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Investor Spotlight: J.P. Morgan and Rockefeller
Foundation
NICK O'DONOHOE AND ANTONY BUGG-LEVINE DISCUSS A NEW
RESEARCH NOTE TITLED, IMPACT INVESTMENTS: AN EMERGING ASSET
INVESTOR SPOTLIGHT CLASS.
11/30/2010
J.P. MORGAN AND ROCKEFELLER FOUNDATION
Global | Affordable Housing | BOP | Education | Energy Efficiency | Energy, Fuels & Generation | General |
Healthcare | Microfinance | Small & Medium Enterprises
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This month, we spoke with two impact
investors, J.P. Morgan and Rockefeller
Foundation, who recently teamed up to
produce a research note entitled Impact
Investments: An Emerging Asset Class. The
conversation below with J.P. Morgan Global
Head of Research Nick O'Donohoe and
Rockefeller Foundation Managing Director
Antony Bugg-Levine focuses on the findings
of this research. Visit the research page to
download the full report.
GIIN: Why are J.P. Morgan, a large financial institution, and Rockefeller
Foundation, one of the oldest American philanthropies, interested in
publishing research about impact investing?
Nick O'Donohoe, J.P. Morgan: From our chief executive officer down, there's a
strong sense at J.P. Morgan that banking institutions have the ability to make a
positive contribution to society. It's important to our stakeholders - employees,
clients, suppliers, and shareholders - that we take leadership and do the right thing.
Dedicating people and capital to support the evolution of the impact investing
industry is a positive contribution a firm like ours should be making.
Our interest in impact investing is not entirely altruistic. Over the last couple of
years it has also become increasingly clear that a major movement is taking place
around impact investing. As a large investment intermediary, it is good for our
business if we participate in thought leadership and the long term the development
of this industry.
Antony Bugg-Levine, Rockefeller Foundation: In the 20th century, the
Rockefeller Foundation was very successful using grant money, working with
government and nonprofits, to create a more equitable and just world. In the 21st
century, we recognize that philanthropy and government alone can no enable us to
fulfill our mission to at the scale we want. If the goal was simply to provide clean
water to a single village in Ghana, or to provide better education in a single
community in India, charity and government subsidy are up to the task. But if the
goal is to provide clean water to the billion people in the world who need it, or to
close the education gaps not just in one village, but in all the villages and slums of
the world, we don't have the luxury to work alone, without the private sector and
for-profit investors.
To achieve our mission today, we have to work in complement with the private
sector and private investors, which is why we see impact investing as a necessary
complement to philanthropy and government.
GIIN: What are the most significant findings of this report?
NOD: There are three key conclusions. First, impact investing is emerging as a
separate asset class. Second, the potential for invested capital in this market is
huge. Although we don't seek to measure every possible impact investing
opportunity, those areas we did choose to look at - affordable urban housing,
microfinance, maternal health, primary education, and rural access to water - could
represent invested capital approaching a trillion dollars, and that is just part of the
investing potential. Third, this report includes the first substantive survey of impact
investors' projected financial returns. In most cases it's too early to have realized
returns, and the range of projected returns is quite wide. But our survey results
show evidence that many investors project commercial or close to commercial
returns.
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ABL: The report also includes important refinement in the definition of what
constitutes an impact investment. We assert more clearly than ever before that the
intention to create social and environmental good is core to the definition of impact
investing. The report also clarifies the two primary ways that impact investment can
create social good alongside financial returns: first, through the production of
products that benefit poor people or the environment; and second, through business
processes that further social justice and economic development goals, such as hiring
low-skilled workers.
GIIN: What does it mean that impact investing is emerging as its own asset
class? What does this mean for investors?
NOD: This is an important question. Impact investing would not be considered an
asset class if we use the theoretical definition of an asset class, such as the one
provided by the CFA, but neither would hedge funds, private equity, or venture
capital, which are each considered an asset class by the investment community
today. The view we take in this report is that an asset class today is not defined
necessarily by the characteristics of the underlying assets, but by the way investors
organize around it. We asked questions like: Does impact investing require a
separate risk management skill set? Does it require a separate organizational unit to
accommodate this skill set? Does it need a separate group of industry organizations
and education entities? Does it require the development of new standardized
metrics, benchmarks, and ratings? In our view, these are the things that define an
asset class in today's investment world. For example, hedge funds typically invest in
equities and credit, but the way institutions have organized around them has
effectively defined them as asset class.
Defining impact investing as an asset class is important because we can then
organize around the unique investment skills necessary, and accelerate the growth
of assets in this market. We recognize that some people won't agree with this
definition, but it's our view that this definition as an asset class is essential to the
long term growth of impact investing.
ABL: As Nick has alluded to, defining impact investing as an asset class encourages
the emergence of a community organized around impact investing, which is
necessary for impact investing to realize its promise. For example, when someone is
making impact investments in education in Hyderabad and someone else is making
impact investments in water delivery in Nairobi, it is important that they recognize
themselves as part of a global impact investing community, rather than the water
industry and the education industry, nor are they simply a debt or equity investor.
