome the challenges in theimpact investment sector, and to democratize the insightsand expertise for anyone and everyone interested in theeld. Divided into four main sections, the report containslessons learned from practitioners experience, andshowcases best practices, organizational structures andinnovative instruments that asset owners, asset managers,nancial institutions and impact investors have successfullyimplemented.

The strategic case for impact investing from the mainstream

investors perspective is the focus of More than an Idea:Creating the Case for Impact Investing. This sectionincludes the following key messages:

Reecting environmental, social and governance (ESG)standards in the investment process, across assetclasses and alongside traditional nancial metrics andcompetent risk management practices, can generatesuperior risk-adjusted, long-term investment returns.Moreover, inadequate ESG capability can lead to poornancial performance.

Institutional investors can shape markets and encouragemanagers to design products with social impact. Recentdata indicates that many institutional investors lookto incorporate ESG standards into their investmentdecision-making. However, so that impact investmentstrategy becomes an institutional priority, decisions

Nearly two years ago, at its Annual Meeting in Davos inJanuary 2012, the World Economic Forum conveneda discussion among mainstream investors and socialentrepreneurs on how to harness the hype of ImpactInvesting. While the list of reasons why impact investingwould remain niche seemed overwhelming, bringing it intothe mainstream was too important an opportunity not topursue.

With this in mind, the Forum launched the MainstreamingImpact Investing Initiative. The rst milestone From theMargins to the Mainstream: Assessment of the ImpactInvestment Sector and Opportunities to Engage MainstreamInvestors was released in September 2013 and providedan overview of the sector, identied challenges constrainingthe ow of capital, and laid the groundwork for mainstreaminvestors to begin a meaningful discussion on impact

investment. Most of the constraints identied t into oneof four broad, overarching challenges: an early-stageecosystem; small average deal size; the t within an assetallocation framework; and double bottom line.

From Ideas to Practice, Pilots to Strategy is the secondpublication in the Forums Mainstreaming Impact InvestingInitiative. The report takes a deeper look at why and howasset owners began to include impact investing in theirportfolios and continue to do so today, and how theyovercame operational and cultural constraints affectingcapital ow. Given that impact investing expertise isspread among dozens if not hundreds of practitioners andacademics, the report is a curation of some but certainlynot all of those leading voices. The 15 articles are meantto provide investors, intermediaries and policy-makers withactionable insights on how to incorporate impact investinginto their work.


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must come from top leadership. Institutions that have acommitment from top leadership for impact investing (ora similar mission) nd it easier to implement the strategyas well as collaborate for shared successes.

Reviewing past successes, those intended or not, canhelp investors evaluate potential strategy within theirinstitutions. Large investors can conduct a rigorous

review and retroactively tag their investments asimpactful (i.e. those with a measurable social andnancial return, but without clear intent). By sharingthis knowledge, such investors help to set a reassuringclimate for future impact investment strategy that wouldinclude explicit intention to generate measurable socialand nancial returns.

Traditional investors are seeing the benets of diversifyingportfolios by working with socially minded investmentmanagers who generate reasonable returns that aresomewhat uncorrelated.

Conventional interpretations of duciary duty can lead toherding, which while providing safety of numbers, canproduce investment decisions that are not in investorslong-term interests. For impact investing to engagepension funds, there must be a clear account of howimpact investing is congruent with duciary duty, andactive engagement with asset owners on why impactinvestments may require funds to reassess their ownattitudes towards what constitutes conventionalinvestment.

The section on Building a Strategy provides examples

of organizational structures, processes and strategiesemployed by large asset owners and asset managers toimplement impact investing, while generating risk-adjustednancial returns and meeting the duciary responsibilitiesof institutional investors. Depending on the organizationalstructure, the frameworks may include impact investing asan investment approach across various asset classes; or,focusing and developing expertise in a particular sector. Thissections key messages include the following:

Impact Investing can be done within a large institutionthrough a variety of operational approaches: a stand-alone team, a hub-and-spoke structure, an outsourcedadviser or an institution-wide commitment and strategy.Whatever the approach, the impact investment thesisand criteria for selecting and evaluating impact should beclear from the outset. In addition to diversifying acrossasset classes, impact investors can increasingly diversifyacross impact sectors as markets deepen

Investors need to ensure that impact investing is

well-integrated into an organizations decision-making processes and has buy-in from major internalstakeholders. If impact investing has received supportfrom top leadership, integration of it throughout

the organization is a matter of communication andcoordination. In other circumstances, it is up to theteams to open communication channels laterally andcollaborate across teams for shared objectives such

as diversied portfolios and reduced costs of enteringnew markets. Impact investors can diversify not onlyacross asset classes, but also and increasingly acrossimpact sectors, as markets deepen and the choice ofinvestment opportunities grows.

Given impact investing is a nascent sector, focusing

due diligence on fund managers track records may

hold the industry back. Investors should rather seek tounderstand the factors determining a fund managersdecision-making process.

Partnership is critical for success. Successful impactinvesting fund managers share four qualities: partneringeffectively with the public sector, using catalytic capital,providing multilingual (i.e. cross-sector) leadership,and placing nancial and social objectives on equalstanding. Moreover, treating investors (LPs) as partnersfrom the outset on governance structures, nancialand development goals, as well as including impactobjectives early in the investment process, is importantto ensuring mission alignment among key players.

Impact investing does not have to be nance-rstor impact-rst, but can be professional-rst. Assetmanagers can apply the same degree of professionalismto investment decision-making as to traditional investing,and so comply with the duciary responsibility ofinstitutional investors. Investors can use a methodicalapproach to building an impact investment portfoliobased on the risk, return and impact prole of individualinvestments and the portfolio as a whole.

Innovations for Unlocking Mainstream Capital looks atinnovative impact investing solutions that can meet theneeds of multiple stakeholders, including commercialinvestors, philanthropic organizations, governments andretail investors. The sections key messages include thefollowing:

Commingling funds serve as innovative forms ofpartnership among previously isolated capital providers.Set up correctly, they can multiply the impact of capitalwhile preserving their contributors interests.

The Social Stock Exchange is a mechanism for openingup impact investing to retail investors, as well as makingit more attractive to mainstream investment. A conduciveenvironment for issuers and investors, along with anecosystem within which they can interact, are importantrequirements for creating a vibrant public impactinvesting market.

Social impact bonds (SIBs) are a novel way of ndingeconomic solutions to social problems and, as such,have tremendous potential for channelling resourcesto programmes that work. Development of a mature,well-organized SIB market based on solid infrastructure

is still very much a work in progress; a robust pipeline ofSIB-ready projects, an ecosystem and a blended-valueinvestor pool are and will be key factors for success


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3. More than an Idea: Creatingthe Case for Impact Investing

3.1 Enhancing Financial Returnsby Targeting Social ImpactBy Gavin E.R. Wilson, Chief Executive Ofcer, IFC AssetManagement Company

Key Insights

Based on IFCs investment track record, a convincingcorrelation exists between those investments that dowell on a nancial yardstick and those that show strongdevelopment results; moreover, integrating ESG criteriainto the investment process appears to enhance nancialperformance.

Incorporating non-nancial factors into the investmentprocess requires additional skills and expense, but it isself-reinforcing rather than counter-productive in terms of

investment performance. The growth in impact investing will serve to develop

common standards, language and measurementyardsticks and thereby reduce transaction costs forinvestors looking to combine social impact with nancialreturns.

The International Finance Corporation (IFC) invests in privateenterprise in developing countries. We do so to promoteeconomic development as well as to make a prot. Whenwe make investments, our aim is that all of them shoulddo well on both dimensions. Of course, they dont alwaysdo so, so we invest a lot of time to understand the linkbetween our investments and their development results.By measuring our development results and nancialperformance, we have seen a convincing correlationbetween those investments that do well on a nancialyardstick and those that show strong development results.

