Investor interest in impact and sustainable investing is mounting. But how do we know that an investor or fund manager is truly putting their money where their mouth is, versus simply re-labeling as ‘impact’ what they were already doing?
The ultimate proof is investors’ impact performance, but as a leading indicator of performance, we can also look at the process by which investors measure and manage their impacts. To what extent is impact a standalone consideration bolted on to the beginning or end of the investment process, as opposed to being integrated throughout?
We call this ‘impact-financial integration,’ and it poses a challenge for investors because financial and impact frameworks and methodologies generally exist in silos. They are not built to talk to one another. Investors who wish to integrate financial, social, and environmental considerations into a seamless investment process are therefore faced with a custom job.
The Impact Frontiers Collaboration , an initiative of the Impact Management Project, recently released a handbook presenting methods of impact-financial integration developed by a group of 13 investors. IDB Invest , the private sector arm of the Inter-American Development Bank Group, is among these organizations. Complementing the handbook, IDB Invest launched a new report outlining our Impact Management Framework in more detail. This blog presents IDB Invest’s approach as well as reflections from the broader Collaboration.
Managing a portfolio for impact
IDB Invest’s Impact Management Framework is an end-to-end set of tools and practices that support the project lifecycle and integrate impact and financial considerations into portfolio management. The framework includes:
- Investment selection. A Strategic Selectivity Scorecard identifies country private sector investment needs by industry, helping us pinpoint sectors where the development gaps are relatively deeper.
- Impact rating system. The DELTA (Development Effectiveness Learning, Tracking, and Assessment tool) is a rigorous, fact-based scoring system that assesses the impact potential of each investment, assigning a score from zero to 10. Embedded within this score is an approximation of the economic and social rate of return (monetization), a stakeholder analysis to consider the most important direct and indirect effects, a sustainability assessment, and an assessment of IDB Invest’s additionality.
- Monitoring. The ex-ante DELTA impact assessment is just the beginning. We track indicators and targets linked to the Sustainable Development Goals throughout the investment lifecycle, provide additional support to clients as needed, and update the DELTA score annually to reflect results achieved.
- Evaluation. In addition to mandatory independently validated final evaluations for each completed investment, we select some investments for more in-depth impact evaluations based on their level of innovation, size, and/or relevancy.
- Learning and dissemination. Our analytics platform visualizes data collected by the DELTA to help us analyze how the portfolio is evolving – from both an impact and a financial perspective – and inform decision-making.
Allocating capital for impact
As a development finance institution, IDB Invest seeks to maximize impact while preserving the long-term financial sustainability of the organization. Our portfolio approach to investing therefore balances these two dimensions.
We make investment decisions using a combination of the DELTA score and the Financial Contribution Rating, which is based on standard financial measures such as risk-adjusted return on capital (RAROC). Proposed investments need to meet certain impact and financial contribution rating thresholds in order to advance. These “hurdle rates” are on a sliding scale, with decreasing financial contribution requirements for highly impactful projects.
Few investments score a perfect ‘10’ in every impact and financial aspect. We want investment officers to be able to construct portfolios of investments that collectively meet our portfolio goals for impact and financial risk and return, with individual investments contributing in different ways.
Scaling Up the Practice
Other investors that participated in the Impact Frontiers Collaboration have different impact and financial goals, and employed impact-financial integration to advance them. For instance, Nuveen, the investment arm of TIAA, is bound by fiduciary duty to seek a competitive risk-adjusted financial return. Nuveen therefore designed an approach to impact-financial integration that would enable it to increase the positive impacts of its investments while fulfilling fiduciary obligations.
The 13 investors that participated in the Collaboration include equity investors, lenders, non-profits and for-profits, and operate in diverse geographies and sectors. The details of their methods of impact management and impact-financial integration are as diverse as they are.
Rather than standardizing the details, the group collectively sought to articulate general steps by which other investors could design and implement their own approaches to impact-financial integration. These steps, along with examples and lessons learned, can be found in our Handbook .
Conclusion
The benefit of greater impact-financial integration for the world at large transcends the benefits for individual investors. It has the potential to change the way financial markets allocate capital to address urgent problems. In an era marked by the coronavirus epidemic, climate change, and historic levels of inequality, building a financial sector that better serves society has never been more important – and more possible.
