Investing in 3-D

Let’s engage in a thought experiment. Consider two investments. Both reliably return 6% a year, and both enjoy comparable liquidity and credit quality characteristics. In other words, financially, they are equal. Their only difference lies in what one’s invested capital actually does. The first one funds credit receivables, generating no discernible social or environmental benefits. The second provides micro loans to Andean women who serve as their families’ primary bread winners.

Which one is better?

This is not a trick question. The answer is intended to be easy. Given identical risk and return characteristics, an investment which promotes desirable social outcomes and more tangible economic impact would be judged the superior investment by a majority of individuals and institutional investors. And so they should. In this example, their only difference is impact. One funds inventory while the latter helps hard working families with children survive.

But now let’s make the question a little bit harder. Say the receivables investment still returns 6%, while the Andean micro-loan portfolio only generates a reliable return of 5.95%, five basis points a year less. This means investors with $100,000 of Andean loan exposure must forgo $50 of annual income relative to the first opportunity. Again, their credit and liquidity risks remain identical.

Which is better now?

The answer here is also intended to be easy, though less self-evident. The determination of which investment is better depends entirely upon the specific objectives of the investor. If maximizing returns is all that matters to the capital provider, they should fund the receivables. Period. But if making a difference in the lives of people and planet is one of the asset owners’ goals, well by all means, they should choose the Andean micro-loan opportunity - and feel justifiably proud they have done so.

At the Impact Evaluation Lab, these are the kinds of questions we help investors ask and answer every day. For us, every investment is three dimensional - i.e., risk, return AND impact. To be clear, we are not prejudicially judgmental about any investment. Many if not most investors want to maximize their risk adjusted returns without prioritizing impact. This is both their legal and moral prerogative. Consider budget-strapped retirees who need their investments to feed and house themselves or fund managers who’s only fiduciary responsibility is to maximize returns. But not all investors optimize risk-return alone. If you happen to be someone who wants your investments both to do well and do good, you need to use more three-dimensional thinking. This is where IEL analytics come into play.

Our work has provided us with insights on how one might reliably generate 5%, 10% even 20% annual returns, while simultaneously building more low-income housing, removing pollutants from our land or water, lowering carbon emissions, or scaling health care solutions to marginalized communities (to name just a few of literally hundreds of worthwhile causes). The asset classes our analytic work spans include public and private equity, public and private credit, cash equivalents and real assets like public infrastructure and housing. No impact investment fund we’ve analyzed to date has fully transcended the risk characteristics of the asset class they embrace - impact equity investments largely generate equity-like returns - but every single one delivers upon their impact mission uniquely. How well they do so matter to investors who want to do well and do good.

As the above thought experiment demonstrates, we would never tell an investor which impact investment fund they should choose before understanding their precise objectives. We are fiduciaries who want our clients to achieve their goals, not ours. To this end, we provide transparency into the authenticity, tangible impact and financial returns of every fund we rate so investors are properly empowered to decide what is best for them. As consummate investment professionals with decades of experience at the world’s largest financial institutions, we are also committed to creating the world’s largest and most authoritative data base on impact funds so every individual and institution that wants to strive for double bottom lines - i.e., financial returns in addition to some type of social, environmental and or economic progress - can be confident they have deliberated all of their viable options fully and chosen wisely.

At IEL, we think a growing share of investment will become three-dimensional. How thoughtfully we allocate our capital matters deeply to our children, our grandchildren, the earth they will inhabit - and many more generations to come.