This sense of community can accelerate how we work and learn together. Because
of the diversity of impact investors, this impact investing community will include not
only traditional investors, but also nonprofits, government, and foundations, all of
whom will need to develop distinct skills, disciplines, instincts, and networks.
GIIN: What types of investors are making impact investments today? What
are their motivations?
NOD: A very broad range of institutions and individuals are making impact
investments today, including development finance institutions; private foundations
like Rockefeller Foundation and Omidyar Network; large-scale financial institutions
like Citigroup, Deutsche Bank, and Prudential Insurance; an increasing number of
private wealth managers like Capricorn Investment Group and New Island Capital;
dedicated commercial banks, like Triodos Bank in the Netherlands and Charity Bank
in the UK; retirement fund managers like TIAA-CREF in the US and PGGM in
Holland; boutique investment funds such as ResponsAbility in Switzerland and Root
Capital in the US; increasingly companies like General Mills and Starbucks; and
community development finance institutions in the US.
ABL: At Rockefeller Foundation, we have been leading an initiative since late 2008
to harness the power of impact investing. As part of this initiative, we have engaged
with more than 1,500 investors around the world, and we have learned that the
motivations for impact investing are not limited to one niche. Some impact investors
have a strong focus on social impact, and are willing to take lower financial returns
or higher risk. Other impact investors, like pension funds, are legally required to
make investments at the risk/return frontier.
Surveying this landscape of diverse participants, we are particularly encouraged by
the leadership role that wealth advisors, family offices, and private banks are
beginning to play in advancing the impact investing industry from a phase of
uncoordinated experimentation to a more coherent marketplace. Interest among
this group has been core to financial services innovation in the past. For example,
venture capital was pioneered by family offices and private banks that have a
greater capacity and appetite to embrace innovation. Generally, institutional
investors wait until innovative models are improved to deploy substantial capital.
GIIN: This report includes the first analysis of impact investors' financial
return expectations. What does this analysis show?
NOD: When looking at return expectations, we segregated the results into
developed markets, emerging markets, debt and equity so that we could compare
the expected impact investment returns to established benchmarks in comparable
asset classes. Our analysis shows that, on average, there appears to be some
financial trade-off in developed markets, but in emerging markets there is very little
expectation of trade-off between expected profit and social good. In an appendix of
the report, the International Finance Corporation, which was set up to make impact
investments and has been doing so for decades, shares a comparison between their
returns and comparable benchmarks, and they appear to be earning profits in
excess of commercial returns.
GIIN: Behind these average return expectations, the report indicates that
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GIIN: Behind these average return expectations, the report indicates that
impact investors have a wide range of financial return expectations. What
do you make of this?
ABL: This range indicates a willingness among some investors to take lower returns
or more risk if doing so will expand their investable options to include deals that
create substantial public benefit not achievable through other means. Many of those
impact investors come from private foundations where they have already focused on
the idea of using capital for good through grant making, which of course gets zero
financial return.
GIIN: The report also includes an analysis of the impact investing market
opportunity. How did you evaluate potential market size? What are the
major take-aways from this analysis?
NOD: We try to estimate just a portion of the impact investing market opportunity
in this report using a framework that helps to identify business sectors around the
world that can provide affordable services to people in the base of the economic
pyramid. We are clear about the assumptions that we make, specifically around the
transferability of business models across regions and the number of people globally
who can benefit from these businesses. Applying this framework, we did a detailed
analysis on five business sectors - affordable urban housing, rural access to clean
water, maternal health, primary education, and microfinance. We estimate that
there is potential for as much as $1 trillion to be invested for social good in these
areas over the next ten years. Obviously this opportunity is huge, and we hope that
this analysis will begin to mobilize capital in those areas and encourage investors to
explore additional opportunities in impact investing.
ABL: Not only does the market sizing in this report make clear the substantial
opportunity for investors, but it also sheds light on the massive opportunity to
improve the lives of poor people.
In an ideal world, these basic services like clean water, education, and healthcare
would be provided to all citizens by governments for free or at very affordable rates.
If governments become more effective at offering these services to more people,
they could reduce the opportunity for impact investors. But the reality today is that
most poor people are buying basic services from the private sector, and they do so
while incurring a huge penalty, in the prices they pay and the quality of services
they receive. There is a real opportunity for impact investors who can deliver
components of these services more efficiently and effectively, and this opportunity
has tremendous social and environmental benefits as well.
At the same time, there is a role for philanthropy and government to complement
investors by subsidizing and the creation and growth of innovative business models
that bring better services to poor people and concentrating their capital on the
poorest communities who will not be able to benefit from market-based solutions.
GIIN: How do impact investors today evaluate their social and
environmental performance? Do you expect that they will become more
sophisticated as the market advances?
NOD: There is a need for more rigorous social impact measurement. In many cases
today impact investors are using anecdotes, instead of quantitative measurements.
Of those who are measuring their social and environmental impact, the
overwhelming majority are using proprietary systems.
