By John Stroud
After business school I felt I had developed many of the quantitative and analytical tools to thrive in finance. Unrelated to my professional endeavors, however, I was always aware of a personal responsibility to serve others. I soon came to learn that these two seemingly disparate aspects of my life were already being used in tandem within an exciting subset of investment management.
Check out our H2 hedge fund letters here.
This Tiger Cub Giant Is Betting On Banks And Tech Stocks In The Recovery
The first two months of the third quarter were the best months for D1 Capital Partners' public portfolio since inception, that's according to a copy of the firm's August update, which ValueWalk has been able to review. Q2 2020 hedge fund letters, conferences and more According to the update, D1's public portfolio returned 20.1% gross Read More
In 2010, during my tenure on the board of the non-profit “Miriam’s Kitchen”, I became aware of, and subsequently enamored with, the concept of impact investing. I spent hours reading through the technical aspects of the world’s first social impact bond, Social Finance Ltd’s work on reducing recidivism in the U.K. In short, I was hooked.
As one of the many former bankers who now work single-mindedly on the facilitation and expansion of impact investments, I have found nothing more important than focus. Said simply, my singular mission now is to catalyze the maximize amount of dollars into projects with the highest level of positive environmental and social change.
With the soaring interest in the areas of technology (clean water creation in sub-Saharan Africa) and creative financing (social/environmental impact bonds in the U.S. and the U.K.), it’s becoming easier to lose sight of some basic blocking and tackling. Two of the areas subsumed in this relatively pedestrian category are deal sourcing and due diligence.
Creating a strategy through an impact investment policy statement is essential and will inform (among a myriad of other strategic considerations) the decision of which vehicles (equity, debt or convertible) to employ to most effectively drive impact.
However, from a sourcing and due diligence perspective, I will highlight in this article the creation of a quality pipeline of deals and the subsequent vetting of those deals to determine where allocation of capital will engender maximum impact.
Developing a stable of quality prospective investees is one of the most time consuming and utterly exhausting aspects of placing impact capital. The considerable rise in interest around impact investing has resulted in a commensurate increase in the number of companies and funds claiming to create environmental and social good.
According to the Global Impact Investing Network (GIIN), the impact industry is growing at an average rate of approximately 20% in each of the last 5 years. It has now established a conservative, estimated figure of nearly $120B in assets under management with more than $22B committed in 2016 alone.
As is typically advisable for any goal-oriented institution, my recommendation is to delegate the sourcing of a robust pipeline of relevant deals to groups that have a laser focus on cultivating and assessing a large number of potential targets. The time spent distilling the universe of groups down to a manageable and appropriate number is time spent away from the primary mission of the foundation, family office, or development finance institution.
Incubators, investment advisory firms, and impact banks can all be a valuable resource when witling down a universe of possible investments and these groups will vary with the investors’ intended geography, impact area, and time frame. As is prudent in all private equity markets, a beneficial rule-of-thumb is to require that any investments made as a result of the advisor’s efforts will sit pari passus with, or along-side, their own investment. Requiring that the advisor has proverbial skin in the game ensures everyone is on the same side of the deal table.
From a diligence perspective, the number of quality ratings vehicles, protocols and measurement systems available now is encouraging.
For example, the IXO Foundation, a South African organization leveraging blockchain technology, has recently developed a ‘proof of impact’ protocol to quantify and verify impact created in specific projects. By validating impact at the project level, IXO hopes to reduce fraud and corruption and increase confidence for would-be impact investors.
Additionally, the Cambridge Institute for Sustainability Leadership, part of the School of Technology within the University of Cambridge, has developed an original framework with the intention of quantifying investment impact. More specifically, the Investment Leaders Group within the institute aims to provide an overarching framework for portfolios to understand and report impact.
Although not every social enterprise or even every impact fund will comport with each of the following metrics, it may be useful to take a more granular look at two more impact measurement standards that have been widely adopted and are available now.
First, the non-profit B Labco-founded in 2006 by Jay Coen Gilbert, Bart Houlahan, and Andrew Kassoy, and currently headquartered in Wayne, PA, administers the B Impact Assessment (BIA). This tool was created to assess and quantify a social enterprise’s overall performance around transparency, accountability, and sustainability and is currently in use by more than 40,000 companies.
The BIA is provided as a public service and is set up as a free, user-friendly, on-line platform. The assessment typically takes between 2 and 5 hours to complete. Companies completing the assessment have the ability to be certified as B Corporations with fees ranging from between $500 and $50,000 depending on annual sales figures.
Once a company completes the assessment, they become more attractive to fund managers who look to attract capital from investors. The more impact the funds can demonstrate within their portfolio companies, the more attractive they themselves become to capital providers.
These fund managers are rated through a different but symbiotic system called the Global Impact Investing Rating System. This rating, referred to as GIIRS, uses the B Impact Assessment, and is designed to shed light on the impact of the fund’s collective holdings. It is the impact measurement equivalent of a Morningstar mutual fund rating. Both standards utilize the familiar 1-5-star rating system for ease of use and simplicity.
Although not universally adopted by social enterprises, the BIA is a wealth of knowledge for capital providers. As such, many funds (who seek to maximize their GIIRS rating), family offices and non-profits are requiring that prospective investees take the assessment to provide greater transparency and insight.
Second, the Global Impact Investing Network, or GIIN, mentioned above, developed a set of standardized reporting metrics called the Impact Reporting & Investment Standards, or IRIS. If we can get past the copious use of acronyms, we’ll find that this common language is critical for due diligence reporting. Just as a financial assessment would certainly go beyond calling a company liquid, so too IRIS has derived a specific protocol around impact as opposed to declaring a company good.
The idea of impact investing is inspiring and the influx of capital into the space is exciting, but the pragmatic scaling of the industry relies upon good, old-fashioned discipline. Employing a well-thought-out sourcing process and a maniacal due diligence methodology, providers of impact capital can ensure that the most effective and well-run companies continue to get funded.
This discipline rewards social enterprises that effectively drive impact and financial results and allows funds to attract greater liquidity. Although not sexy, the result is often an increased allocation of capital away from companies concerned only with shareholders and toward the impact space where all stakeholders benefit.
Better sourcing and diligence increases the size and scope of the impact industry. Let’s keep focused on that.