Impact Investing and the Promise of Real Assets
For institutional investors looking to explore impact investing, real assets are a great place to start.
For institutional investors looking to explore impact investing, impactdriven ‘real assets’ such as affordable housing may be the place to start.
IMPACT INVESTMENTS — those that seek a specific social or environmental impact alongside financial returns — continue to grow rapidly. Early movers such as niche firms and foundations have blazed the trail, but as investor interest grows, larger investment management firms — including large institutional investors—are building capacity in this area.
However, like cryptocurrencies and AI, impact investments add variables that don’t easily fit with more conservative investment management theories and practices. So, where might investors start in this nascent market?
In a world of low interest rates, high prices for many traditional investments, and the increasing willingness of institutional investors to explore alternatives, could real assets— investments in real estate or infrastructure projects — be a starting place to try out impact investing? The answer is Yes. But first, a little background.
Defining Impact Investing
Whereas traditional responsible investing tended to reduce harm by avoiding certain business practices or products, impact investments strive for positive impacts — such as improving health outcomes or supporting the shift to green energy — that also produce a financial return.
Investments using this relatively new approach are growing fast. In 2017, more than US$114 billion in impact investing assets were under management globally, up from US$77.4 in 2015. Deloitte suggests the global market will grow to US$1 trillion by 2020, and another estimate proposes more than US$2 trillion by 2025. In Canada, CAD $9.2 billion in 2015 (more than doubling from CAD$4.1 billion in 2014) may jump to more than $30 billion by 2023.
Impact investments have been made across a range of asset classes, social and environmental issues and regions. In terms of
asset classes, debt products represent the largest class of assets under management, with equity the third largest. Perhaps surprisingly, real assets are the second-largest class of assets under management.
Early impact investors include a number of organizations that may be unfamiliar to many in the mainstream financial markets. Some of the most active players are niche firms like Acumen (founded in the U.S.), Bridges Ventures (UK) and Calvert Impact Capital (U.S.) as well as powerful foundations like Rockefeller (U.S.) and Mcconnell (Canada). Triodos Bank (The Netherlands) is perhaps the largest, most prominent global bank with a historically significant stake in impact investments. In Canada, credit unions and other community-based banking organizations — notably in Quebec — have led the way.
However, because impact investing is still new, historical performance data, comparable product models, value and risk analysis, and other traditional investment information are often ‘fuzzy’ — if available at all. By definition, impact investing requires deliberate attention to measuring impact — adding another variable that can complicate investment decisions considerably. Impact measurement is one of the trickiest dimensions of impact investing — and one that is only beginning to take shape.
Nevertheless, an increasing number of large investment firms are signalling interest or beginning to build capacity. The Economist recently reported that Blackrock, the world’s biggest asset manager, with US$6 trillion under management, had launched a new impact division. Even more boldly, Black-
Blackrock founder and CEO Laurence Fink has stated that his firm
considers more than just financial performance.
rock founder and CEO Laurence Fink stated in his 2018 letter to CEOS of public companies that his firm would now consider more than just financial performance across its portfolios:
“To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Your company’s strategy must articulate a path to achieve financial performance. To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends — from slow wage growth to rising automation to climate change — affect your potential for growth.” Elsewhere, Goldman Sachs has acquired an impact-investment firm, Imprint Capital; and two American private-equity firms, Bain Capital and TPG, have launched impact funds. Prudential and RBC Financial Group also have impact investing units, while J.P. Morgan and BNY Mellon have developed white papers on the topic, signalling future interest.
While these commitments sound promising, it remains unclear whether all these firms are acting consistently with the high standards that the earliest adopters brought to impact investing. It is possible that some are repositioning current approaches and products (notably in responsible investing or using Environmental, Social and Governance [ESG] analysis) — a practice sometimes called ‘impact washing’, according to Kelly Gauthier of Purpose Capital.
Affordable housing is one of the most effective interventions
for creating positive social and health outcomes.
As for institutional investors, while some of the largest pension funds have started making impact investments, their efforts represent a tiny sliver of the market. In the UK — arguably the leading market for impact investing — only four of 20 major pension funds had made impact investments, investing about £1.380 billion by comparison to more £300 billion in traditional investments.
