Comment: How good is your portfolio?
Close monitoring of environmental, social and governance concerns has generated trillions of dollars in so-called ESG investments, totaling approximately $45 trillion at the end of 2022. The motivation behind each of these investment decisions was to improve social and environmental outcomes while generating a little lag.
But measuring the impact of finance is more complex than is commonly thought.
Avoiding so-called sin stores hasn’t stopped anyone from smoking or drinking. Likewise, it remains to be determined whether ESG strategies that exclude oil and gas stocks have any discernible impact on climate change. Investing based on one’s values promotes moral consistency but rarely changes fundamental corporate behaviors.
In contrast, investments with real impact produce positive outcomes that otherwise would not have been achieved, an attribute called additionality.
For example, the proceeds from green bonds are used to measurably reduce CO2 emissions. Similarly, public and private equity investment in industries dedicated to the underserved – including healthcare, education, affordable housing and financial inclusion, among others – has been shown to improve the lives of those who are marginalized. Many strategies in each of these sectors have simultaneously delivered returns at or above market levels.
For the past five years, from 2017 to 2022, the Sorenson Impact Foundation has been conducting a bold experiment in Salt Lake City. After early successes in mission-related investments, SIF consciously committed 100% of its investable assets to positive outcomes.
The results are now clear: SIF’s investments have made a very significant impact without sacrificing returns. In fact, SIF has achieved quantifiable social and environmental impacts while outperforming its market benchmark (75% MSCI ACWI Index and 25% Bloomberg US Aggregate Bond Index). Notably, SIF has outperformed its market interest rate benchmark by 100 basis points on an annualized basis since inception on 1 January 2018 and its private investments have shown a 64% net internal return since inception.
Our experience proves that it is possible to do good through disciplined, mindful investing. Qualitative results were achieved while at the same time meeting our quantitative targets.
One might wonder what types of investments deliver strong returns alongside measurable impact. We have invested in an activist hedge fund that implements specific value-added impact and ESG initiatives in each of its portfolio companies, in addition to the traditional activist playbook. One of our venture capital funds invests in portfolio companies whose business models target marginalized groups. SIF’s private lending includes strategies that provide small business loans to underserved borrowers worldwide. Our affordable housing strategies feature dedicated impact teams that develop tailored social programs that improve tenant resilience. Each of these investments seeks a return that is equal to or better than the benchmark for its respective asset class. Their financial goals are not concessional, but their social and environmental impact can be tangibly documented.
A growing number of institutional investors are setting fixed return targets for parts of their portfolio, such as inflation plus 400 basis points or low to mid teens, annualized for the specific life of an investment. The impact investing market can also be approached in this way, using risk-return targets as constraining or sorting mechanisms. As with all investments, future returns combined with impact targets can never be fully known in advance.
While a common industry standard for measuring impact investing is yet to emerge, many investors have begun to rally around the United Nations Sustainable Development Goals. Professional impact investment managers typically direct their investments toward some form of social inclusion (SDGs 1-5, 7-8, 10, and 17), environmental sustainability (SDGs 6 and 11-15), and/or broader economic opportunity (SDGs 1 –11) back , 1 and 16). Using the UN SDGs as a common language has improved standards for impact reporting while facilitating shared purpose.
To date, companies in SIF’s mission-driven investment portfolio have helped mobilize $5 billion in capital for underserved borrowers, mobilize more than $300 million for global public health solutions, reach 490 million students, Create and/or maintain and remove 216,000 affordable housing units or avoid 294 million tons of CO2 emissions. Some of our mission-related investments have been truly groundbreaking: For example, one of our early-stage venture capital firms has shipped more than 6 million ounces of breast milk to working mothers.
At the same time, SIF’s approach to asset diversification and risk management has been aligned with industry best practices. We take an all-weather approach to asset diversification, carefully monitoring our exposures by industry, region and multiple asymmetric risk factors.
There’s an active, healthy debate about what exactly constitutes an “impact” investment.
Like traditional investors, we constantly debate where we are willing to make tradeoffs between higher returns and greater impact. The range of impact investing opportunities spans multiple asset classes, including cash, credit and bonds, public and private equity, venture capital, and real assets such as renewable energy and low-income housing.
We now see significant untapped opportunities ahead. Our most recent study of the US environmental and social impact investment market alone has identified $4.5 trillion in viable impact investment opportunities per year over the coming decade (see Table 1 below). The global funding gap for housing, education, healthcare, financial inclusion, economic mobility and gender equity is clearly in the trillions of dollars. Many of these opportunities generate returns at or above the market while providing portfolio diversification benefits.
As the global human family grows from its current record 8 billion to 10 billion by the end of this century, business and finance must find more ways to promote holistic, sustainable development for all. Our experience shows that it is possible to invest in multiple companies that serve the needs of the underserved while meeting specific financial goals. All that is required is heightened awareness, intention, and discipline.