This has positive implications for the ongoing debate onsocial impact investing.

An independent study by the World Bank GroupsIndependent Evaluation Group 1 looked at 176 IFC debt andequity investments totalling US$ 3.1 billion that reached

early maturity in the three-year period of 2006-2008.Thestudy looked at each projects development and investmentoutcomes, scoring each outcome high or low. Projectsscoring high on both outcomes or low on both outcomesrepresented 83% of all projects. This rose to 89% when the

analysis focused on equity investments only (64 investmentstotalling about US$ 800 million).

In our experience, superior nancial performance seems togo hand in hand with strong development results. This is notcompletely surprising, since an investment in a companythat grows fast, employs more people, pays more taxes,invests more in research and development, responds well

to environmental and social issues and increases exports,is likely to yield good returns and support local economicgrowth.

This correlation also emerges when we look at an investeecompanys nancial returns and its ESG performance.

The preliminary results from two internal analyses weconducted on our equity portfolio suggest that companieswith good environmental and social performance achievenancial returns dramatically better than those with lowenvironmental and social performance. This result holds fornon-listed as well as listed companies; leaders in ESG alsodisplayed lower return volatility. These correlations reectthe instinctive belief that well-managed companies willscore well on many dimensions; but, what does it say aboutcausation?

Traditional investment theory holds that nancial returns(or, more precisely, risk-adjusted returns) will be negativelyaffected if an investor introduces a non-nancial objective.

The argument is simple: adding a new constraintnecessarily limits the attainment of the original objective.

A double bottom line is not a free lunch. If this is true,it has challenging implications for the mainstreaming ofimpact investing. Can nancial returns and social impact

be mutually reinforcing, or are they bound to restrict eachother?

This is where it gets interesting. We have integrated our ESGanalysis into our investment decision process. Essentially,when evaluating a potential investment, we are assessing acompanys current ESG performance (including its capacityto improve). While it is just one of many criteria examined,we have come to the conclusion that strong ESG capabilitytoday is a predictor of future nancial performance; inother words, to predict a companys nancial performance,pay attention to its current ESG capability. So, includingan additional objective of promoting environmental andsocial sustainability actually supports attaining the nancialobjective. The additional objective has helped not hinderedthe achievement of the rst.


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While superior ESG capability may be a leading indicator ofstrong nancial results, this does not mean that the formeractually causes the latter. Nevertheless, we have goodanecdotal evidence from our portfolio that inadequate ESGcapability can certainly cause poor nancial performanceby negatively affecting business operations. For example, amining company that loses its licence due to environmentalinfringements or social issues is not doing much good forthe local economy or for its investors. Viewed from theportfolio level, the risk-return ratio is improved if these typesof poor performers are excluded, thus enhancing overallreturns as well as reducing risk.

Of course, IFCs experience is focused entirely oninvestments in developing countries; it is possible that therelationships we perceive between nancial returns, ESGcapability and social impact are peculiar to developingcountries with their less-developed capital markets. Theserelationships may also be driven by our particular styleof minority growth equity investing. Still, the alignment isremarkably consistent across region, sector and vintage

year when viewed from the perspective of both our directinvesting and fund investing businesses.

One caveat is worth mentioning: it takes time and effort toincorporate non-nancial factors into investment decision-making. It may lead to better decisions, but it doesrequire resources. IFCs Development Impact Departmentcomprises about 25 staff, with 25 more specialists ininvestment departments who measure development impact.In addition, 16 corporate governance and 60 environmentaland social sustainability specialists work on over 600investments made each year (and many that we decidenot to make), as well as on a portfolio of nearly 2,000existing investee companies. We use our IFC PerformanceStandards on Environmental and Social Sustainability togovern our investment activities, covering both the duediligence conducted prior to investment and the subsequentperformance of our portfolio companies on a range ofenvironmental and social issues.

These standards are designed to help clients avoid,mitigate and manage risk as a way of doing business in asustainable way. Launched in 2006 and updated in 2012,IFCs Performance Standards dene thresholds of behaviourthat we expect our portfolio companies to reach across a

number of areas, including assessment and managementof environmental and social risks and impacts; labourand working conditions; resource efciency and pollutionprevention; community health, safety and security; landacquisition and involuntary resettlement; biodiversityconservation and sustainable management of living naturalresources; indigenous peoples; and cultural heritage. Weview this not only as a compliance activity but also asone where we advise and assist our clients to improveperformance on dimensions relevant to their businesses.Our internal team includes specialists in all these areas,some with technical backgrounds and others with legal orinvestment expertise.

Similarly, IFC has established its Corporate GovernanceMethodology, a system for helping investee companies andother clients to address corporate governance risks andopportunities.

While we rmly believe that attention to ESG criteria addsto our track record on nancial performance, this is nota free good that can be replicated by every investor. Asa development nance institution, IFCs strategic driversinclude both nancial sustainability and development impact.

The double bottom line approach requires more resources,but in our experience this is self-reinforcing rather thancounter-productive.

Recommendations

Common standards are vital. As impact investing evolves,many debates on how to dene and measure social impact,and various types of social objectives, will arise. However,if we can develop a common language, as exists on thenancial side of the equation, it will become much easierto compare different investors, investees, investment stylesand strategies and thus understand where the alignmentis strongest (and where not).This will differ by industry andregion and will evolve over time.

In 2002, we convened a group of 12 commercial banks,leaders in project nance, to discuss environmental andsocial issues in their eld. In the following year, these banksused IFCs environmental and social standards, then referredto as IFCs safeguard policies, as the basis for a voluntaryrisk-management framework known as the EquatorPrinciples. This framework has been adopted by 78 nancialinstitutions from 35 countries, covering an estimated 70% ofinternational project nance debt in developing countries. 2

Similarly, in 2005, the United Nations helped initiate thecreation of the Principles for Responsible Investment (PRI),

a set of six core principles for institutional investors lookingto incorporate ESG criteria into their long-term investmentdecision-making. Currently, about 1,200 investorsrepresenting US$ 35 trillion in assets under managementhave signed on to the principles. 3

These examples illustrate how like-minded early adopterscan create a template for a set of minimum standards. Forimpact investing, these standards could cover how socialimpact is dened and measured prior to investing, and howit is subsequently evaluated as investments mature. Theobjective would not be to cajole investors into becomingimpact investors, but to allow those looking to invest withimpact to speak a common language and develop a sharedset of investment approaches and evaluation tools.

Conclusion

Where will social impact investing go from here? Traditionalinvestment theory might suggest that greater capitaldeployed in a specic area tends to reduce returns,including social returns; however, this is the sametraditional thinking that suggested nancial returns couldnot be aligned with social impact. Far from reducing socialand nancial returns, the growth in impact investing willactually help to develop common standards, languageand measurement yardsticks; these in turn will reducetransaction costs associated with a double bottom line,thereby benetting investors, investees, social entrepreneursand their clients.


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of a sound investment process. We are convinced thatmarkets in which all relevant ESG risks and opportunitiesare correctly priced offer powerful incentives. Companiesthat effectively manage their impact on the environment andsociety, while adhering to high standards of governance andintegrity, should also enjoy a premium. However, the positiveimpact of integrating ESG factors in an investment strategyis likely to be indirect and difcult to quantify and measure.

Pillar Two: Investing for targeted and measurableimpact without comprising nancial returns

It follows that the second pillar of our responsible investmentstrategy is to look for investment opportunities that allowus to generate a much more targeted, direct and potentiallymeasurable outcome, but without compromising nancialsuccess: this is our denition of impact investing. Weacknowledge that our approach will only have a true impactif responsible investment becomes mainstream.

