This recap of Tideline’s recent Compass Series event was written by Yael Cohen. Watch the full recording here.
At a time of both growth and momentum in impact investing as well as uncertain economic conditions, participants in Tideline’s third annual State of the Investment Market Compass Series highlighted a number of opportunities and challenges to navigate in today’s cross currents.
Thoughtfully design an impact strategy
Panelists began by discussing their approaches to impact investing, including how they compare to practices for investing in traditional markets. Eddie Madzikanda, Director at Temasek, explained that a key difference between Temasek’s approach to impact investing versus other strategies relates to the ticket size. He shared that “most of the more effective managers that fit in with our [impact] strategy have been regional managers with a fund size slightly smaller than what we are used [to]. This has meant we have had to adjust our check sizes slightly down.”
A smaller commitment amount has helped to ensure that the investment is in line with the manager’s strategy, recognizing that encouraging managers to accept larger investments might lead to a deviation. Another key message that Madzikanda conveyed and that was echoed by others on the panel is that “impact intentionality is key…impact can’t be a byproduct of the strategy – it has to be the North Star.”
Building off the importance of intentionality, Dimple Sahni, Managing Director of Multi Asset Impact Investing at Anthos Fund & Asset Management, added that the impact investment strategy at Anthos today equally weights impact and financial return objectives. Anthos is currently building an impact-efficient frontier to use in parallel with its existing financial efficient frontier. Both Madzikanda and Sahni shared their conclusion that, based on experience, investors can achieve market rates of financial return in impact investing.
Impact diversification is a key to portfolio resilience
In an environment with increased inflation and economic headwinds, many investors are focused on portfolio volatility and the importance of diversification.
Sahni argued that “impact diversification is really important because it creates resilience in the portfolio, so when public markets are doing well, typically the impact positions tend to outperform. But when they’re not doing well, it’s our private market funds that are also holding in place. [This kind of approach is] actually de-risking our portfolio.” She added that the investment team at Anthos is looking at investing in affordable housing given inflationary pressures, as well as energy generation and digital infrastructure, which can help hedge inflationary risks in other asset classes.
Megan Reilly Cayten, Senior Investment Manager at Climate Asset Management, added that natural capital – the world’s stocks of natural assets which include geology, soil, air, water and all living things – is a long term, global real asset that belongs in a resilient portfolio. She explained that, historically, nature has been managed in a way to maximize short-term exploitation for economic gain. However, she has found that when the focus is sufficiently long-term (more likely in this era of increasing weather volatility and other environmental shocks), investors can manage natural capital assets in a way that delivers better, more resilient commercial and impact returns. What the market needed, she argued, was a long-term focus and increased scale of investment. “The wonderful thing about nature restoration is that you need it everywhere so there’s so much opportunity,” Cayten said.
Rodney Foxworth, Co-Founder at Worthmore, also discussed his hope that asset owners would shift to a longer-term view, with a focus on historically underinvested markets. He highlighted the scale of the talent and opportunity that had been excluded from investment, making the case for DEI-focused investing as both moral and economic. Foxworth asked, “Are you really going to sideline so much opportunity and talent by excluding [and not investing in] the vast majority of folks? It’s a nonsensical non-economic strategy.” Foxworth reflected optimistically on new approaches and structures that support scaling high impact businesses, for example exits through redeemable equity, and profit sharing.
Collectively, the panelists argued that allocating to impact strategies was a form of risk mitigation, because impact investments had the potential to outperform financially while also providing long-term portfolio resiliency. Moreover, a total portfolio approach could help to avoid over-concentration in the highest risk or most volatile asset classes.
Strategic clarity is the best tool for navigating regulation
Deciphering regulations is an increasingly significant challenge for impact investors. Laura Houët, Partner and Co-Head of ESG at CMS, reminded viewers that important regulatory frameworks, such as SFDR and the EU Taxonomy, are not in fact defining impact, but rather are about disclosure. One difficulty Houët noted is that impact strategies vary widely (e.g., by sector, theme, appropriate metrics, target outcomes) and “at the moment we don’t have anything to talk about how to properly compare impact” across sectors and strategies. This in turn has created difficulty in the way regulations have been implemented, leaving an enormous scope for interpretation. In addition, the rules continue to change. For example, there will be a consultation to revise SFDR in the coming months.
Cayten emphasized the difficulties of navigating regulations that are still being written. For example, a majority of Climate Asset Management’s natural capital investments is expected to be in the agriculture space, which is not yet part of the EU Taxonomy.
Houët urged fund managers to be driven by their own thesis rather than regulations, stating: “we [lawyers] need to make the regulation fit you rather than the other way around.” Similarly, Cayten commented, that “LPs [we are talking to] want Article 9, but it doesn’t tell us how to generate impact.” Madzikanda also voiced that, in line with Temasek’s commitment to intentionality, they are looking to invest in opportunities where impact is “ingrained in the firm and everything they do.”