Impact investing

Analysis

Impact investing and hedge funds

A sustainable strategy

Impact investing is a sustainable and competitive strategy for hedge funds. Here are five considerations for hedge funds as they move towards social finance.

Impact investing: A win-win for hedge funds

Impact investing can be defined as “the intentional allocation of capital to generate a positive social or environmental impact that can be—and is—measured.” It blends the earlier concepts of investment screens and social selection criteria with the newer enhancements of intentionality and impact metrics.

Hedge fund managers have been slow to adopt impact investments, however as the industry faces performance challenges, it may be time to take a closer look at how this type of investing may support alpha generation. Not only will it propel hedge funds higher on the social spectrum, but impact investments can allow hedge funds to competitively differentiate. Impact investing marries environmental, social, and corporate responsibility with a sustainable strategy.

Download our report for more insight or scroll down to read five considerations for hedge funds.

The value of impact investments for hedge funds

The lack of a clear hedge fund leader in impact investing suggests there may be open space for early movers to gain a competitive advantage. The biggest value proposition for this strategy is that a growing class of investors wants to see these types of products within their suite of investment options. The value-add to managers is not only about interest in a specific fund, but also about how this creates opportunity to bring in new clients and deepen relationships with existing clients. Competition is fierce and any opportunity to show responsiveness to investor demands while being first in an untapped market is key.

Five considerations for impact investing by hedge funds

For managers taking a closer look at impact investing, and others already in the social space, we suggest the five following considerations:

1. 

Defining meaningful impact measures. The lack of standardization for impact performance measures is a key challenge for impact investment managers. The wide range of impact measurement practices and metrics makes it difficult for investment managers to efficiently integrate impact measures into investment decision making. As transparency around impact measurement and reporting increases, a growing evidence base of impact disclosure will better enable the market to evaluate impact investment as an investment strategy.

2. 

Solving for intentionality, additionality, and differentiation. Hedge fund managers may have a few more hoops to jump through, conceptually, than other types of investment managers, before actively engaging in impact investing. While a full discussion of these is beyond the scope of this report, three elements are notable:

  • Intentionality. This practice means that a portfolio manager’s intention toward the positive, whether social or environmental, sets impact investing apart from other strategies that may measure performance only after the fact.
  • Additionality. Another metric for success is that an investment needs to create measurable social impact. But for this investment, as it were, there may not be any additional value-add or impact beyond what previously existed.
  • Differentiation. As the market matures, participating fund managers will want to differentiate their approaches around decision making and showcasing the value of the algorithms and trading/investing philosophies that support impact investment.

3. 

Achieving comparable performance. Investors will want to measure the performance of impact investing versus established benchmarks, and weigh it against the opportunity cost of other investments not selected. In one solution, Cambridge Associates (CA) and the GIIN jointly launched an impact investing benchmark in 2015, which assesses the performance of 51 private investments. Initial results have been encouraging. Across all vintage years, funds in the Impact Investing Benchmark posted a 6.3 percent internal rate of return, versus the 8.6 percent returns of funds in the Comparative Universe. These early findings illustrate that achieving comparable performance—or at least attaining returns which may be close enough to satisfy regulatory guidelines for institutional investing by foundations—may be a reasonable anticipation for impact investments. Hedge funds were not represented in the benchmark, yet managers considering entry into the market may find these results promising.

4. 

Ensuring fiduciary compliance. Recent ERISA (Employee Retirement Income Security Act) guidance may help pave the way for greater adoption of social strategies, including impact investments. In essence, a 2015 Department of Labor bulletin clarified that plan fiduciaries may invest in socially oriented funds so long as the investment is “economically equivalent—with respect to return and risk to beneficiaries in the appropriate time horizon—to investments without such collateral benefits.” As the market matures it will be vital for fund managers to ensure that their investment strategies and disclosures continue to keep pace with the evolution in regulatory oversight.

5. 

Growing demand in a challenging marketplace. The demand for impact investments may not yet support launching a dedicated impact strategy. Complicating this further, the hedge fund industry has recently faced market challenges that may negatively influence current traction for impact investing approaches. As social awareness is generally trending in the marketplace, and with millennials showing high interest in impact investments, and their influence rising as assets grow, it may be merely a matter of time before demand increases. If this happens concurrently with managers achieving comparable financial returns using impact styles, a new and welcome type of demand challenge may emerge: finding the opportunity to deploy capital effectively.

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