Pillar Three: Collaborating to build the sector whilebecoming a leader in responsible investing

With that in mind, our strategys third pillar is focusedon thought leadership and industry initiatives to provideinsights and raise wider awareness about topics related toresponsible investing.

Responsible investment must be led by a person highlyfamiliar with the organization and the existing investmentapproach. Specialist know-how in the eld is also required.For this, Zurich recruited an analyst with experience inresponsible investment. However, the ultimate goal isto have everyone in IM thinking as a single responsibleinvestment team.

Resources Need to Be Allocated and Incentives Aligned

A strategic approach to responsible investment, basedon a clear vision and supported by strong leadership,will ensure that an organization devotes the resourcesnecessary to accomplishing the task. Effectively managingchange, driving engagement, and ensuring that responsibleinvestment goals are expressed in general investmentmanagement concepts and vice versa, require both strongleadership from the top and diffused ownership andempowerment of the objectives throughout the institution.

Responsible investment brings with it a new language,concepts and market participants. This is particularly truewhere impact investments are concerned. However, Zurichhas consciously rejected creating a designated responsibleinvestment department on the side, which would introduceparallel structures to IM. In accordance with Zurichsoverall CR approach to fully embed the respective focustopics within the topic-owning departments, responsible

investment will be fully integrated into IMs culture.

Zurich embarked on this journey by embedding CR targetsinto individual goals as part of the overall objective-settingprocess. Within IM, the CIOs targets, as well as those of the

CIOs leadership team, already reect the goal of responsibleinvestment. Targets to support responsible investment arealso included in the individual objectives of most seniorIM staff, and of all those directly involved in responsibleinvestment initiatives.

Selecting and Working with Investment Products:Green Bonds and Beyond

Roughly 30% or US$ 65 billion of Zurichs investmentportfolio is held in government, government-guaranteedor supranational bonds. Within this minimum risk assetclass, green bonds have emerged as a potential opportunityfor impact investing and have been predominantly issuedby supranational institutions such as the World Bank,IFC, European Investment Bank and others. Green bondproceeds are ring-fenced, meaning they can be used onlyto fund projects that either mitigate climate change or helpcommunities to adapt to its consequences. Currently nostandardized approaches for project selection frameworksand measuring impact exist. However, all major issuersapply well-developed internal methods to set targets andtrack progress of the environmental impact of underlyingprojects. Green bonds are of the highest credit quality, andwhile returns are modest, so are the risks.

The green bond market is still relatively small, with totaloutstanding issuance at around US$ 10 billion, dependingon the exact denition. The market attracts many buy-and-hold investors, and individual issues have tended to berelatively small compared to standard bond issues in thesupranational space. While the impact of underlying projectsis impressive, most of these would also have received

funding through the supranationals regular bond-issuanceprogrammes. After a number of conversations with theissuers, Zurich realized that the true impact would lie in itsability to invest in size, and to make a signicant contributionto the markets development by actively and regularlyparticipating in it.

Zurich conducted an in-depth analysis of green bondsthat conrmed they would complement the existingportfolio well, and allow for a minimal increase in yield withan equally minimal increase in risk. Zurich also weighedvarious restrictions and limitations, and determined that up

to US$ 1 billion would be a prudent allocation for one ofits largest balance sheets. Most of Zurichs investments inNorth America are managed by external asset managers,so the same approach was chosen for green bonds andthe process supported by the manager selection team.

At the outset, a dedicated mandate was established totie the potential allocation to the anticipated level of greenbond issuance in the market. Eventually, green bonds maybecome part of Zurichs broader xed-income portfoliobenchmarks.

Once the allocation parameters were established, portfolioguidelines were drafted and the search for an externalasset manager began. Standard processes and theestablished investment committee governance werefollowed throughout. With regard to the manager selectioncriteria, a collaborative approach to support developmentof the green bond market, including an active dialogue


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with issuers and other market participants, was deemedvital. Despite the relatively simple nature of a green bond,it took many months to complete the process. The verynotion of green meant that educating people about thebonds and addressing their perceived concerns formed asubstantial part of this effort. Joint responsibility, sharedby the head of responsible investment together with theregional investment management team,helped to accelerate

the process in some cases, but slowed it down in others.Carefully planning joint efforts and dening responsibilities isimportant. To date, Zurich has invested over US$ 200 millionin various green bonds. Next steps will include following asimilar process for green bonds issued in other currencies.

Recently Zurich began two other projects to determineimpact investing strategies for private equity and debtinstruments. These projects will follow a similar overallprocess, but they will take more time than the one relatedto green bonds, as the risks and the return opportunitiesare considerably more complex. These types of investmentstend to be more fragmented and less liquid, and areoften not geared to institutional investors of a certain size.Some of the challenges include nding people with theright skills and nding the right partners to engage with.More complicated structures also face more regulatoryrestrictions; while mandates need to be narrow enough toeffectively control risks, they should be sufciently broadto allow for necessary scale. They also need to take intoaccount any limitations when it comes time to measureimpact. As a global team, and with the ability to tap into theknow-how of some of the leading asset managers, Zurich iscondent that these challenges can be overcome.

The Journey towards Responsible Investment IsLong and Cannot Be Completed Alone

Insurance is a long-term business, as policy-holders expectus to provide security for 10, 20 or many more years in thefuture. Responsible investment can generate the superiorinvestment performance our shareholders and policy-holders expect from us in a sustainable and fair way, but todo so requires the right processes and incentives, and getsto the heart of investment philosophy and organizationalculture.

It will require many years to establish a culture in whichresponsible investment practices are fully integrated intoZurichs overall investment philosophy and approach. Therewards of achieving this in terms of investment returns andpositive impact will, however, be well worth the effort. Acommitment to responsible investing engages our existingemployees and helps in recruiting new talent. It will enhancethe Zurich brand not just with todays customers, but alsowith those in growth markets who will form tomorrowsmiddle classes. It also sends a signal to our shareholdersthat Zurich truly takes a long-term view. Most importantly,it is consistent with our long-term company strategy andvision for a more secure world.

3.3 Evaluating Past ImpactfulInvestments to Create a FutureImpact Investing StrategyBy Elizabeth Littleeld, President and Chief Executive Ofcer,Overseas Private Investment Corporation (OPIC); MitchellStrauss, Special Advisor, Socially Responsible Finance,

OPIC; and Astri Kimball, Senior Advisor for Policy andOperations, OPIC

Key Insights

Most impact investments need different types ofcapital at different stages of the investment life cycle.Development nance institutions (DFIs) are a powerfulbridge; they can provide nancing, align different sourcesof capital, and provide risk mitigants that remove the

barriers to allocating capital to impact investments. By tagging investments retroactively as impactful

investments; institutions can demonstrate a track recordacross investment products with a full spectrum ofnancial, social and environmental returns; this can helpreinforce strategic case for impact investing.

It is difcult to draw a line between those investmentsthat had social and nancial intent at the outset, andthose that did not have this dual intentionality. A strictdenition and a clear methodology are critical.

The Overseas Private Investment Corporation (OPIC) is theUS Governments development nance institution. Workingexclusively with the private sector for over 40 years, OPICmobilizes private capital to help solve critical developmentchallenges in emerging markets. With a portfolio of US$ 18billion and operating in over 100 countries, OPIC achievesits mission by providing investors with debt nancing,guarantees, political risk insurance and support for privateequity funds.

OPICs Portfolio Review

In recent years, OPIC has made it a priority to supportimpact investing through requests for impact investing fundproposals; new product development to address specicmarket gaps and needs; and identifying and highlightingimpact investments in its portfolio.

In 2012, we set out to determine how much of OPICsbusiness met the strictest denition of impact investing:

investments with partners whose very business models aim to address social or environmental problems while generating sustainable nancial returns . We conducted a fullreview and tagging process of our portfolio to apply thistest to each of our investments, and found that determiningintent was often subjective and not always clear-cut.Knowing this, we rst identied OPIC commitments insectors whose investors tend to be socially motivated, suchas agriculture, health, education, renewable energy, nance,housing for the poor, and water and sanitation.


