This is Part 1 of a two-article series. The second article explores practical advice for stakeholders.
There is a growing gap between available impact capital and conservation investments. This has become a major focal point for investment professionals in the field. One reason for this trend may be that conservation investments are not meeting investor expectations due to a lack of quality opportunities.
This idea is backed up by publicly available data. According to the GIIN 2017 Annual Impact Investing Report, interest in impact investing worldwide is growing at a quick pace. Investors providing 205 survey responses committed $22.1 billion to around 8,000 impact investments in 2016. That amount of capital was reported to have increased by 17 percent to $25.9 billion in 2017.
Yet the rate of conservation investments does not appear to be keeping pace with the increase in available capital. According to the Forest Trends "State of Private Investment in 2016” report, investors from 159 survey responses have $3.1 billion of undeployed capital from $8.2 billion in commitments to conservation investments.
According to interviews conducted by Network, investors are looking for investments with levels of sophisticated management and business planning comparable to typical mainstream investments. To access the growing, underdeployed pool of impact capital, environmental entrepreneurs must better understand how to appeal to impact investors.
These interviews included investment experts, staff advisors, and fund managers in the impact investing space. They described what impact investors are looking for when putting their money to work for environmental outcomes.
The interviewees were asked whether they believed investors would accept below-market returns if investments had strong, verifiable impact. The consensus was that investors first and foremost want to see strong financial underpinnings in investment opportunities.
If an underlying business model does not work, then investors will not risk their capital. Returns are expected to be commensurate with risk. Therefore, investors who take the leap need to be assured that they are being adequately compensated. After all, impact investors are still investors.
Jeff Finkelman is a senior research associate at Athena Capital Advisors, where he covers the impact investing market. The firm manages $5.5 billion across a client base of 45-50, working primarily with high-net-worth clients but also collaborating with foundations and endowments.
Finkelman said giving up return on investment to make a business model work is not a desirable outcome for his clients. “We generally don’t have much demand for strategies that rely on giving up return as a means of generating impact... As an investment advisor, we place a large emphasis on the financial risk and return profiles of the strategies we consider.”
Other interviewees strongly supported this statement.
Howard Fischer is CEO of Basso Capital Management and cofounder of Gratitude Railroad LLC. Gratitude Railroad is an organization that catalyzes opportunities to move capital toward impact investment opportunities. They primarily advise on impact opportunities, but also have some discretionary capital for investments.
Fischer said that he will not accept a cut in returns for sake of impact. “I look at the deal first. Is it well run? Is there a good business plan? Is it likely to be profitable? Then, does it serve a purpose?”
One response deviated from the consensus. Jacob Israelow, whose opinion differed, is the founder and managing director of Dirt Capital Partners. His firm invests in farmlands in the northeastern United States in support of farmland conservation, land stewardship, and farmer viability. He said, “I typically work with investors who prioritize impact alongside traditional investment metrics. That group of investors is growing.”
Client Interest and Approach
Within the growing world of impact investing, there is substantial interest in investments with environmental outcomes, the interviewees agreed.
Brad Harrison is a managing director of Tiedemann Advisors. This firm is one of the largest independent investment and wealth advisors for high-net-worth individuals, families, trusts, foundations and endowments. As of January 2018, the company had $18 billion in assets under advisement and $1.6 billion committed to impact investments.
Harrison said that in his firm, thematic impact investments in the sustainability space are the impact opportunities most sought after by investors. However, he sees trends in interest shifting toward impact opportunities that can provide strong interrelated social outcomes. “For example, a sustainable timberland investment can generate quality jobs in rural communities and deliver optimal results for people, planet and profit.”
Israelow said he generally works with investors seeking out conservation-oriented investments. “Our investors care a lot about land conservation as a part of their portfolios… They are primarily individuals and families that care about agricultural land conservation, ecological land management, and supporting farmers.”
Finkelman estimated that a quarter of his firm’s clients ask the company to manage their portfolios with some level of consideration for social, environmental or motivational factors. “Athena Capital Advisors does not try to sell its clients on impact investing.”
Athena Capital Advisors takes impact advising cues from the individual investor. Each client asking for impact in their portfolio has a different suite of interests. Impact strategies depend on the needs of the individual client.
“Some clients are focused on maximizing impact generally,” Finkelman said. “Others focus in on a specific issue area.”
Finkleman’s firm takes a dual approach in working with the investor, featuring two steps that occur simultaneously. In the first step, he and his research team create and present “landscape reviews.”
“We look at an issue area to try to figure out what impact means in that area. What opportunities exist?” Finkelman said.
In the second step, the portfolio management team talks to the client about goals. The team drafts an Investment Policy Statement to capture information about the client’s wishes for investment screening and impact strategies. This serves as a guideline for how the portfolio should be managed.
“Our clients share their interests and objectives with us, but we also hope our research helps them learn about investment opportunities they may not otherwise have considered,” Finkelman said.
Investment Categorization and Strategy
According to several of the interviewees, the line between a standard investment and an impact investment is not always clear. Finkelman and Harrison both said that they have not observed market consensus around impact definitions and standards. What defines impact and what outcomes occur can depend on who is assessing the opportunity.
Harrison said, “There is a lot of great work being done. But a lack of industry standardization still poses some challenges.”
Interviewees described how their firms take custom approaches in categorizing and assessing potential investments. Most are waiting for market standards and definitions to coalesce before they rely on the signals and efficiencies that standardization offer.
“Tiedemann takes a holistic view,” Harrison said. For instance, affordable housing that incorporates environmental sustainability measures such as energy efficiency retrofits would fall into the environmental category. He said Tiedemann has made a commitment to integrating the environmentally-focused United Nations Sustainable Development Goals as a framework.
Harrison said that often, the “least sexy” investments are the most impactful from a financial and environmental perspective. Interesting conservation strategies such as carbon sales or wetland mitigation banking are too small and complex to attract major mainstream capital. “People don’t totally understand them… It is hard to justify them in a traditional for-profit environment.”
When ecosystem service-market transactions are deployable at scale, his firm would be ready to engage, Harrison said. “We would love to see these kinds of investments more institutionalized. We do what we can to support ecosystem service-market transactions and nonprofits to the extent possible.”
Gratitude Railroad is a boutique shop and takes a more randomized approach in assessing impact investment opportunities. Fischer said the firm’s investment arm is willing to invest in anything impact-related and does not adhere to a designated impact threshold or categorization methodology.
“We know it when we see it,” Fischer said.