The Practice of Impact Investing
The World Economic Forum’s report, From Ideas to Practice, Pilots to Strategy, is a collection of articles that offer concrete approaches and actionable insights for professionals interested in engaging more with impact investments.
For TIAA-CREF, a full-service financial services company specializing in the distinctive needs of those working in the academic, research, medical, and cultural fields, social impact investing is deeply ingrained in who we are. Impact investing is part of our company-wide commitment to direct capital towards high-quality investment opportunities consistent with our overall investment strategy, and to create measurable social outcomes. This commitment stems from TIAA-CREF’s legacy of community investing and our mandate to engage in responsible investing on behalf of our investors. As of December 31, 2012, TIAA-CREF’s social impact investing portfolio consisted of $663 million in assets under management; by year-end 2013, TIAA-CREF will have committed an additional $100 million to the portfolio.
As impact investing has matured, TIAA-CREF has updated its approach to ensure it can access quality opportunities across select themes, asset classes, and geographic regions. As a result, TIAA-CREF has been able to diversify its holdings and set the stage to include more of these types of investments in its portfolio.
Why Impact Investing Makes Sense for TIAA-CREF
TIAA-CREF’s Social Impact Investment Program traces its roots to the mid-1980s, when the firm joined six insurers to create and fund New York’s Housing Partnership Mortgage Corporation. The purpose of that initiative was to provide mortgage financing for the rehabilitation and production of housing in low-, moderate- and middle-income neighbourhoods. That investment signalled to the market that we were open to this sort of investment opportunity and paved the way for many other impact investments. Since our initial impact investment three decades ago, the firm has demonstrated its responsible investment commitment in a number of ways. These include offering investment options subject to explicit environmental, social, and corporate governance (ESG) guidelines, community investment and shareholder advocacy.
Responsible investments are important to TIAA-CREF for three main reasons. One reason is that our clients typically work in the nonprofit arena, with many in higher education. They are highly educated, aware, and knowledgeable about the social and environmental impact of their investments, and feel favourably about our focus on the “double bottom line.” Another reason is that our proactive efforts have a positive effect on our relationships with state-level insurance regulators, some of whom prioritize meaningful, voluntary, community investing. For example, we are subject to statutory requirements in some states that are related to publicly disclosing our community development investment policy and reporting on specific investments. To do this, we work via collaborative efforts, such as the California Organized Investment Network, to bring together multiple stakeholders, including regulators, insurance companies, and community development organizations, to enhance shared learning. The third reason is that impact investments can provide exposure to new markets and emerging sectors, both in the United States and abroad.
Over the years, we learned how to develop an impact investing strategy consistent with the investment objectives of our General Account, a portfolio of more than $200 billion that supports the claims-paying ability of our annuity and insurance products. The General Account is a conservatively managed portfolio, with 87 percent of its assets invested in fixed income. In seeking greater diversification and risk-adjusted returns, this account has increasingly sought opportunities for direct private investments across several asset classes including real assets, private equity, and private fixed income.
Strategy Evolution: Updating Our Approach to Be Portfolio-Wide
In the summer of 2012, TIAA-CREF initiated a review of its social impact investing strategy. Over the previous decades, TIAA-CREF had launched a series of varied social investment programs, some closely linked to a specific asset class (such as deposits in leading community development banks, and private equity in microfinance), and others that covered more than one asset class, such as our corporate social real estate portfolio. A specific group was in charge of executing these investments (i.e. sourcing, evaluating, and monitoring them), effectively controlling the entire investment process and creating a distinct sub-portfolio of responsible investments. This process was similar to the organization of other investors that were incorporating responsible investments into their portfolio.
The Global Social & Community Investing (GSCI) team, created in 2006, was tasked with the 2012 strategy review. The review process was designed so it would aggregate diverse and balanced input from critical internal and external stakeholders. First, the process included more than a dozen meetings with key internal stakeholders to clarify the internal rationale, appetite, enterprise-level commitment and resources available to support the strategy for the General Account’s Social Investment Program. The GSCI met with groups that included the Board of Trustees, Senior Investment Management leadership, the Product Management and Business Development areas within Asset Management, and Government Relations.