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From there, each individual investment was examinedagainst the intentionality test to identify those investmentsthat were specically intended to bring positive socialimpact alongside nancial sustainability. The review revealedthat of OPICs US$ 3.6 billion in nancing and insurancecommitted in 2012, US$ 333 million qualied as impactinvestments. This same methodology was applied to OPICscommitments going back to 2008, ultimately identifying 129

impact investment projects over the ve-year period totallingUS$ 2.4 billion in commitments.

OPICs Impact Investing*2008-2012

Number of impact projects: 129

Value of impact projects: US$ 2.4 billion

Host country jobs: 10,657

* Numbers represent impact investing with intent. They excludetransactions generating social or environmental returns that were not the

main intent of the project.

Impact Investments vs Investments with Impact

All OPIC transactions aim to have development impact, but not all are tagged as impact investments.Two examplesillustrate the distinction:

Tagged as an OPIC impact investment: MicroEnergyCredits (MEC)

OPIC committed a US$ 10 million loan to MEC for thedevelopment of carbon credit programmes. Low-incomepopulations access to clean energy products, such asclean stoves for cooking and heating, water puriers andsolar lighting, will be made easier and more affordablethrough this loan that directly links the purchase of thoseproducts to the generation of carbon credits. MEC is anenvironment-and-social-rst investor that qualied as animpact investor through OPICs tagging process.

Not tagged as an OPIC impact investment, despite being an excellent venture: Sante GMT (Sante)

OPIC provided a US$ 10 million loan to Sante, thelargest dairy and juice production facility in Georgia.Theloan enabled the company to improve milk productionand distribution, with 20 new milk collection centresthroughout the country and strong local job creation.Sante has had a powerful development impact; however,according to our denition, it did not qualify as an impactinvestment because it was undertaken strictly as aneconomic venture.

Lessons learned from OPICs portfolio review

1. Identify and adhere to the industrys standard denitionfor impact investing (investments with intent to addresssocial or environmental problems while generatingsustainable nancial returns)

2. Create a process to assess and document the intent

behind each investment 3. Do not underestimate how difcult it will be to draw a line

between those investments that had social and nancialintent at the outset, and those that did not have this dualintentionality

4. Value quality over quantity To truly understand this sector and its role in a portfolio, it

is better to have an inventory of truly impact investmentsthan a large number of investments that fall in a greyarea.

5. Develop a methodology that tracks the performance ofeach nancial instrument

6. Do not expect nancial return data right away We sought to determine if our impact investing portfolio

performed differently than the rest of our portfolio;however, we were unable to draw clear conclusionsas most of OPICs nancing and guarantees, whilecommercially priced, have long tenors, often with multi-year grace periods. Since few of these investmentshave come due, it is not yet possible to determine if thisportfolio is performing differently relative to OPICs widerportfolio of assets.


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OPIC Impact Investment Tools

In response to the needs of the impact investment sector,and to address the gaps in the sector, OPIC tailors itsrange of nancial and insurance products to support impactinvesting.

Impact investing equity funds: In 2011, OPIC issued

a request for proposals for impactinvesting funds. Inresponse, 88 groups including 63 funds, 7 funds-of-funds and 18 debt and micronance vehicles submitted proposals. The result was a historiccommitment to impact investing, as OPIC approvedUS$ 285 million in funding for six impact investing funds,which are expected to catalyse US$ 875 million ininvestments.

Example: Sarona Frontier Markets Fund 2, LP (Sarona) .Sarona, a fund-of-funds, is targeting funds that investin frontier countries with per capita GDP of less thanUS$ 12,000, and in sectors such as water, healthcare,education, access to nance and sustainable agriculture.

Fixed-income notes for impact investors: OPIC issuesxed- and oating-rate notes to eligible investors andportfolio managers seeking to ll socially responsibleinvesting or impact investing portfolio allocations thatmeet the impact investing test. These notes carry the fullfaith and credit of the United States, have maturities of1 to 20 years and are priced at the relevant US Treasurynote plus a small spread.

Working capital: In many cases, we found that OPICs

standard project nance is not well suited to the impactinvestment sector. Many innovative impact investingbusinesses are distributing retail products for low-incomehouseholds, such as single-home power sources, LEDlights or cookstoves. These businesses primarily needworking capital to nance the growth in inventories, butworking capital nance is new to many OPIC originationand credit teams. We have since been developingguidelines to enable the institution to offer working capitalnance.

Financial intermediary facilities: OPIC provides nancingand political risk insurance to nancial intermediaries thatlend to the impact investment sector. OPIC can leveragethe outreach and track record of proven performers,which increases access to capital in various impactsectors through a portfolio approach.

Example: Grassroots Business Fund (GBF) . GBF

provides nancing and business advice to for-protcompanies that have a strong commitment to bringingmeasurable and sustainable social and economicimpact.GBF uses a US$ 20 million OPIC loan to investin high-impact businesses in Latin America, Africa and

Asia.With its two complementary vehicles, a privateinvestment fund and a non-prot organization, GBFexpects to invest in 40 to 50 businesses over the nextve years, providing economic opportunity for millions ofpeople.

Example: Global Partnerships. OPIC is investing upto US$ 15 million in the Global Partnerships SocialInvestment Fund 5.0, which works to expand opportunityfor people living in poverty in the Latin America andCaribbean region.Global Partnerships provides loans tosocial enterprises,as well as micronance investmentvehicles that combine nancial support with othernon-nancial services such as healthcare, education ortraining.

Financial intermediary facilities: OPIC provides nancingand political risk insurance to nancial intermediaries thatlend to the impact investment sector. OPIC can leveragethe outreach and track record of proven performers,

which increases access to capital in various impactsectors through a portfolio approach.

Example: Grassroots Business Fund (GBF). GBFprovides nancing and business advice to for-protcompanies that have a strong commitment to bringingmeasurable and sustainable social and economicimpact. GBF uses a US$ 20 million OPIC loan to investin high-impact businesses in Latin America, Africa and

Asia.With its two complementary vehicles, a privateinvestment fund and a non-prot organization, GBFexpects to invest in 40 to 50 businesses over the nextve years, providing economic opportunity for millions ofpeople.

Example: Global Partnerships. OPIC is investing upto US$ 15 million in the Global Partnerships SocialInvestment Fund 5.0, which works to expand opportunityfor people living in poverty in the Latin America andCaribbean region. Global Partnerships provides loansto social enterprises,as well as micronance investmentvehicles that combine nancial support with othernon-nancial services such as healthcare, education ortraining.

Market Gaps in the Impact Investment Sector

1. Lack of information about nancial return, byinstrument

-> Tag portfolios to help the impact eld reinforce andclarify denitions-> Share information with investors and managers

2. Limited range of investment products

-> See OPIC investment funds and xed income notes

3. Pioneer gap; dearth of investment-ready, scalableenterprises

-> See OPIC working capital, early-stage capital and thePi platform.


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Early-stage equity capital and co-investmentopportunities aligned capital: Most investmentsneed different types of capital at different stages ofthe investment life cycle (see Figure 1).Many impactinvestments that OPIC has reviewed have requiredearly-stage grant or equity capital to cover operatinglosses or to establish proof-of-concept and make theproject nanceable. On the other hand, an early-stage

risk capital provider may need access to larger amountsof capital to scale up its successful project. Philanthropiccapital is a solution here; it can be invested in a waythat catalyses DFIs, which in turn catalyse commercialcapital, creating a powerful leverage effect. As OPIChas neither an equity nor a grant instrument, we havepartnered with grant and equity investors who wantedto benet from OPICs origination and due-diligencecapabilities by investing alongside us.