In the U.S., research by the Accelerating Impact Investing Initiative (AI3) found that 15 state and city pension funds and four religious pension funds had made impact investments, although the total assets under management was not specified. In Canada, pension funds in Quebec have been early adopters. Benefits Canada has reported that, “While impact investing is still not practised by the majority of pension funds in Canada, funds in Quebec are an exception.”
Despite the early leadership of a few funds, impact investing remains unfamiliar to many major pension funds and other institutional investors. So, where might major institutional investors start? An important possibility lies in the recent shift among institutional investors to real assets.
The Shift to Real Assets
Definitions of real assets vary, but generally they comprise ‘hard’ physical assets of three types: real estate, infrastructure and com- modities. Most institutional investors consider these to be ‘alternative investments’ in contrast to more common investments like public and private equities in companies, as well as a range of debt and fixed income instruments.
Real estate is the most familiar form of real asset, including public and private equity and debt investments in buildings and land. It also includes public securities in the form of REITS (real estate income trust securities). According to Credit Suisse, real estate investments by institutional investors are “principally in office and retail space. However, rental apartments, logistics properties, seniors’ housing and hotels are also under consideration.”
As for the other two categories of real assets, infrastructure includes debt and equity investments in physical assets that produce income, such as toll roads, bridges or utilities; while commodities and other real assets are a more diffuse category comprising metals, agricultural products and the like.
Among the respondents to a Blackrock survey of major institutional investors, real assets made up about 11 per cent of their total portfolios. Nearly all — 96 per cent — had invested in real estate, 66 per cent in infrastructure and 29 per cent in commodities. Infrastructure investments were noted to be rising particularly fast in comparison to the others.
Real assets provide investors with a number of benefits that
make them uniquely valuable within their overall portfolios. According to a white paper by Credit Suisse, real assets offer “stable income returns, partial protection against inflation, and good diversification with other investments in the portfolio.”
Alexander Dyck, the Manulife Financial Chair in Financial Services at the Rotman School and a Fellow of our Michael LeeChin Institute, highlights two of these benefits in particular:
“Unlike fixed income, where returns are fixed in nominal terms, real assets returns normally vary with changes in consumer price indices. This means that real assets provide a natural inflation hedge, making them attractive to institutional investors whose liabilities are also affected by price indices changes, as is the case where promised returns are indexed. What everyone cares about is risk-adjusted returns and the impact on diversification.”
Real assets’ risk adjusted returns have not been stellar in the data Prof. Dyck has seen, but he notes that they definitely add to diversification. Scale may also be a consideration. Many real asset investments tend to be large, which means they may be attractive to institutional investors who tend to seek larger opportunities to reduce transaction costs. But real assets can be illiquid and have long-term investment horizons. While this is a disadvantage in some portfolios, it can be an advantage for institutional investors who wish to match predicted long-term liabilities with stable long-term income. For those looking for short-term exposure to real assets, REITS can be a solution, as they tend to be more liquid.
Given these benefits and the nature of current markets, real assets are a growing part of institutional investors’ portfolios. The shift to real assets is expected to continue, if not accelerate, across institutional investors’ portfolios. At the same time, they are building capabilities, expertise and investment teams specializing in real assets.
Real Assets and Impact Investing
As institutional investors expand their exposure to real assets, some are also exploring impact investment. For those doing both, it may be possible to leverage their growing expertise by selecting at least some real asset investments that produce both the right risk-adjusted market returns and generate social or environmental impact.
A number of impact investments in real assets have already been created in the UK, Europe and elsewhere that may provide guidance on how to proceed. Two early funds include those from Bridges Ventures (UK) and Oltre Venture (Italy). But there are many more. A 2015 GIIN report assessed the financial
performance of 55 real assets impact investing funds of vintage years 1997 through 2014, grouped into three sectors: timber, real estate and infrastructure. Overall, it noted two key findings. First, risk-adjusted market rates of return can be achieved in impact investing, as evidenced by the fact that the distribution of impact investing fund returns mirrors the distribution of conventional real asset fund returns (see Figure Two). And second, fund selection is key to success, as the distribution of individual fund returns varies widely. As the report states “This applies equally to impact investing funds and conventional funds.”
