(November 4, 2013) — Sir Ronald Cohen, one of the most celebrated names in private investing, has spoken to aiCIO about how he wants the largest institutional investors to join him on his latest mission: impact investing.
The approach takes social, responsible investing (SRI) or environmental, sustainable, and governance investing (ESG) a step further and sees capital allocated to distinct projects that aim to improve the world around us.
Goldman Sachs is about to launch a $250 million “social impact” fund whose returns are linked to the success of projects such as affordable housing, pre-school education and how many young criminals commit new offences after leaving New York’s notorious Rikers Island prison.
Morgan Stanley has also announced its own impact investing venture, the Morgan Stanley Institute for Sustainable Investing, which has the goal of attracting $10 billion worth of client funds for projects intended to provide social benefits as well as financial returns.
Cohen, who was brought on board by the United Kingdom’s government to launch The Big Society, (a pot of cash destined to fund social improvement projects in the country) has become the figurehead for this burgeoning industry—and wants aiCIO readers to be part of it.
aiCIO: How do you convince institutional CIOs about impact investing?
Ronnie Cohen: I discovered with the venture capital (VC) industry that as long as large institutional investors did not have an allocation, and someone responsible for deploying it, it was incredibly difficult to raise capital. VC first went to the CIO, then it was sent through to the public stocks manager, and then to someone else. There was no pot, and no-one wanted to see performance from something that is untested. So the breakthrough for VC was when the Employee Retirement Income Security Act (ERISA) changed in 1978 and private sector pension funds were not just allowed to invest in it, but had to explain why they weren’t investing in it. We now have something similar with impact investing (II).
aiCIO: Do you think investors are sufficiently aware of II to make an allocation?
RC: First of all, there is not a single view of what II is. There is going to be a huge spectrum of it. But the defining characteristic have to be greater than the ESG thinking that has motivated a lot of people to make allocations.
With II, we are looking at returns that are correlated to the achievement of social performance. In theory, that could be a public or private company, but in reality, many of these markets start off private. You have the market for funds that are investing in social impact bonds, and you have the market of funds that are place-based investments for profit, like Bridges Ventures.
The easiest way to make progress in this area is for institutional investors to appoint someone who is responsible for this investment allocation. I would rather social and environmental were kept separate—environmental investing already has supporters and I would like to get social going—and within that I would like to see anything that is correlated to social performance. Interestingly, Harvard has recruited the CalPERS ESG head…
aiCIO: This might be a difficult concept for investors focused on numbers – how would they measure it?
RC: We are getting much closer to being able to do that convincingly now. Bridges Ventures has issued a fund report showing social and investment returns—it centres on a multiple-placed investment that’s gone to some of the poorest districts and shows the number of people in work or being put through training, for example. I think the “profit with purpose” tag is becoming clearly motivated by social missions. What there isn’t yet is a set of metrics, but there is an approach.
Let’s take a social impact bond. An institutional investor looks at the organisation that is going to receive the capital and provide a service to the population, does its homework and the bond looks like it is going to give a 7% return. But the investment committee says: “We would expect this to be 11%.” Now we have to look beyond just feeling like it is going to give a social return—we need figures and evidence. The CIO can say to the investment committee: “If we are looking at 4% on a $10 million investment over seven years, that’s going to be roughly $450,000. If a thousand prisoners are rehabilitated and do not reoffend, where previously they might have done, is that worth $450,000? Or is the figure $10,000 or $1,000?”. From there, the CIO can say: “We will plot the delivery of the social return, if we agree going into the investment that $450,000 is a perfectly acceptable thing for a foundation to be foregoing in financial return in order to rehabilitate a person whose life would be otherwise in and out of prison.” You can monitor it year-in-year-out.
Because of this approach of measuring social outcomes, we are moving away from saying that social returns are unquantifiable. As always with the investment world, it is going to take a few thought leaders. With VC it was the AT&T pension fund and some peers that came out and said: “It’s an act of faith but we think it’s going to work and we are going to put some money behind it.”
Continues on page two…
Continued from page one…
aiCIO: So you think pension funds should lead on II, or is the approach more suited to other institutional investors?
RC: If you consider a foundation or an endowment, would you consider they would only think a social return was worth it just in their specific area? Or would a social impact bond that was improving conditions generally be acceptable? There are certain rules that need to be defined about the ambit of the social objectives of an endowment—and it’s pretty difficult to argue that no moral guidelines should be set on the activities of an educational endowment. Many educational endowments don’t invest in tobacco stocks, as an example.
Considered simply in pursuit of financial returns it would be worth investing in this asset class, because if you can achieve 7% to 8% over seven years, compounded and uncorrelated, that’s a pretty useful thing to have in a portfolio.
If you then go to pension funds with fiduciary responsibility there is a much greater need to protect against the downside. With many of these issues, it is in the long-term interest of the beneficiaries that these issues be dealt with. The Global Impact Investing Network has published a paper showing how foundations can initially step in to redress the risk/returns and allow pension funds a potentially more comfortable entry point to II.
In the early days of VC when local authorities began to invest—and they were the first, it was half of the money from corporate US funds and the rest from local authorities in the UK—because they said to themselves: “If we don’t create young businesses, years from now, we’re not going to have any public businesses to invest in, you need to renew the corporate base of the country.”
And if you look at the impact of social issues on pensioners’ lives, the pension fund might argue that given the very long-term liabilities of the fund, it might be better off doing something for cohesion of society.
aiCIO: Do you think looking long-term for society will help institutional investors elongate horizons that have been shortened by the financial crisis?
RC: That’s part of the reason why we’re better off looking at II as a private asset class. With private asset classes we use 10-year funds; take a social impact bond, which has a seven-year duration with the organisation behind it doing a lot of similar work to VC. People will be prepared to be more patient. We will refine the financial engineering of these bonds but still it takes time for a non-profit to absorb capital and raise its capacity to deal with an increasing number of people who measure social performance.
aiCIO: …and pick the right projects to pique investors’ interests.
RC: That’s right—we need to do a lot of experimentation. It needs to be a longer term timeframe, but all these investors who live in society, and are serving people who are members of it, need to make some allocation to it. Take it out of the corpus of the portfolio, for reasons of measuring performance and watch this space. Investors will see a lot of innovation coming and a lot of financial and social results being achieved. Just as when I invested in Bridges and expected to see around a 12% return (in fact it was 15% IRR) you may well see in this space that instead of achieving 7% from a social impact bond, you achieve 13%.
aiCIO: Many investors already like to tell their “local community” about how they have been helping to regenerate it or solve social problems; this seems like a natural extension.
RC: Exactly, I have spoken to investors and there is interest. If you look at the endowments at Duke, Dartmouth, Princeton, there are people on them who are interested in it. People often have a fear of failure, which is why there is an advantage to getting people to do things as a group together—that’s how the private equity industry got funded and look where that is today.
Related content: Taking a Hit for Impact Investing: How Big Funds Can Encourage Smaller Peers & Can Pension Funds Do Without Sin?