Example: Portfolio for Impact (Pi).Pi is a new initiative toincrease OPIC support for smaller, highly developmentaland innovative early-stage companies in the impactinvestment space.This platform represents a response tothe growing demand for OPIC to provide nancing thatsupports the scaling-up of socially-oriented enterprises.OPIC will underwrite deals of up to US$ 5 million andcreate a portfolio of up to US$ 50 million over two years.Consistent with OPICs interest in aligning different typesof capital, Pi will present co-investment opportunitiesfor other socially-minded investors in a more efcientmanner, and serve as an important bridge betweenphilanthropic and private capital.

Example: Rockefeller Foundation partnership. In

a collaboration supported by the World EconomicForums Global Agenda Council on Social Innovation,OPIC is entering into a partnership with the RockefellerFoundation to co-invest in impact investments globally,combining the Foundations programme-relatedinvestment capability with OPICs origination, due-diligence and debt-nancing capabilities. The partnershipaims to create an innovation in process, whereby thetwo parties and more parties in the future cancollaborate on and co-invest in impact investments thateach institution would otherwise not have been able toconsider on its own.

Political risk insurance for impact investors: OPIC offersinsurance products that signicantly mitigate specicrisks posed to impact investors in developing countries.Political risk insurance offers protection against losses totangible assets, investment value and earnings that resultfrom political perils in 150 developing countries. Withoutthis insurance, potentially impactful investment may nottake place.

Example: MicroVest Capital Management LLC(MicroVest). OPIC provides political risk insurance onloans made by investment funds managed by MicroVestto micronance institutions throughout the developingworld. OPIC can also provide insurance against changesin government regulations (e.g. changes in interest ratecaps for micronance institutions).

Next Steps for the Impact Investment Sector

1. Clarify the denition of success. The impact investingeld urgently needs common denitions and clarity aboutexpectations, by investment instrument, of both socialand nancial return. This sector should strive to compilegood information to demonstrate a track record acrossthe range of investment products with a full spectrumof nancial, social and environmental returns. This datagathering can more clearly situate impact investing inrelation to corporate social responsibility and sociallyresponsible investing (SRI).

2. Align different types of capital to grow and supportinvestment-ready enterprises.

3. Work with development nance institutions. They arepowerful bridges, providing the nancing and riskmitigants that remove barriers to allocating capital forimpact investments.

4. Beware of overpromising. While the impact investmentsector has the potential to be truly transformational, it isin its early stages and will take many years of slow, hardwork to deliver on its promise. We must be careful not tolet expectations get ahead of reality and need to be bothoptimistic and realistic, pushing hard and aiming high,but also nurturing the sector with patience.

Figure 1: Different Stages Require Different Capital MixesSource: OPIC


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Integrating Environmental and Social Goals intoInvestment Practice

There have been a number of efforts to integrateenvironmental and social information into investmentdecision-making in recent years, as advocates have(correctly) identied the lack of systems for processingthis information as a fundamental barrier to impact

investment. These efforts are often explicitly counterposedto conventional, mainstream investment analysis, which hasno standard method for integrating environmental and socialinformation.

The institutional investment culture likely disfavoursincorporating new types of information, as unconventionalapproaches such as environmental and social analyses canbe labelled as dilettantish or motivated by nonnancialconsiderations. Interviews with mainstream investors aboutresponsible investment reveal language that marginalizesimpact or responsible investment strategies, such assoft as opposed to quantitative or rigorous analysis,and this even in a post-nancial-crisis period when thesupremacy of nancialized mathematics and the rigor ofconventional analysis has come into question. As a result,mainstream investors often begin with a bias against impactinvestments.

For impact investing to gain mainstream acceptance,advocates will need to forthrightly challenge the ideathat a concern for environmental and social outcomesnecessarily means taking your eye off the ball with regardto investment returns.

Advocates may need to directly challenge conventionsfor measuring short-term performance; to advocatefor investment analysis that focuses as much on thefundamental value of assets as on their price movements;and to resist a rhetoric of rigour used more to policeconventional boundaries than to identify sound investmentstrategies. Merely claiming that using ESG standards makesfor a more effective analysis is unlikely to do the trick.

The primacy of short-term performance standards has notserved institutional investors well over the past 15 years;many critics feel that those standards have contributed to

the nancial crises and poor economic performance thathave so affected the beneciaries. Trustees and staff shoulddirectly engage consultants and managers on the long-termvalue propositions of investment strategies. They should askhard questions on how investment propositions are linkedto generating real economic value. Reorienting institutionalinvestment culture towards long-term wealth creation willlikely support the integration of environmental and socialanalysis into investment decision-making.

Agency Issues and the Challenge of Intermediation

Investment decisions by asset owners typically involveinput from a series of internal and external stakeholders.

Theoretically, members delegate authority to boardmembers, who direct staff and help choose consultants,who in turn select managers; however, this decision chain isnot so linear in practice. The agency issues inherent in this

network of decision-makers such as alignment of interestsand variance in time horizons for performance assessmentand rewards are often implicated in critiques of marketshort-termism, bubbles and fraud. More generally, theinteraction of agents with different institutional and personalagendas necessarily shapes the availability of investmentsin the marketplace and how these options are presented tovarious decision-makers along the chain.

Impact investing faces a particular challenge whenconsidering agency issues, as it takes more multiple setsof decision-makers for impact investing to explore andadopt something new and different. For example, a staffmanaging a large university endowment decides that animpact investing strategy would benet long-term portfolioperformance and better achieve the universitys mission.

The Board of Trustees must sign off on any newly proposedstrategy. In turn, its investment consultants must have theability and willingness to identify investment options that tinto this strategy. Fund managers must meet social goalsas well as the consultants other criteria for investability.

Those managers will need a sufciently robust pipelineof opportunities with social impact to merit investing at ascale large enough to attract investment not only from thisone endowment, but also from enough investors so thatthe endowments position will not be too large for the fundstaffs comfort.

Of course, any investment faces these challenges. Butthe nature and newness of impact investing means thatthe eld may lack products that t neatly into existingasset allocation schemes. If impact investing is seen byagents in the chain as a marginal or niche activity, they

may dismiss it as unappealing. Further, for the strategy tobe successful, agents in the chain must develop their owncapacity to manage impact investments, and those withoutthis capacity may resist the perceived (and real) costs ofdeveloping it.

How can advocates for the eld address this issue? No easypath for navigating agency issues exists. Perhaps it is bestto say that impact investors need to regularly review whetherthey are taking multiple stakeholders into account as theydevelop their strategies and tactics. They may also seekto concentrate efforts on key actors in the chain assetowner trustees and investment consultants are frequentlymentioned in this regard who have particular inuence onhow decisions are made.

One obvious path forward is for large asset ownersthemselves to signal demand for different kinds of products,and to engage the market through requests for proposalsthat call for ESG-themed investments. Alternatively, theycan engage investment consultants to introduce ESG-related issues into the management selection and evaluationprocess. But it is too easy to claim that these forms of assetowner interest alone will move the market. More generaleducation across stakeholders in the asset management

supply chain on the long-term implications of ESG analysiswill be necessary for institutional investors to becomeplayers at scale in the impact investment marketplace.


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Conclusion

To say that existing institutional investment culture throwsup barriers to impact investing is not to say that impactinvesting cannot grow to scale in the mainstream investmentcommunity. We have seen an openness across a variety ofchannels in the institutional investment community, a historyof engagement on environmental and social issues among

many investors, and important and recent movements thathave expanded interest in the eld. These developmentssuggest that impact investing on a much larger scale than iscurrently practised is very possible.