In Canada, a group of foundations including RISQ, Tides Canada, Trico Charitable Foundation, Vancity Community Foundation, Bealight Foundation and The Mcconnell Foundation worked together to create New Market Funds, an impact investment fund that develops affordable multi-family rental properties. It is no coincidence that one of the earliest collaborative impact investments in Canada occurred in the affordablehousing space. The financial benefits of the right investments in real assets are clear. Among possible impact investments, a significant advantage of real assets are their relatively clear, understandable and measureable social or environmental impacts.
Not only is the affordability of housing a major economic challenge in major cities globally, it is a key social challenge. Research shows that affordable housing is one of the most effective interventions for creating positive social and health outcomes. There are also a range of environmental improvements that can be made in housing and through other real assets that make them even more attractive to impact investors.
Acccording to Beth Coates of St. Clare’s Multifaith Housing Society in Toronto: “The positive social benefit and impact of appropriate housing cannot be understated. It is significant and can be easily tracked and measured in both financial savings and improved quality of life.” However, she warns that government funding remains crucial to ensure affordability due to high real estate, construction and operation costs, and the need for ongoing rent subsidies, before such assets are likely to attract other investors.
There are also a number of well-studied environmental improvements that can be made as a part of real estate and infrastructure investments, with attractive environmental and financial benefits. In the 2015 GIIN study, impact investments in real estate assets had the objectives shown in Figure One. In contrast to many other impact investments, these benefits are well researched, understandable, compelling, and relatively easy to quantify and monitor over time. Nevertheless, to date many impact-driven real asset funds remain relatively small and could present challenges to institutional investors looking to make sizable investments.
How to Get Started
More and more resources are being developed to help investors explore impact investing in real assets, including the release of two key publications. “Impact Investing in Real Estate” by Impact in Motion [available online] describes the strategies of successful impact funds and trends. To assess the social need and opportunities for impact investors, it looked at the sectors affordable housing, underserved communities, and ageing. Within these sectors, it found that affordable housing and underserved areas appear to be highly attractive for impact funds, yielding interesting niche investment opportunities with low competition.
Going forward, Impact in Motion expects impact investing in real estate or real estate-related businesses to grow and increase its share of the overall impact investing market. This development will be driven by the availability of profitable niche investment opportunities, impact funds looking for larger scale, lower risk investments and the opportunity to attract new groups of investors, and investors diversifying their impact portfolio.
Meanwhile, The Impact’s “Real Assets and Impact Investing: A Primer for Families” outlines motivations, approaches and examples of investments made by family offices in real assets that might be instructive to institutional investors. Notably, the paper highlights social and environmental benefits to suggest that, “Real asset investments are particularly well-suited for investors whose impact objectives include supporting underserved communities, enhancing resource efficiency, or improving sustainable food and fiber systems.”
As well as financial, social and environmental benefits, impact investment may accrue a range of other benefits to institutional investors that might be described as ‘goodwill’. These include improved relationships with government and other regulators, within the industry, with customers, community and employees.
In closing
For centuries, real estate and other hard assets have been a familiar, tangible and relatively safe investment. More recently — given historically-low interest rates and a desire to increase returns and decrease uncertainty — real assets have grown quickly
within institutional investors’ portfolios. With the parallel rise of impact investing, institutional investors should consider real assets with a social or environmental benefit as a possible way to leverage their growing expertise in and exposure to traditional real assets.
Impact investing in real assets brings many of the same financial benefits as basic investing in real assets: income, diversification and capital gains, among others. However, it adds a range of social, environmental and other benefits that are compelling and measurable. In sum, impact investing in real assets is an excellent way for institutional investors to turn assets into strong returns — and impact.
Rod Lohin is Executive Director of the Michael Lee-chin Family Institute for Corporate Citizenship at the Rotman School of Management, which conducts research on sustainability strategy, social enterprise and impact investing. He is a co-founder of Openimpact.ca, an inventory of impact investments in Canada, a joint project with Purpose Capital. He is also a founding member of the Board of Rise Asset Development, a micro-finance organization helping people with a history of mental health and addiction issues to explore entrepreneurship.