This is Part 2 of a two-article series. The first article describes the gap between impact capital and conservation investments.
Conservation managers and entrepreneurs who are looking to make their projects stand out as investment opportunities should be sure to supply the information that investors want. Impact investing experts interviewed by Network expressed a surprising lack of interest in most impact metrics and measurements aside from carbon sequestration. They instead indicated that they prioritize honest assessments of risk. They also value an understanding of how an investment opportunity can fit into a larger portfolio.
Managers looking for impact capital can gain an edge if they orient their pitches to the specific risk tolerance profiles of the investors or funds.
Financial Risks, Liquidity and Misalignment
“There is an interplay between issues [our clients] care about and the needs of the portfolio,” said Jeff Finkelman, senior research associate at Athena Capital Advisors. Often, he has found that working in the impact space means working with new teams or startup firms. This is a risky proposition when managing a portfolio.
Other interviewees echoed this idea. “There are lots of interesting conservation finance strategies coming to market, particularly in the ecosystem services space,” said Brad Harrison, managing director of Tiedemann Advisors. He said that when it comes to impact investing in these emerging fields, the firm’s Investment Group takes a very structured and diligent approach to investment analysis as a fiduciary obligation to its clients.
Jacob Israelow, founder and managing director of Dirt Capital Partners, said he has also experienced that many impact investors and investment advisors are reluctant to invest in teams with less experience. “Many don’t invest with first-time funds or in new approaches with limited track records.”
Finkelman said it is important for investment managers to be clear about the risks the investment opportunity contains. The more honest capital seekers are about their risk profiles, the more reassured investors will be that they understand the risks they face and are prepared to mitigate them.
Howard Fischer, CEO of Basso Capital Management and cofounder of Gratitude Railroad, said that understanding whether the fund or investment opportunity is well-managed is of the utmost importance. After all, if the business or fund fails then it does not matter how much theoretical impact it could have.
According to Harrison, "It’s important to apply a rigorous approach to investment due diligence – carefully reviewing the strategy, track record, team, and theory of change.”
Harrison said traditional investment structures are not always compatible with the optimal needs of impact assets. “There can be a disconnect between how the typical private equity fund is structured, the typical investor’s liquidity requirements, and what is in the best interest of the particular asset.”
A typical equity fund will look for investments with 5-to-10-year exits. Timber, for example, does not grow on a 10-year cycle. The longer time frames that many conservation investments require can make aligning investment and ecological outcomes difficult.
“This is the patient capital problem impact investors are looking to address,” Harrison said.
Israelow said an additional challenge is the limited number of industry capacity-building intermediaries in the conservation investing space. “This is changing because of deliberate field-building activities over the last several years.”
Still, the limited management capacity of existing businesses and funds makes it difficult to underwrite large volumes of complex conservation deals, Israelow said.
Relationship-based industries rely on experienced, embedded institutions that can connect investor capital with opportunities on the ground. Without reliable institutions possessing established social capital and technical expertise in the field, conservation impact investments can seem riskier to investors.
Impact Metrics and Measurement
According to the GIIN State of Impact Measurement report, impact metrics are an important way to link outcomes to dollars invested, enhance the rigor of impact strategies, and encourage greater participation and investment in the space. Much collective effort has gone into studying and improving the reporting metrics available in impact investing. When asked about the importance that metrics play in their decision making and investment strategies, interviewees had varied responses.
Harrison, Israelow and Fischer all expressed a similar idea about impact measurement. They agreed that much of the time, impact measurement does not matter to investors if the project and the management team are very obviously environmentally-oriented. The consensus seems to be that if investors know intuitively that their money is having an impact, quantifying that is interesting but relatively unimportant.
“Many investors are not interested in computing the extent of impact for its own sake, as some outcomes are difficult to measure cost-effectively, if at all,” Israelow said. “In the broader universe there is a lot of demand for more meaningful metrics. This can lead to people creating metrics and data that are not all that meaningful.”