The intent here was to highlight some of the well-knownways in which conventional investment-decision-makingculture may disfavour impact investment. Efforts to engagethe mainstream in impact investing will be best servedif this culture is taken into account. The challenges ofchanging how investments are made, and how success ismeasured, are necessarily part of bringing impact investingto scale and those challenges are unlikely to be met bynancial innovation and incentives alone.


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4. Building a Strategy:Integrating Impact Investing

in the Mainstream InvestorsPortfolio4.1 A Portfolio Approach to ImpactInvestment: A Framework for

Balancing Impact, Return and Risk By Yasemin Saltuk, Director of Research, J.P. Morgan SocialFinance

Key Insights

This research presents a tool for the analysis of impactinvestment portfolios across the three dimensions thatdetermine their performance: impact, return and risk.

Key considerations that investors face when building aportfolio include choosing an organizational structure tomanage the portfolio, and dening impact and nancialtargets with which the portfolio will be built.

These targets can be translated into a graphicalrepresentation of the three dimensions to show theprole of individual investments and of the entireportfolio.

This is an extract from A Portfolio Approach to ImpactInvestment (Y. Saltuk, J.P. Morgan Social Finance, October

2012), a report written as a practical guide to building,

analysing and managing portfolios of impact investmentsfor professional investors. Since completing this work, we have been using the framework for managing our own portfolio and representing the prole of our targets and investments. For the full report, visit: www.jpmorganchase.com/socialnance.

In traditional nancial analysis, investment managementtools allow investors to evaluate the return and risk ofindividual investments and portfolios. This research presentsa tool to analyse impact investments across the threedimensions that determine the performance of these assets:impact, return and risk. Throughout, we reference theexperiences of impact investors with case studies of howthey approach each step of the portfolio construction andmanagement process. The content for this research wasinformed by our own investment experience as well as thatof 23 institutional investors that we interviewed. Figure 2gives an overview of the report structure, and we provide asummary of the key ndings.

Throughout, the term social is used to include both social andenvironmental concerns.

Also, the term institutional investor refers to non-individual investors, including foundations, nancial institutions and funds.

Figure 2: A Portfolio Approach to Impact InvestmentSource: J.P. Morgan


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Building an Impact Investment Portfolio

Find a home for the portfolio

To successfully build a portfolio of impact investments,investors need to assign an individual or a team to source,commit to and manage this set of investments, andinstitutions are setting up their organizations in different

ways to address this need.

Table 2: Organizational Structures across Institutional Investors

Some institutions establish a separate portfolio with its ownmanagement team, while others employ a hub-spokestrategy where a centralized impact team partners withvarious portfolio managers across instrument types (such asxed income and equity) to manage the portfolios multipledimensions. Still others bring the total institution in linewith the impact mission. Table 2 shows some examplesof investors including foundations, pension funds, nancial

institutions and fund managers, and their organizationalstructures.

Source: J.P. Morgan

Investor Type Example Portfolio Management

Foundation The Rockefeller Foundation Separate team The F.B. Heron Foundation Whole institution

Pension fund TIAA-CREF Hub-spoke partnershipPGGM Hub-spoke partnership

Financial institution Storebrand Separate teamJ.P. Morgan Social Finance Separate team

Fund manager MicroVest Whole institutionSarona Asset Management Whole institution

Target Population Target Business Model Target Impact

Income level Product/service provider to target population Number of target populationreached

Degree of inclusion Utilizing target population retail distribution Percentof business reaching tar-get population

Region of inhabitation Utilizing target population suppliers Scale of outputs

Implementing energy and natural resource ef-ciency

Quality of outputs

Dene an impact thesis

Once the organizational structure is in place, the portfolio

management team will need to articulate the impact missionof the portfolio to set the scope of their investable universe.For many impact investors, the impact thesis is usuallydriven by the value set of an individual or organization andcan reference a theory of change, often with reference tospecic impact objectives such as access to clean water oraffordable housing. An impact thesis can reference a targetpopulation, business model or set of outcomes throughwhich the investor intends to deliver the impact (see Table 3for examples).

Table 3: Illustrative Components of an Impact ThesisSource: J.P. Morgan


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Dene nancial parameters

Alongside the impact thesis, the investment team willdetermine the investment scope with respect to theparameters that can drive nancial performance. Theseparameters include the instruments that will be eligible forinvestments; the geographies and sectors of focus; thegrowth stage and scalability of the businesses that will be

targeted; and the risk appetite of the investor. Abandon the trade-off debate for economic analysisIn setting the investment scope and return expectations,we encourage investors to abandon broad debatesabout whether they need to trade-off nancial return inexchange for impact. We rather propose that investorsrely on economic analysis on a deal-by-deal basis of therevenue potential and cost prole of the intervention they arelooking to fund, and set risk-adjusted return expectationsaccordingly.

A Framework for Impact, Return & Risk

Once the target characteristics of the portfolio are dened,investors can map the following across the three dimensionsof impact, return and risk: a target prole for the portfolio,the expected prole of the individual opportunities andthe prole of the aggregate portfolio, which can then beassessed against the target.

Map the target prole

To illustrate how different investors might map their portfoliotargets, we present the graph of our own J.P. Morgan SocialFinance target portfolio the shaded grey area in Figure 3 alongside the prole that might be targeted by an investorwith a higher risk appetite and a lower return threshold(Figure 4), and the graph that might represent the target foran investor pursuing only non-negative impact with a lowrisk appetite (Figure 5). 4

Figure 3: J.P. Morgan Social Finance TargetPortfolio Graph

Source: J.P. Morgan

Figure 4: High Risk Investors TargetPortfolio GraphSource: J.P. Morgan

Figure 5: Non-negative Impact Investors Target Portfolio GraphSource: J.P. Morgan

Figure 6: One Investment in the Contextof Portfolio TargetsSource: J.P. Morgan


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Map the individual investments

Next, we map out expectations for an individual investmentbased on assessments of the impact, return and risk. Oncethat investment is mapped, we can then compare it to theportfolio target as shown in Figure 6. Although we showan example in which the individual investment prole doest within the portfolio targets, in general investors may not

require that each investment necessarily ts within the targetrange, so long as the aggregate does.

Map the aggregate portfolio and compare to target

Once the portfolio begins to grow, we can consolidate theindividual investment graphs into one graph representingthe characterization of the portfolio as a whole, aggregatingthe individual graphs by either overlaying them or averagingthem(simply, or on a notional-weighted basis). Then, thisaggregate can be compared to the target prole for theportfolio to ensure alignment.

Expand the dimensions of the graph, if desired

Investors should consider the three-dimensional graph as atemplate. For some, the simplicity of this approach might beappropriate for aggregating across large portfolios at a highlevel. Others might prefer to use a more nuanced frameworkthat better reects the different contributing factors of theparameters represented on each axis impact, return andrisk.5 As an example, we could consider an investmentgraph across six dimensions, splitting each of the three intotwo components, as shown using a hypothetical investmentin Figure 7. Alternatively, an investor might choose to showfour dimensions, where risk is split by nancial risk andimpact risk.

Figure 7: Illustrative Graph in Six Dimensions

Source: J.P. Morgan

The bold blue hexagon illustrates the prole of a hypothetical debt investment.

Once the targets have been set and the portfolio begins

to grow, investors are then faced with managing theinvestments to ensure that the portfolio delivers both impactand nancial returns in line with the targets.

Financial and Impact Risk Management

Identify the risks in the impact portfolio

On an individual investment basis, the risks that arise forimpact investments are often the same risks that wouldarise for a traditional investment in the same sector, regionor instrument. Just as we abandon the trade-off debate

on return across the asset class and encourage deal-by-deal analysis, we encourage investors to assess the riskprole that results from their particular impact thesis andmotivation.

