What is impact and how does it fit into an institutional portfolio?

When looking at the range of views on impact investing, I’m reminded of a Winston Churchill quote: "If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.”

Confusion about impact abounds, so here I’m going to attempt to look through the fog and identify some different impact interpretations and their implications for investors.

In my view, the most important distinction is between impact investing (which is strictly defined) and investing for sustainability outcomes (where positive outcomes are intended, but not all criteria for impact investing are met). Even that distinction comes with a twist: it’s not black and white, but rather a continuum. Moreover, both approaches can be combined: impact investments can be part of an overall approach to investing for sustainability outcomes.

This is the first of two blogs on impact investing, the second part focuses on investing for sustainability outcomes: Why invest for “sustainability outcomes”?

Impact investing: definitions and components

A well-known definition of impact investing is the one by the International Finance Corporation (IFC) and GIIN (the Global Impact Investing Network): “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.”

According to GIIN, the practice of impact investing is further defined by the following elements:

• Intentionality: an investor’s intention to have a positive social or environmental impact through investments is essential to impact investing.
• Investment with return expectations: impact investments are expected to generate a financial return on capital or, at minimum, a return of capital.
• Range of return expectations and asset classes: impact investments target financial returns that range from below market (sometimes called concessionary, in particular by development-driven institutions) to risk-adjusted market rate, and can be made across asset classes, including but not limited to cash equivalents, fixed income, venture capital, and private equity.
• Impact measurement: a hallmark of impact investing is the commitment of the investor to measure and report the social and environmental performance and progress of underlying investments, ensuring transparency and accountability while informing the practice of impact investing and building the field.

However, this definition was formulated several years ago and some refinement has taken place as more private sector investors have allocate capital for impact. At Schroders, we follow the more recent Impact Principles definition, with the following core components:

• Intentionality (as above);
• Impact measurement (as above);

• Contribution: impact investing is not just about identifying impactful investment opportunities, but also about providing financial and non-financial support as an investor to deepen the impact of portfolio companies or assets.

Return expectations in impact investing

It is important to be clear about return expectations, since they are crucial for eligibility in investors’ portfolios. By defining a range of return expectations, the GIIN definition allows for concessionary returns, at least in some cases and for some investors such as donors and development-driven public sector investors.

This effectively highlights another important distinction within impact investing, between concessionary and non-concessionary impact investments. Since for most investors the concessionary type is at odds with the concept of fiduciary duty, it is very much a niche.

In contrast, the non-concessionary type is aligned with fiduciary duty and fast-growing. This is what we focus on primarily here at Schroders. (The exception being some of the blended finance offerings of BlueOrchard, where public investors give up returns to make projects investable (i.e. non-concessionary) in innovative asset classes and themes (e.g. climate adaptation in EM) and via de-risking measures unlock capital from private investors).

Impact across asset classes

Another nuance is that while impact investing can be found across asset classes, it is more widespread in private assets than in public assets (see Impact investing behind the scenes: four ways investor capital builds a sustainable future). However, public assets offer benefits in terms of scale (market size), liquidity and solvency, which can be crucial for specific types of investors, such as insurance companies. It is also often related to specific themes (see The 4 pillars of impact investing and how they work in the real world).

Impact investing in regulation & Schroders’ approach

And what about regulation? People tend to equate SFDR’s article 9 with impact, but that is not correct.

Article 9 funds are those that have explicit sustainability goals as their objective, which is not exactly the same as impact. At Schroders, our Impact driven funds are a subset of our article 9 funds.

The Impact-driven funds distinguish themselves by leveraging the impact management, measurement and governance of BlueOrchard - a leading impact investing manager with more than 20 years of experience in the sector and a member of Schroders group as of 2019. Our Impact driven funds have additional management, measurement and governance requirements and safeguards to ensure the core components of impact investing: intentionality, measurement and contribution. These safeguards include impact assessments (e.g. scorecards and other tools) per investment and impact committees.

In other words, you cannot make the cut unless your entire investment process embeds impact in all its different stages (from origination to exit). This tunes in well with clients who demand rigor and clarity on impact, and are after true impact.