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Features How the Rich Impact InvestWatching how the rich invest is always interesting and now we can also see how they approach impact investing thanks to a new report, Evolution of an Impact Portfolio: From Implementation to Results. The report tracks the US$37 billion investment portfolio of KL Felicitas Foundation (KLF) and how over the past seven years it has moved to having 85 per cent of its portfolio in impact investments. The Foundation is on its way to 100 per cent, and in doing so it has invested across multiple asset classes while also achieving returns that are competitive with or outperform key indices. The report's author, social and environmental investment firm Sonen Capital, says it demonstrates that "impact investments can compete with, and at times outperform, traditional asset class strategies while pursuing meaningful and measurable social and environmental results". For environmental investors, it also shows that environmental themes and assets are a key component of most of the asset classes, even for such a large portfolio. US$37 billion is a huge portfolio, but not only is it possible to put it all into impact investments, the report says it is likely the international impact sector could have a significantly larger capacity to absorb capital as the universe of suitable impact investments continues to grow. The foundation's asset allocation strategy has seen it invest about 45 per cent of its assets in a variety of sustainable strategies; 21 per cent in thematic investments; 8.5 per cent to responsible investments, mainly negative screening; and 10 per cent to "impact first" investments that put social or environmental impact above financial performance. At the end of 2012 less than 15 per cent of its assets were in non-impact investments. "Thematic and Impact First strategies provide the greatest opportunity to align investments with narrow social and environmental objectives, and thus, this portion of the portfolio contributes most to the Foundation's impact intentions," it says. Contrary to what some may think, high impact investments are available in all asset classes, including cash, fixed income, public equity, private equity, real estate, and hedge funds, even if the asset classes are not all equal. This is heartening to know but also crucial as investing US$37 billion is a huge task and needs access to as many asset classes as possible. The Foundation's asset allocation targets are: As an investor gets bigger it has access to more assets classes until it is so big it needs all asset classes. The report reminds us it is harder for smaller investors to diversify, saying "it is important to keep in mind that diversifying a $10 million portfolio limits one's ability to access certain strategies and managers that could have otherwise been invested in". This applies even more so to non institutional investors, but retail investors can still access most of the key asset classes above, namely cash, fixed interest, public equity, and real estate, although at this stage only public equity offers real choice for environmental investors. So, yes, the rich do live in a different world.
Meanwhile, there is plenty to interest and cheer the retail investor. The universe of impact investments including environmental investments is growing across all asset classes. Public markets have opportunities for "far reaching and broad impact". And not surprisingly, public equities offer the most choice. Investing in public equities can increase the overall impact achievable in a portfolio and is critical to achieving global impact on a meaningful scale. KLF invests in sustainable equities through fund managers with a range of strategies for environmental, social and governance (ESG) evaluation. Some identify ESG related risks that could negatively affect impact and financial returns, and opportunities that could position a company for improved financial and impact returns. Some have best in class strategies, and apply positive ESG screens that evaluate company performance on topics like climate change, resource productivity, employee benefits and corporate governance and transparency. Other managers have a greater emphasis on environmental sustainability and how companies can position themselves to capitalize on long term global trends such as resource scarcity, climate change, increased urbanization and higher protein diets. Impact themes for analyzing public equity include the greenhouse gas emissions intensity of sales, the use and management of hazardous materials, and the percentage of products with Design for Environment standards. Climate change is a key theme. "The underlying fund managers in the public markets strategies invested in companies that were well positioned to grow as a result of environmental trends and could deliver impact globally by reducing resource consumption, increasing efficiency and developing environmentally friendly technologies," says the report. KLF's due diligence for managers started with a universe of over 300 impact managers and included negative screening (including nuclear energy), positive screening, and social and environmental themes. Managers who did not meet financial criteria or did not have a track record were also screened out. Those "Managers who met KLF's financial criteria for a given asset class were then evaluated more deeply for impact". As not every investment could deliver both maximum impact and financial performance, favour was given to "investments that achieved the most reasonable balance between financial results and impact goals". For the cash asset class, KLF invested in deposits with community focused banks and liquid funds that provide debt to social enterprises. It looked at themes such as community development and financial services, such as basic financial services, education lending, housing finance and community revitalization projects in the most impoverished parts of the US, microfinance loans to the working poor around the world, and financial services to low income groups in the US. For the fixed interest asset class, KLF invests in managers who support the development of microfinance and small and medium enterprises in the developing world. Last year it began to also include sovereign and corporate debt issues that integrate environmental, social and governance factors that can affect repayment. For hedge funds, KLF has investments in two funds with a primary theme of water and a secondary focus on agriculture and energy. For water, it will look at infrastructure, utilities, and treatment technologies. For agriculture it will look at processing, fertilizer, equipment and retail; and for energy it will consider wind, solar, biofuels, geothermal, energy efficiency and waste management. For the private equity asset class KLF had over the seven years made allocations to 13 private equity, venture capital, and private real assets funds with clear social and environmental objectives as well as financial return targets. The main themes include clean or renewable energy, sustainable food and agriculture, water delivery and financial services for underserved populations. Investments include information technology; agriculture; job creation in the US, China and India; African agriculture; Indian healthcare; community clean energy production; and social campaign design; among others. Although private equity is a small part of the portfolio, the "experience has had an overwhelmingly positive influence on our ability to deploy capital to greater effect in more traditional strategies and asset classes," says the report. The allocation to real assets is around themes such as conservation and ecosystem services. Environmental conservation includes land restoration and permanent conservation including through sustainable housing, wetland and stream mitigation banking, conservation finance, carbon sequestration, transfer of development rights, and sustainable timber and agriculture. Ecosystem services include greenhouse gas offsets, biodiversity, forestry management, rangeland conservation, and enhanced agriculture practices. Investing in commodities and ecosystem services helps to monetize the benefits of environmental goods such as clean drinking water and carbon sequestration through ecosystems and habitat preservation, it says. An example of a real estate investment is protecting a high conservation value coastal rainforest in British Columbia while providing a limited number of homes to an ecologically minded community. What is clear from KLF's overall asset allocation is that environmentally positive investments are a cornerstone of the portfolio and are in most of the asset classes. The report aims to provide a framework for impact investors to establish an impact investing strategy and move through concrete steps to implement and maintain the strategy. Adding "impact" to investment, it says, means that investors need to conduct an additional layer of due diligence to assess the value of investment opportunities according to their values and mission. This is apart from the financial analysis that goes into normal investment decision making. Constructing a diversified "alpha generating portfolio of investments" also means developing an extensive universe that can be culled to a short list. This is getting easier as impact themes and assets continue to grow. "We are extremely excited to share this report with the broader financial services industry in the hopes of discrediting the myth that investing for positive social and environmental outcomes requires a financial sacrifice," says Sonen Capital senior managing director, Raúl Pomares. "In the spirit of KLF's mission, the Foundation's hope is that others can learn from this experience and use these lessons to inspire them to action in mobilizing their assets to align with their values and address the world's challenges, without necessarily a trade off in return."
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