There are also some cross-market risks to consider,including the early stage of the market and its supportingecosystem; mission drift; the responsible combination ofdifferent types of capital (including grants); and the moralhazard of recognizing impact failure or nancial loss. Thedevelopment of the market over time should erode someof the risks associated with its early stage and ecosystem.While some of these risks will remain in place, investors willlikely develop better processes for recognizing and dealingwith them.

Manage risk through structural features

Once the risk prole of the investment is determined,investors manage it using structural features such asseniority in the capital structure, fund intermediaries andcompensation-related or covenant-based incentives.With respect to the currency risk that arises for investorsallocating capital internationally, some investors referenceddiversication across countries as the preferred means ofmanagement.

Manage friction between impact and return

Many investors cite that they pursue opportunities wherethe impact mission is synergetic with the nancial returnpursuit. Several organizations also acknowledged that, attimes, friction can arise between these two pursuits. Someof the challenges referenced include the investees growthcoinciding with a reduction in jobs; the investee maintainingmission; or ensuring impact measurement. Some investorsmanage these challenges by building covenants referencing

the mission into the deal.

Portfolio diversication

Investors often nd a softer approach to diversication tobe more suitable to the private nature of this market. Ratherthan setting exposure limits as can more easily be done forpublic equity portfolios, impact investors tend to start witha more opportunistic approach. They assess the merits ofinvestments mostly on a stand-alone basis, while monitoringthe broader concentrations in any sector, geography,instrument or impact pursuit. Once the portfolio reaches acritical mass, many of them become more strategic aboutdiversication, considering an investments individual meritsalongside those in the context of the broader portfolio.


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Looking Forward

Challenges should ease over time

To be successful today, investors need to be realistic aboutthe stage of the market, employing patient capital, bringinga dynamic approach and taking an active management roleto the investment. Whether investing directly or indirectly,

they need to navigate a broad ecosystem to ensuresuccess. Investors today share a collaborative spirit inmeeting these challenges with the broader goal of catalysingcapital towards impact investments. This research has beena rst step towards sharing the experiences of these eldbuilders to help investors establish a strategic approach toportfolio management for impact investments.

About J.P. Morgan Social FinanceJ.P. Morgan Social Finance was launched in 2007 tocatalyse the growing market for impact investments andaccelerate the delivery of market-based solutions to social,economic and environmental challenges. Our business isdedicated to growing this market through client advisoryservices, principal investments and research.

Disclosures

J.P. Morgan is the global brand name for J.P. MorganSecurities LLC and its afliates worldwide. This research iswritten by Social Finance Research and is not the product ofJ.P. Morgans research departments.For further disclosures,please see the full publication at www.jpmorganchase.com/ socialnance.

Copyright 2012 JPMorgan Chase & Co.

4.2 Leveraging Expertise across Asset Classes for An InstitutionalImpact Investment MandateBy Amy M. OBrien, Managing Director, Global Social &Community Investing, Teachers Insurance and Annuity

Association - College Retirement Equities Fund (TIAA-CREF)

Key Insights

As impact investing efforts within an organization grow,organizing and coalescing around important themes and/ or organizational strengths is key.

Institutional structures and outreach efforts needto ensure that even if the impact investing team isseparate from other teams, it is well integrated into anorganizations decision-making processes and has buy-in from major internal stakeholders.

As it moves into its next phase, the impact investmentsector is shifting from an approach based on a single-asset-class into a cross-asset-class strategy, asevidenced by the TIAA-CREF example.

For TIAA-CREF, a full-service nancial services companyspecializing in the distinctive needs of those working inthe academic, research, medical and cultural elds, socialimpact investing is deeply ingrained in who we are. Impactinvesting is part of our company-wide commitment todirect capital towards high-quality investment opportunitiesconsistent with our overall investment strategy, and tocreate measurable social outcomes. This commitmentstems from TIAA-CREFs legacy of community investing andour mandate to engage in responsible investing on behalf ofour investors. As of 31 December 2012, TIAA-CREFs socialimpact investing portfolio consisted of US$ 663 million inassets under management; by year-end 2013, TIAA-CREFwill have committed an additional US$ 100 million to theportfolio.

As impact investing has matured, TIAA-CREF has updated

its approach to ensure it can access quality opportunitiesacross select themes, asset classes and geographicregions. As a result, TIAA-CREF has been able to diversifyits holdings and set the stage to include more of these typesof investments in its portfolio.

Why Impact Investing Makes Sense for TIAA-CREF

TIAA-CREFs Social Impact Investment Program traces itsroots to the mid-1980s, when the rm joined six insurers tocreate and fund New Yorks Housing Partnership MortgageCorporation. The purpose of that initiative was to provide

mortgage nancing for the rehabilitation and productionof housing in low-, moderate- and middle-incomeneighbourhoods. That investment signalled to the marketthat we were open to this sort of investment opportunity andpaved the way for many other impact investments. Since


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our initial impact investment three decades ago, the rm hasdemonstrated its responsible investment commitment in anumber of ways. These include offering investment optionssubject to explicit ESG guidelines, community investmentand shareholder advocacy.

Responsible investments are important to TIAA-CREF forthree main reasons. One reason is that our clients typically

work in the non-prot arena, with many in higher education. They are highly educated, aware and knowledgeable aboutthe social and environmental impact of their investments,and feel favourably about our focus on the double bottomline. Another reason is that our proactive efforts have apositive effect on our relationships with state-level insuranceregulators, some of whom prioritize meaningful, voluntarycommunity investing. For example, we are subject tostatutory requirements in some states that are related topublicly disclosing our community development investmentpolicy and reporting on specic investments. To do this,we work via collaborative efforts such as the CaliforniaOrganized Investment Network to bring together multiplestakeholders, including regulators, insurance companies andcommunity development organizations, to enhance sharedlearning. The third reason is that impact investments canprovide exposure to new markets and emerging sectors,both in the US and abroad.

Over the years, we learned how to develop an impactinvesting strategy consistent with the investment objectivesof our General Account, a portfolio of over US$ 200 billionthat supports the claims-paying ability of our annuity andinsurance products. The General Account is a conservativelymanaged portfolio, with 87% of its assets invested in xed

income. To achieve greater diversication and risk-adjustedreturns, this account has increasingly sought opportunitiesfor direct private investments across several asset classesincluding real assets, private equity and private xed income.

Strategy Evolution: Updating Our Approach to BePortfolio-Wide

In the summer of 2012, TIAA-CREF initiated a review ofits social impact investing strategy. Over the previousdecades, TIAA-CREF had launched a series of variedsocial investment programmes, some closely linked to aspecic asset class (such as deposits in leading communitydevelopment banks, and private equity in micronance),and others that covered more than one asset class, such asour corporate social real estate portfolio. A specic groupwas in charge of executing these investments (i.e. sourcing,evaluating and monitoring them), effectively controlling theentire investment process and creating a distinct sub-portfolio of responsible investments. This process wassimilar to the organization of other investors that wereincorporating responsible investments into their portfolio.

The Global Social & Community Investing (GSCI) team,created in 2006, was tasked with the 2012 strategy review.

The review process was designed so it would aggregatediverse and balanced input from critical internal and externalstakeholders. First, the process included more than adozen meetings with key internal stakeholders to clarify theinternal rationale, appetite, enterprise-level commitment

and resources available to support the strategy for theGeneral Accounts Social Investment Program. The GSCImet with groups that included the Board of Trustees,Senior Investment Management leadership, the ProductManagement and Business Development areas within AssetManagement, and Government Relations.

The review process also included signicant externalbenchmarking gathered from sources such as meetingswith insurance company peers, as well as investmentbanks, foundations and faith-based retirement plans tobetter understand the various investment approaches,programme types, programme size and return expectationsof those active in this space. We spoke to these groupsabout their programme history, asset-class expertise andhow they dene social investments. We explored how theyallot resources to their social investment initiatives, theirsource of funding and the staff placement that governsthese programmes. We asked in detail about their dealsourcing, size, risk and return trade-offs relative to traditionalinvestment valuation criteria. Finally, the team engaged with

industry thought leaders and practitioners who providedinsight into market trends, opportunities and ideas for newinvestment structures, as well as information on policyefforts underway to facilitate the growth of the social impactinvestment space.

