One candidate for the title “next new thing” is “impact investing.” As the term suggests, this refers to investing with an eye to the ways in which the investor’s decisions make an impact upon society beyond his own portfolio.
This sounds a lot like socially responsible investing, or like its close cousin, environmental, social, and governance focused investing. But SRI and ESG are both far too well established to be the next new thing. “Impact investing” is distinct in that it adds to the usual SRI ideas the notions of intentionality and impact metrics. This goes beyond the more negative use of screens characteristic of the cousins.
By standard definition the new thing, II, is the intentional allocation of capital to generate a positive social or environmental impact that is then subject to measurement.
A new Deloitte Center for Financial Services report, drawing on Preqin data, makes the following points about II:
- The hedge fund world is behind the curve here compared to others in the world of investment management. Indeed, Deloitte could not find any example of a hedge fund “currently self-identified as an impact investment.”
- Nonetheless, hedge fund managers do create ESG and SRI funds and accordingly share classes, and those often become part of the portfolios of impact investors.
- An average of five share classes in the SRI or ESG space have been launched each year of the last decade by hedge fund managers. Three quarters of these are SRI, the other quarter ESG. These share classes are available for impact overlay managers.
- The total assets under management of hedge funds using either ESF or SRI strategies are less than $10 billion. This makes for a fairly small space, given that total global hedge fund AUM exceeds $3 trillion.
- Deloitte suggests that hedge funds could up their game in a couple of ways: providing behind-the-scenes influence on direct investments, and positioning themselves for greater use by impact overlay managers.
Two Foundations that Champion II
The champions of II include notably the Rockefeller Foundation and the Omidyar Network.
The Omidyar Network is quite new. It is the brainchild of Pierre Omidyar, who is perhaps better known as the founder of eBay. Omidyar established this network in 2004 with the idea that “market forces can be a powerful driver for positive social change.” In fact, eBay itself is sometimes cited as evidence for that proposition: eBay has allowed millions of people to run their own businesses, effectively creating opportunities where there were only logistical barriers before.
The Omidyar Network’s five focal points for impact investing are: education; emerging tech; financial inclusion; governance & citizen engagement; property rights.
The Rockefeller Foundation, on the other hand, is a good deal older. One might say it owes its substance to the second industrial revolution, not the third. It was created in 1913 with the stated goal of “promoting the well-being of humanity throughout the world.” In the 21st century, its website describes its goals with a bit more specificity, “building greater resilience and more inclusive economies.”
Hedge funds are not foundations, and of course hedge funds, as the Deloitte study puts it, must keep their focus “largely on financial returns.” They are bottom line operations.
Still, hedge funds could well take the two steps mentioned above, to align themselves with impact investing in a sustainable way.
The report discusses the degree to which impact investing has gotten regulators’ attention of late in the U.S. The Internal Revenue Service, for example, has recently issued guidance relieving charitable foundations of the requirement of selecting investments based on the highest rate of return. Similarly, some observers, working from an April 2016 Concept Release, believe the Securities and Exchange Commission may soon include reliable ESG information in the disclosures it mandates.
Perhaps most important, the Department of Labor is on board. Last year, it clarified the ERISA guidelines in a way that helps (as Deloitte puts the point) “pave the way for greater adoption of social strategies, including impact investments.”
Fund managers in general are well advised to keep abreast of such regulatory developments, and perhaps even to take cues from them in terms of the development of their own strategies, facing toward their portfolio companies on the one hand and their own investors on the other.