Introduction

Money managers have long had multiple options when putting their clients’ funds to work. Traditional asset classes—stocks, bonds, and cash equivalents—are joined by alternative direct investment opportunities in real estate, commodities, and derivatives. More and more, funds are being created that leverage expertise in venture capital and private equity through debt and equity investments. Each of these investment vehicles has a distinct risk profile and investor expectations, and all have one key investment motive: maximizing financial returns.

Over the last decade, the idea of impact investing—marrying financial returns with social returns—has moved from a nascent investment theory employed by a few philanthropic organizations and forward-thinking fund managers to a widely known buzzword in the investment industry. However, while momentum around impact investing has grown, it remains challenged by numerous questions and investor misperceptions that have kept the movement from gaining mainstream support in the investment community. In fact, the Investment Management Summit hosted by The Financial Times in October 2015 yielded the following list of thoughts from financial advisers on impact investing:1

  • “I cannot tell what is an impact investment and what is not.”
  • “I cannot be sure what impact my investment is really having.”
  • “I fear impact investments are not made with the same financial rigor as other investments.”
  • “Even when I was persuaded of the idea, I could not find enough opportunities that would have an impact on my client’s chosen problem.”

Thought leaders in the impact investing industry and even traditional asset managers continue to grapple with these issues today, because the idea of what exactly encompasses impact investing remains relatively undefined. While this analysis will not attempt to provide definitive answers and solutions to the concerns listed above, it does seek to provide financial advisers and money managers with a better understanding of an investment vehicle in evolution.

Using data from the fifth annual survey of impact investors compiled by JP Morgan and the Global Impact Investing Network (henceforth written as the “JP Morgan/GIIN survey”), ImpactBase’s catalogue of impact investment funds, and other recent data sources, this paper offers a framework for integrating impact investing into a broader portfolio strategy by detailing trends, strategic opportunities, return potential, and risks. In addition to reviewing the opportunities for impact investing to grow, this paper will challenge several myths that limit its usage and will provide solutions for overcoming perceptual, institutional, and legal barriers.

To provide examples of impact investing in practice, the report uses case studies of Bay Area impact funds and their investments. The Bay Area’s position as a leader in venture capital—in 2015, nearly 50% of all venture capital investments made in U.S. companies were made in the Bay Area (including San Francisco and Silicon Valley)2 —along with its robust innovation ecosystem, has allowed the region to catalyze a broader impact investing movement that now extends across the U.S. and the globe. Throughout the following chapters, this paper will answer the following questions:

      1. What education of investors and money managers needs to take place to deploy more assets in an impactful manner?
      2. As the impact investing trend grows, where can standards, definitions, and collective understanding be improved so that best practices are captured and improved upon?
      3. What barriers to investment can be addressed via changes to perception, institutional practice, and government policy?

Spotlight on Impact:

Bay Area Equity Fund

Overview:

One of the first impact investing funds to demonstrate an ability to generate above-market-rate returns was the Bay Area Equity Fund (BAEF). Launched in 2004, BAEF is managed by DBL Investors in partnership with the Bay Area Council, which established two real estate equity funds and a revolving loan fund for redevelopment efforts in addition to BAEF. The $75 million private equity fund was capitalized by investments from foundations, pension funds, banks, insurance companies, and individuals that sought to grow companies in parts of the Bay Area with historically high unemployment levels. BAEF invested in 18 developing Bay Area companies, with notable successful investments in Tesla Motors, Pandora, SolarCity, BrightSource Energy, and Revolution Foods.

Financial and Social Impact:

As of the end of 2014, BAEF had produced a 4.1x cash-on-cash return to limited partners and an internal rate of return of 24%, a significant financial return considering that the holding period covered an economic recession. For comparison, the top quartile return of compa-rable investment funds tracked by Cambridge Associates was 9.3% over the same period. In addition to financial returns, BAEF portfolio companies produced more than 15,000 jobs over a 10-year period (well above the initial goal of 1,500 jobs), while engaging the community through workforce training programs.

Investment Example:

BrightSource Energy, headquartered in Oakland, is a global designer and developer of concentrating solar thermal technology that produces steam for electric power, petroleum, and industrial process markets. The company’s solar thermal energy systems generate power the same way as traditional power plants—by creating high temperature steam to turn a turbine. However, instead of using fossil fuels or nuclear power to create the steam, Bright-Source uses the sun’s energy. At the core of the company’s proprietary solar thermal system is a next-generation solar field design that enables the creation of high pressure, high temperature steam. The steam can then be integrated with conventional power plant components for elec-tricity generation or for use in industrial process applications.