When the strategy review process was complete, theoverarching mandate remained the same: to achievecompetitive risk-adjusted returns and generate specicsocial and environmental outcomes. But compared to thelegacy approach, the new strategy included some importantdistinctions.First, the new starting point placed a greater emphasis

on asset allocation and the appropriate mix ofinvestments across multiple asset classes. Second, thereturn expectations for all investments needed to becommensurate with the appropriate asset class targetreturns for the General Account. Third, we needed amore coherent investment-strategy communication plan.Within our institution, it was critical to communicate anddemonstrate throughout the rm that impact investmentwas not a philanthropic endeavour, similar to portioning outgrants. Rather, it was an investment opportunity that hadpotential to provide diversication and boost more than thebalance sheets bottom line. To accomplish these goals,

TIAA-CREF set a thematic framework for impact investing,delineating three areas for investment focused on low- tomoderate-income communities globally: Affordable housing Inclusive nance Community and economic development

TIAA-CREF decided to focus on these areas because,following the review process, each of them met the criteria,which were: Facing capital gaps which had not yet been adopted by

mainstream investors Having a market-based solution for addressing select

social needs Having quality deal ow that reected the balance

between nancial and social return potential Offering signicant potential for TIAA-CREF to play a

market leadership role given our in-house expertise


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By focusing on the three areas, TIAA-CREF not onlyintroduced impact investing as an investment strategy toadditional investment teams internally, but it also developedexpertise in these areas through the use of high-qualitysourcing opportunities.

TIAA-CREFs portfolio seeks to invest both directly andthrough funds, depending on asset class, sector expertise,

size of investment and geography. When appropriate,investing in funds can mitigate risk, given the complexnature of rapidly evolving regulatory frameworks in emergingcountries and sectors as well as the need for local presenceand operational expertise in the relevant business models. Itcan also offer greater diversication and provide valuable co-investment opportunities.

Investments we have made in this area include the followingexamples:

TIAA-CREF Investments

Developing World Markets Micronance Equity Fund I: A private equity fund focusing on nancial inclusion servingunderserved communities

Urban Partnership Bank:Investment in FDIC-insured certicates of deposit (CoDs)at community development banks that provide nancialservices to underserved US neighbourhoods in Chicago,Illinois; Cleveland, Ohio; and Detroit, Michigan

ProCredit Holdings: A private-equity investment in a bank that provides global

micronance and nancing solutions to small and medium-sized enterprises (SMEs) and to low- and middle-incomeindividuals

Impact Community Capital: A Community Development Financial Institutions (CDFI)initiative of eight insurance companies (including TIAA-CREF) to facilitate investments beneting low-incomefamilies and underserved communities

Avanath Affordable Housing: A real estate equity fund that invests in affordable multifamily

US housing properties

Executing the Investment Programme

A common institutional investor model organizes teams byasset class. Our experience and belief is that a partnershipmodel is central to the execution of the social investmentprogramme. Otherwise, some potential transactions mightget overlooked because their relatively small size mightnot merit a fund managers attention. A partnership modelshould be built upon a coordinated approach that tapsinto internal expertise and pulls together a small team, onethat can identify potential transactions and evaluate socialand environmental returns with investment managementcolleagues.

How does it specically work? First, a rm-wide mandatehinges on the support of senior leadership, including bothexecutives at the rm and the board of trustees. Its backingof the programme signals that social impact investing isa priority, and it intentionally allocates resources for theinitiative. This is not a static, one-time decision; rather,it is a continuous process involving periodic reviews,assessing nancial, social and environmental results. On

an annual basis, the GSCI team reviews the strategy with Asset Management senior leadership using our proprietarytemplate for analysing transactions, and proactively identiespossible modications, opportunities and challenges.

To facilitate the integration of impact investing withinvestment expertise across several different areas of therm, senior leadership has assigned ownership of thestrategy to the GSCI team. Under the enhanced strategy,the team could look at all the investments from a portfolio-wide perspective, ensuring they t within asset-allocationparameters in terms of themes and geographic reach.

The GSCI team engages select investment teams to analyseinvestment opportunities in specic asset classes that mayhave a tangible social impact. The team is charged withbuilding partnerships (as described below) with other teams,originating high-quality investment opportunities, tappinginto investment expertise and working with asset-class-specic teams to do due diligence and invest in impactinvestment deals. The GSCI team is involved to somedegree in each of the ve steps required to execute theannual investment programme:

1. Sourcing potential investments: Impact investing

opportunities, unlike a bond or equity trade or evena real estate transaction facilitated by a broker or anintermediary, typically do not cross an investmentmanagers desk. As a result, the GSCI team plays apivotal role in proactively originating deals and creatingrelationships to learn about such opportunities. Todaysimpact investing market lacks a formal marketplace tofundraise (although emerging platforms like the GlobalImpact Investing Networks ImpactBase exist), whichmeans that deal ow origination requires overcominginformation asymmetry. The team considers each dealto determine whether it ts within one of the threeapproved themes and is eligible for nancial evaluation.

2. Financial evaluation: Once a potential deal is identied,it must go through enhanced due diligence, whichbrings together the deep asset-class expertise ofboth the investment management and GSCI teams.Investment management partners aligned with particularasset classes bring their experience in structuringand analysis-specic expertise to the due-diligenceprocess. For example, the team that manages privateinvestments would lead the underwriting process for aprivate equity fund or private debt impact investmentopportunity.

3. Social impact & sector evaluation: The GSCI teamsimultaneously determines whether the transactionmeets the rms social-impact criteria in addition toproviding best-in-class sector exposure. This step


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is run in conjunction with the nancial evaluation,but it falls largely to the GSCI team, which has thesector knowledge to determine whether the dealhas the potential for measurable impact. This stepincludes reference checks and marketplace analysisto determine, for example, whether a community andeconomic development investment can enhance accessto essential services, such as credit or healthcare for

low- or moderate-income families. Meetings with thesponsors and potential investees in the countries orcommunities in which they operate are a very importantpart of the analysis. One example of evaluating animpact thesis would be leveraging the Principlesfor Investors in Inclusive Finance framework (whichis backed by the UN and to which TIAA-CREF is asignatory). The framework offers guidance on specicaspects including client protection, transparency ofproduct, range of services and affordability.

4. Investment decision: This step entails presenting the

investment committee (comprised of senior leadershipfrom the respective asset class teams and the head ofthe GSCI team) with a formal investment proposal forreview and approval. The committee meets every timea deal is proposed, and the approval process is animportant step in the overall portfolio management.

5. Portfolio management and reporting: Once the

investment committee approves the deal, the portfolio-management team for the relevant asset class hasongoing operational and supervisory responsibilities.

The GSCI team is involved in monitoring the investmentto ensure it maintains its social mission and delivers on

its promise to improve the environment or community. These types of investments can have a multi-yearinvestment horizon, mandating consistent review toensure they stay on target to deliver on their impactinvestment potential. By maintaining an active oversightrole, the GSCI team is also in a position to learn ofpotential co-investment and secondary nancingopportunities that it might otherwise not be offered.

Keys to Success: Integrating Impact Investingacross a Platform

Looking ahead, we believe an increasing number of nancialinstitutions will seek impact investment opportunities asthey strive to meet nancial and social goalswhetherfrom their own mandates, from regulators or shareholders,or from a combination of these drivers. As the demand forimpact investing increases, investment rms can prepareby ensuring their organizations are structured to max

wef impact investing december 2013

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