The review process also included significant external benchmarking—gathered from sources such as meetings with insurance company peers, as well as investment banks, foundations, and faith-based retirement plans—to better understand the various investment approaches, program types, program size, and return expectations of those active in this space. We spoke to these groups about their program history, asset-class expertise and how they define social investments. We explored how they allot resources to their social investment initiatives, their source of funding and the staff placement that governs these programs. We asked in detail about their deal sourcing, size, risk, and return trade-offs relative to traditional investment valuation criteria. Finally, the team engaged with industry thought leaders and practitioners who provided insight into market trends, opportunities, and ideas for new investment structures, as well as information on policy efforts underway to facilitate the growth of the social impact investment space.
When the strategy review process was complete, the overarching mandate remained the same: to achieve competitive risk-adjusted returns and generate specific social and environmental outcomes. But compared to the legacy approach, the new strategy included some important distinctions.
First, the new starting point placed a greater emphasis on asset allocation and the appropriate mix of investments across multiple asset classes. Second, the return expectations for all investments needed to be commensurate with the appropriate asset class target returns for the General Account. Third, we needed a more coherent investment-strategy communication plan. Within our institution, it was critical to communicate and demonstrate throughout the firm that impact investment was not a philanthropic endeavour, similar to portioning out grants. Rather, it was an investment opportunity that had potential to provide diversification and boost more than the balance sheet’s bottom line. To accomplish these goals, TIAA-CREF set a thematic framework for impact investing, delineating three areas for investment focused on low- to moderate-income communities globally:
- Affordable housing
- Inclusive finance
- Community and economic development
TIAA-CREF decided to focus on these areas because, following the review process, each of them met the criteria, which were:
- facing ‘capital gaps’ which had not yet been adopted by mainstream investors
- having a market-based solution for addressing select social needs
- having quality deal flow that reflected the balance between financial and social return potential
- offering significant potential for TIAA-CREF to play a market leadership role given our in-house expertise.
By focusing on the three areas, TIAA-CREF not only introduced impact investing as an investment strategy to additional investment teams internally, but it also developed expertise in these areas through the use of high-quality sourcing opportunities.
TIAA-CREF’s portfolio seeks to invest both directly and through funds, depending on asset class, sector expertise, size of investment, and geography. When appropriate, investing in funds can mitigate risk, given the complex nature of rapidly evolving regulatory frameworks in emerging countries and sectors as well as the need for local presence and operational expertise in the relevant business models. It can also offer greater diversification and provide valuable co-investment opportunities.
Investments we have made in this area include the following examples:
Developing World Markets Microfinance Equity Fund I: A private equity fund focusing on financial inclusion serving underserved communities
Urban Partnership Bank: Investment in FDIC-insured certificates of deposit at community development banks that provide financial services to underserved US neighborhoods in Chicago, Cleveland, and Detroit
ProCredit Holdings: A private-equity investment in a bank that provides global microfinance and financing solutions to small and medium-sized enterprises (SMEs) and to low- and middle-income individuals
Impact Community Capital: A Community Development Financial Institutions initiative of eight insurance companies (including TIAA-CREF) to facilitate investments benefiting low-income families and underserved communities
Avanath Affordable Housing: A real estate equity fund that invests in affordable multifamily US housing properties
Executing the Investment Programme
A common institutional investor model organizes teams by asset class. Our experience and belief is that a partnership model is central to the execution of the social investment program. Otherwise, some potential transactions might get overlooked because their relatively small size might not merit a fund manager’s attention. A partnership model should be built upon a coordinated approach that taps into internal expertise and pulls together a small team, one that can identify potential transactions and evaluate social and environmental returns with investment management colleagues.
How does it specifically work? First, a firm-wide mandate hinges on the support of senior leadership, including both executives at the firm and the board of trustees. Its backing of the program signals that social impact investing is a priority, and it intentionally allocates resources for the initiative. This is not a static, one-time decision; rather, it is a continuous process involving periodic reviews, assessing financial, social, and environmental results. On an annual basis, the GSCI team reviews the strategy with Asset Management senior leadership using our proprietary template for analysing transactions, and proactively identifies possible modifications, opportunities, and challenges.
To facilitate the integration of impact investing with investment expertise across several different areas of the firm, senior leadership has assigned ownership of the strategy to the GSCI team. Under the enhanced strategy, the team could look at all the investments from a portfolio-wide perspective, ensuring they fit within asset-allocation parameters in terms of themes and geographic reach.
