Impact investing has grown over the last 15 years into a global industry. It is led by asset owners that recognise how capital drives economic, social and environmental outcomes. The practice of evaluating the impact of assets across the investment life cycle – during due diligence, while invested, and upon exit – is becoming increasingly standardised and sophisticated. However, while investors are using an impact lens for asset selection, applying an impact lens to inform portfolio construction decisions is still rare.
Yet, if impact is the core of an investment strategy, we believe that it must feature not only in asset selection but also in portfolio construction. This can be implemented through strategic asset allocation across different asset classes.
At BII, when we launched our latest five-year strategy in 2022, we set out to deliver a range of impact and financial objectives. Since then, we have spent time considering how to optimise our portfolio for impact through factors including risk, return and liquidity. It has led to the development of an asset allocation framework, to set the guardrails of integrating impact in portfolio construction.
This report focuses on two key areas relating to portfolio construction. First, it describes why integrating impact in portfolio construction is valuable to investors. Only by understanding if and how impact correlates with these other dimensions, and constructing a balanced portfolio accordingly, can we best deliver on our mandate to maximise impact, both in the short- and long-term.
Second, the paper sets out how we integrated impact into portfolio construction at BII. This includes how we standardised the measurement of impact, risk and return for our portfolio. Further, as an equity-funded patient investor, we added a lens on liquidity to ensure the portfolio was generating cash receipts or dividends at a sufficient pace to continue supporting new investments each year. We then set out to test the relationships between impact, risk, return and liquidity, and see how these dimensions inter-relate in order to optimise our portfolio.
What have we learned from our own portfolio?
Our analysis debunks the widely held belief around the negative relationship between impact and financial return: we found no statistically significant relationship between impact and returns. However, we found a positive relationship between higher impact and/or riskier investments and time to realise returns from the investment.
We hope this paper will be of use to other investors integrating impact into portfolio construction. We encourage other investors implementing a holistic approach to portfolio construction to consider publishing data and insights from their portfolio to further move this important discussion in impact investing forward.
