Impact Adjusted Returns — Is there room in your portfolio for deeper impact?

Over the past several years, much research, time, and discussion has gone into busting the myth that investors must sacrifice return for impact. It is not hard to find such an article from most firms in the impact investing industry. It is safe to say that there are many opportunities to receive market rate returns while creating a positive impact. However, I think it is worth asking:

SHOULDN’T WE BE WILLING TO ACCEPT LOWER RETURNS TO GENERATE GREATER IMPACT?

We can hope that there may someday be no tension between financial returns and positive impacts, but we must admit that this tension exists in numerous industries and asset classes. So, perhaps we should make some room in our portfolios for investments that deliver lower returns but deeper impact.

For many, choosing impact over return may feel like no sacrifice at all, even if there is a significant financial opportunity cost from making that choice. Helping to house families struggling to find affordable housing has a value that is not measurable in a brokerage account statement. Seeing employees thriving and building wealth won’t appear on a company’s balance sheet. You won’t find assurance that an energy company isn’t poisoning the water flowing into nearby communities by looking at their cash flow statement.

Investors commonly accept lower rates of return when there is lower risk. Accepting a lower rate of return when there is a deeper impact may be necessary to make some deals work.

At Impact Charitable, we are seeking, analyzing, and creating investment opportunities that offer what I call “Impact Adjusted Returns” (“IAR”). We believe that donor advised funds offer a unique opportunity to target impactful opportunities within a portion of our investment portfolio that are not able to deliver market rate returns. With no set timeline or future event driving liquidity requirements; all funds set aside for charity have an opportunity to analyze investments with a stronger impact lens.

There is a large area of opportunity where an IAR approach can yield investments opportunities that would not otherwise be funded by the capital markets. Instead of holding all investments to the same risk/return standards demanded of traditional investments, an impact investment can be analyzed based on the positive impact created relative to the forgone financial return or increased risk.

In comparing a traditional market rate investment with an IAR investment, we can seek to determine what the financial return differential is between the competing opportunities. In some cases, this differential may be quite large, but in other cases, it may be only a few basis points. If we can define what the forgone expected financial return would be, we can then determine if the impact created by the investment is worth that tradeoff. The same can be done with a risk comparison between opportunities, though perceived risk can vary significantly.

Most fundamentally, an Impact Adjusted Return approach asks:

IS THE EXPECTED IMPACT WORTH THE FINANCIAL RETURN THAT I WILL BE FOREGOING?

And:

IS THE ADDITIONAL RISK WORTH THE EXPECTED IMPACT OF THIS INVESTMENT?

Many individual impact investors and a small number of foundations are already effectively taking this kind of approach, though they may not articulate it this way. I take this approach in my own personal angel investments, and I know of many others who, in practice, do the same. For many, the potential impact of an investment opportunity can far outweigh concerns around return, risk or liquidity. However, that notion may not survive traditional credit committees or financial advisors. We hope to see that begin to change, especially for dollars set aside for charity.

Note:

This is the beginning of a series of blog posts to further explore the idea of Impact Adjusted Returns and apply it to different asset classes. We will also analyze how IAR investments can be included in a reasonable investment portfolio, especially with dollars set aside for charity or when the portfolio value exceeds the expected needs of the investor.

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