Using a standard measurement system is important because it allows us to
understand the impact we're having as an industry by aggregating comparable data,
rather than relying on fragmented anecdotes. Common standards also give us a
basis to create benchmarks that can help us understand, for example, whether an
investment into a water delivery system in one country is as effective as a similar
investment in another country, not just in terms of financial returns, but also with
respect to basic social outcomes.
NOD: The lack of clear social performance metrics is a major barrier to impact
investing. If investors are not using a third-party independent measurement system
- for financial statements or social impact reporting - their results are going to be
treated with skepticism by the investor community. Reporting standards like IRIS
and third-party ratings systems like GIIRS are fundamental to mainstreaming
impact investment.
GIIN: The report includes a section on risk management and overall
management of impact investments. What is different about managing
impact investments?
NOD: Traditional investments are made along two dimensions - risk and return -
and both are relatively easy to measure. Impact investing introduces a third
dimension of social and environmental impact. With this comes new risks, and chief
among them is reputational risk, as we are seeing in Indian microfinance now.
Impact investors have to understand how they are creating impact, and they have
to make sure that do it ethically and sustainably.
ABL: Effective impact investors must do all the things financial professionals do and
also be more savvy about the ways their investments intersect with the broader
society because the basic services they may be providing - education or healthcare,
for example - are important emotional and politically-sensitive topics. Successful
impact investors must also understand how to navigate a relatively complex set of
institutions, including development finance institutions, government, nonprofits, and
foundations. Being able to measure our social impact, and to communicate it clearly,
will be crucial both to improve the productivity of impact investments and to
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will be crucial both to improve the productivity of impact investments and to
preempt the pressure that can come from the many people who are inherently
skeptical about the ability of for-profit investment to support equitable economic
development.
GIIN: You mentioned that the lack of consistent social performance
reporting is a major barrier to the growth of impact investing. Are there
other barriers that need to be addressed?
NOD: The notion of fiduciary responsibility among traditional investment managers,
pension funds, and other asset trustees is another barrier to impact investing.
Fiduciary responsibility is traditionally defined as a maximization of the risk-adjusted
returns, and there is no room in that definition for positive social outcome. We are
beginning to see some progress in Europe, for example, where investors are
beginning to integrate social factors into their thinking about fiduciary responsibility.
But real change will be very difficult and will take a long time.
ABL: Pioneering impact investors have had to spend a lot of time and effort
explaining and defending the concept that for-profit investment can be a tool for
achieving positive social and environmental outcomes. This research note
complements other reports, most notably the Monitor Institute's
Investing for Social and Environmental Impact, that have clarified how impact
investing can be both a morally legitimate and economically effective way to address
global problems. The less time people have to spend defending and defining impact
investing, the more time and energy can go to addressing the challenges of making
impact investments work.
GIIN: There is a decades-long movement around socially responsible
investing. How is impact investing different from socially-responsible
investing?
ABL: Impact investing builds on the idea created by the socially responsible
movement that asset owners can approach their investments not only asking how to
maximize financial return, but also considering the social impact of their invested
capital. However, socially responsible investment has mainly focused on the
avoidance of investments in companies that generate negative social effects. While
techniques such as shareholder advocacy and management engagement are starting
to blur the lines, impact investing, in contrast, focuses on capitalizing projects and
enterprises that create social and environmental good.
NOD: Another difference between socially responsible investing and impact
investing is that impact investing is typically done in debt or private equity markets,
while socially responsible investing has focused on creating demand incentives for
publicly-listed companies to focus on good corporate citizenship. This is because we
think of impact investing as the provision of new capital to businesses that create
social or environmental benefit. Public equities are not excluded from impact
investing per se, but normal day-to-day equity trading is essentially an ownership
transfer of shares, rather than the infusion of new capital to a business.
GIIN: How has your organization benefited by taking a leadership role in
the development of the impact investing industry?
NOD: Impact investing resonates strongly with our employees which is important
because investment banks succeed when they have the best people. Contrary to
public opinion, getting and keeping the best people is not just about how much
they're paid, it's also about initiatives like impact investing that enable them to feel
good about working for this firm. When we first launched the Social Finance group,
we received emails from a thousand employees asking how they could help.
Employee engagement has benefited tremendously because of our involvement in
impact investing.
GIIN: What did you gain from collaborating?
ABL: Investment banks and private foundations have traditionally operated on
separate sides of a world that has been organized around two basic assumptions:
that the only purpose of for-profit investment is to make money, and that the only
way to solve social problems is through philanthropy and government. At its core,
impact investing is a challenge to both of those assumptions and to the idea that we
can continue to operate in separate worlds.
For impact investing to be successful, organizations like J.P. Morgan and Rockefeller
Foundation are increasingly going to have to work together. Working together on
this report has forced both our teams to push our thinking further by working
through our ideas and communicating with people who have different perspectives.
It is only by overcoming the challenges of working across this previous divide that
we can deepen the bonds required for impact investing to realize its potential to
deliver both financial profit and global solutions at the pace and scale necessary in
the 21st century.
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