Fischer said his firm does not quantify exact impact. His team does discuss it, but “like many nascent organizations, we are resource-strapped.”
“Measurement is important – it’s an area we are always trying to improve,” Finkelman said. He collects and aggregates information that investment fund managers make available.
According to Finkelman, reporting from the fund level will need more standardization for impact investing to continue to grow. “There needs to be a set of expectations for impact measurement and reporting that managers know their investors want them to meet. This would be a big step.”
Harrison said Tiedemann takes a high-level view with environmental and sustainability strategies, focusing on a small handful of reliable metrics. His firm is not overly prescriptive with metrics, especially because they tend to invest through third-party investment managers. To him, measuring carbon is the single most attractive type of metric because it is quantifiable and verifiable. According to Harrison, it is the most universally applied metric and can be used to measure performance across asset classes in a portfolio.
“We are interested in any investment strategy where you can accurately measure carbon reduction or sequestration,” Harrison said. “We want to get the most bang for the buck.”
In recent years, Harrison has seen many high-net-worth individuals and foundations seek to divest from carbon intensive sectors for more sustainable opportunities. “Over the past five to six years, I have had a number of interesting debates with clients around the strategic implications of low-carbon portfolio management.”
This divest/invest movement is a large part of what is growing the private market for environmental investment strategies, Harrison said. “It’s the environmental conservation projects specifically that are especially compelling. They can significantly lower the carbon footprint of an investment portfolio.”
However, Harrison said, “Impact investors often overemphasize their focus on metrics.” In reality, they need to be linked with sound investment strategy and decision-making. He expressed skepticism at the accuracy and relevance of some environmental-impact metrics. Part of the disconnect is that each impact category has different measures of success. Compiling all of that into one cogent number and narrative is not really possible.
Finkelman and Harrison said they experience frustration with the lack of attention paid to the larger portfolio that business and fund managers are looking to sell opportunities to.
According to Finkelman, within the environmental impact space there is usually heavy emphasis on individual investment opportunities and the returns they generate. “If impact is really going to be integrated into investing, impact investments can’t be viewed as opportunistic.”
As Finkelman sees it, there is not enough collective emphasis on how impact can be generated and allocated on a portfolio level. He drew a parallel to the process of asset allocation, which involves deciding how a portfolio should be distributed across stocks, bonds, and other asset classes. He wants to see the same kind of thinking applied to the impact goals of a portfolio.
Harrison’s firm takes a “total portfolio” approach to environmental impact investing. “We work to generate environmental outcomes across asset classes in a client portfolio.”
For instance, within public equities and fixed income markets, Harrison’s team might seek strategies with low carbon intensity. Within private equity and venture capital, they look for investments in cleantech finance, sustainable timber, regenerative agriculture, wastewater energy, EV infrastructure, and food systems.
Thus, entrepreneurs and investment managers seeking funding can stand out by placing greater emphasis on how their investments can fit into the sustainability strategy of a larger portfolio.
Despite some of the disconnects that the interviewees see between the expectations of the investors and what investment opportunities provided, they remain very optimistic about the future of the impact space.
Investment managers looking for funding must target the right kinds of investors, but there are plenty out there, Finkelman said. It is important to align investable opportunities with the interests and needs of the investors.
“We are of the view that impact and return are not mutually exclusive. There are opportunities to achieve all objectives,” Finkelman said. “The set of opportunities is quickly growing and will continue to grow.”
Harrison said his experience shows there is a lot of interest in conservation investments. “There is a lot of institutional money that needs to be put to work.”
Similarly, Israelow said that there are a lot of investors looking into conservation investments. For instance, Dirt Capital has not had trouble attracting capital. “There is plenty of interest out there - more demand than opportunity.”
Israelow indicated that as the space matures and investment intermediaries develop, the quantity and sophistication of conservation-investment opportunities will reach the expectations of more mainstream investors and investment advisors.
Note: An adjustment to a quote from Brad Harrison was posted on 7/27/2018. A quote attribution was corrected on 7/30/2018 to indicate that the comment is from Harrison.