January 20, 2011

Impact Investing Gains Foothold in Philanthropy: J.P. Morgan, The Rockefeller Foundation

Report uncovers huge profit and investment opportunities

Impact investing, which intends to create positive social or environmental effects beyond financial return, has gained traction in the philanthropic community in recent years.

By providing capital to fund managers and companies, impact investments can create social good alongside financial returns through the production of products that benefit poor people or the environment, and through business processes that further social justice and economic development goals, such as hiring low-skilled workers.

Several large foundations have created investment programs in recent years, for example, and public charities such as Calvert Foundation are getting into the game.Assets in the sector are currently estimated at $50 billion and are expected to grow to $500 billion over the next three years, according to a report on MarketWatch.

A recent research note published by J.P. Morgan Global Research suggests that impact investing will establish itself as an important investment movement in coming years. “Impact investments: An emerging asset class”is the result of a collaboration between J.P. Morgan and The Rockefeller Foundation, in partnership with the Global Impact Investment Network.

The report distinguishes impact investments from socially responsible investments, which it says try to minimize negative impact rather than proactively create positive social or environmental benefit.

According to the report, impact investors range from commercial financial institutions to pension funds to private foundations, family offices, private wealth managers and high-net-worth individuals. These invest across the capital structure, across regions and business sectors and with a variety of impact objectives.

The authors’ analysis of five sectors that serve people at the “base of the economic pyramid” uncovered a potential profit opportunity between $183 billion and $667 billion and a potential investment opportunity approaching $1 trillion over the next 10 years.

The research note includes a survey of leading impact investors, which found that their return expectations varied dramatically, from competitive to concessionary. Some expect to outperform traditional investments, while others are prepared to trade off financial returns for social impact.

Interestingly, the survey found that entrants into the impact investment markets increasingly believe they do not have to sacrifice financial return for social impact; many, in fact, have a regulated, fiduciary duty to generate risk-adjusted returns that compete with traditional investments.

The report argues that impact investments are an emerging separate asset class. “An asset class is no longer defined simply by the nature of its underlying assets, but rather by how investment institutions organize themselves around it.” An emerging asset class, the report says:

  • Requires a unique set of investment/risk management skills
  • Demands organizational structure to accommodate these skills
  • Is serviced by industry organizations, associations and education
  • Encourages the development and adoption of standardized metrics, benchmarks and/or ratings.

As analogues, the report cites hedge funds and emerging markets whose unique characteristics prompted mainstream institutions to define them as separate asset classes within the category of alternative investments. “We note that this definition was a key catalyst in driving the institutional growth of these assets over the last 20 years.”

According to the research note, impact investment risk management has a unique set of complexities that arise from social performance measurement and reputational exposure. Measuring and monitoring social performance are essential to track progress toward the intended effect and to manage the reputational exposure, but these are challenging and can be expensive implement. The report says market initiatives are in place to build third party systems to facilitate these efforts.

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