The GSCI team engages select investment teams to analyze investment opportunities in specific asset classes that may have a tangible social impact. The team is charged with building partnerships (as described below) with other teams, originating high-quality investment opportunities, tapping into investment expertise, and working with asset-class-specific teams to do due diligence and invest in impact investment deals. The GSCI team is involved to some degree in each of the five steps required to execute the annual investment programme:
- Sourcing potential investments: Impact investing opportunities, unlike a bond or equity trade or even a real estate transaction facilitated by a broker or an intermediary, typically do not cross an investment manager’s desk. As a result, the GSCI team plays a pivotal role in proactively originating deals and creating relationships to learn about such opportunities. Today’s impact investing market lacks a formal marketplace to fundraise (although emerging platforms like the Global Impact Investing Network’s ImpactBase exist), which means that deal flow origination requires overcoming information asymmetry. The team considers each deal to determine whether it fits within one of the three approved themes and is eligible for financial evaluation.
- Financial evaluation: Once a potential deal is identified, it must go through enhanced due diligence, which brings together the deep asset-class expertise of both the investment management and GSCI teams. Investment management partners aligned with particular asset classes bring their experience in structuring and analysis-specific expertise to the due-diligence process. For example, the team that manages private investments would lead the underwriting process for a private equity fund or private debt impact investment opportunity.
- Social impact & sector evaluation: The GSCI team simultaneously determines whether the transaction meets the firm’s social-impact criteria in addition to providing best-in-class sector exposure. This step is run in conjunction with the financial evaluation, but it falls largely to the GSCI team, which has the sector knowledge to determine whether the deal has the potential for measurable impact. This step includes reference checks and marketplace analysis to determine, for example, whether a community and economic development investment can enhance access to essential services, such as credit or health care for low- or moderate-income families. Meetings with the sponsors and potential investees in the countries or communities in which they operate are a very important part of the analysis. One example of evaluating an impact thesis would be leveraging the Principles for Investors in Inclusive Finance framework (which is backed by the UN and to which TIAA-CREF is a signatory). The framework offers guidance on specific aspects including client protection, transparency of product, range of services, and affordability.
- Investment decision: This step entails presenting the investment committee (comprised of senior leadership from the respective asset class teams and the head of the GSCI team) with a formal investment proposal for review and approval. The committee meets every time a deal is proposed, and the approval process is an important step in the overall portfolio management.
- Portfolio management and reporting: Once the investment committee approves the deal, the portfolio-management team for the relevant asset class has ongoing operational and supervisory responsibilities. The GSCI team is involved in monitoring the investment to ensure it maintains its social mission and delivers on its promise to improve the environment or community. These types of investments can have a multi-year investment horizon, mandating consistent review to ensure they stay on target to deliver on their impact investment potential. By maintaining an active oversight role, the GSCI team is also in a position to learn of potential co-investment and secondary financing opportunities that it might otherwise not be offered.
Keys to Success: Integrating Impact Investing across a Platform
Looking ahead, we believe an increasing number of financial institutions will seek impact investment opportunities as they strive to meet financial and social goals—whether from their own mandates, from regulators or shareholders, or from a combination of these drivers. As the demand for impact investing increases, investment firms can prepare by ensuring their organizations are structured to maximize future opportunities. That process needs to begin by first securing and sustaining top-level support for impact investing.
A focused approach helps to provide clarity for the roles and responsibilities of each part of the organization with regard to impact investing. It will also, of course, include setting annual and overall portfolio allocations.
In our experience, having a dedicated impact investing team that sits alongside investment managers has proven to be a successful model. The team handles a variety of activities such as identifying, tracking, and measuring investment opportunities across a range of asset classes, and ensuring that the program delivers on its promise to achieve competitive social and financial results. The team serves as a catalyst, engaging managers of specific asset classes to use their expertise in evaluating transactions. It also plays a pivotal role in communicating the benefits of the program and dispelling common myths, including the perceived elusiveness of finding investments that can deliver both social and financial returns. These investments not only exist, but also are likely to proliferate. The investment firms that prepare themselves opportunistically today will be well positioned to succeed in this space.
The market for impact investing opportunities is in its formative stages; however, as it matures, investors will have additional opportunities to put money to work—in areas that can provide benefits to their portfolios’ bottom lines and create societal change.