​In Impact Investing, Better Measurement Means Better Impact, Better Returns

Joel Anderson  |

In general, investing has always been defined by the supposedly quantifiable. Balance sheets, income statements, and, most of all, returns. However, even within the world of quantifiable, things can still get pretty murky. Particularly within the world of expansive portfolios crammed with a variety of asset types, many of which are in non-traditional classes, it can be difficult for funds to know exactly what they own and exactly how it’s doing. That’s where the software company Addepar comes in.

“The mission of Addepar is to power the global financial system to efficiently allocate capital and mitigate risk,” says Daniel Bookstaber, COO. “That’s a pretty ambitious mission. The whole theory with Addepar is that you have massive pools of capital, about $77 trillion of ultra-high net worth and high net worth assets in the US, and they are increasingly invested in the very complex portfolios. They are multi-asset class, multi-custodian, multi-currency, and there isn’t really good technology out there to help the owner of those portfolios understand what they own and how it’s performing.”

And the advent of impact investing has muddied that perspective even further. As a focus on sustainability has gone more and more mainstream, it’s added yet another factor to consider: How do you gauge what impact a portfolio is having? How is that weighed against returns? Finding a way to settle on clear metrics that can give managers the ability to truly weigh their fund’s impact is clearly an essential piece of really finding success with impact investing.

That’s why Addepar has partnered with The ImPact, an organization of family offices cofounded by Justin Rockefeller, to use its software to better help those people trying to make a social impact through investing.

Bridging Impact Investing and Practical Reality

Part of the reason Addepar has placed a new focus on impact investing is market-based.

“A lot of our clients have been talking to us for a while about impact investing and the challenges that come with it,” says Bookstaber. “Our clients are the primary motivation that has pushed us in this direction.

Particularly for millennials, the emphasis on sustainability in investing has become a major focus. Socially conscious investing has become more and more important as assets continue turning over to a younger generation.

“A lot of our clients are family offices or registered investment advisers, especially working with younger generations,” he continues. “There’s about $59 trillion of global wealth expected to change hands in the next generation, and 72% of those future inheritors are interested in the business of creating the social value. That’s something our clients have been seeing, and as a result, they are often talking to us about the importance of impact investing as an offering they can provide.”

However, simply pursuing impact investment in name only is likely to fall short. The impact side of things needs to be something more than an idea.

“A lot of our clients, prior to buying Addepar, struggle to understand what they own and what their exposures are. So imagine layering on this the additional dimension of impact investing, it becomes challenging,” says Bookstaber. “Addepar is extraordinarily good at helping an investor classify all of their assets and then measure their exposure across different dimensions. Impact investing is one dimension that Addepar helps clients both classify and then measure.”

That’s where Addepar comes in. Any portfolio that’s truly committed to making an impact is undoubtedly going to need to have some capacity to know how much impact is being made.

“One of the key catalysts of impact investing is measurement,” says Bookstaber. “Measurement starts with trying to understand which investments have some sort of impact, and what that impact is, whether it’s social, environmental, etc. If you look at a lot of the work that The ImPact has published on impact investing, that’s one of the key principles. It’s very important to measure the impact that a portfolio has. And that actually ends up being a pretty daunting task when you have a complex portfolio.”

In that sense, Addepar brings a unique value proposition to any family office or fund advisor: the capacity to put their impact into an appropriate context.

“One of the benefits of Addepar is there’s a lot of benchmark capabilities,” continues Bookstaber. “A lot of our clients will say, ‘Not only are we going to measure the overall environmental or social impact of these investments, but we’ll still benchmark it. We’ll still hold ourselves to an S&P 500 or other absolute return benchmark and compare our performance against that benchmark.’ And so then the exercise for our clients is demonstrating not only can they still perform against an agreed upon benchmark, but can they also make a positive social or environmental impact.?”

By working with Addepar, funds can make the clear argument about where impact investing places them in a broader context. Showing consistent alpha, or even beta, against major benchmarks is one way to demonstrate how impact investing can be deployed without compromising returns.

Impact Investing as Art and Science

But how do you measure impact? That’s a difficult question. However, it’s difficult in a way that’s not unusual in the world of finance. For all the numbers involved, investing typically involves a certain amount of interpretation. Even without the inclusion of a social impact component, approaches to investment can still vary widely.

“One the challenges with impact investing is that it’s as much art as it is science,” says Bookstaber. “Suppose I have a 401(k) with a bunch of equities and I have decent amount of knowledge about how to invest in equities - there’s always that art versus science tension. I can look at a lot of quantitative metrics to assess a company’s health. I can look at its revenue growth, margins. I can look at the P/E ratio to assess the value, etc. So there’s a lot of metrics that I can use to determine the attractiveness of an investment. Impact investing is not too different.”

It’s especially difficult in the case of impact investing, given that you’re defining metrics of success that include two different sides: returns and impact. What’s more, not only are those metrics themselves difficult to precisely define at times, they’re impossible to precisely predict.

“Obviously it’s impossible to predict the future return of any individual investment,” says Bookstaber. “If only the world was as straightforward as ‘this investment has a 7% return and this investment has a 6% return,’ but any investment provides uncertainty. And I think that’s where Addepar really shines as a tool. Investing is always uncertain. It’s always difficult. Even if you’re trying to make these types of trade-offs. And so it’s extremely difficult, laborious, and even tedious to try and measure what you’re doing. One of the benefits that Addepar provides is clarity and transparency into that process, so that you can very quickly and easily assess what your exposure is to impact investments versus non-impact investments, what has the return been on an absolute basis versus a benchmark. It makes the conversation, and as a result, the decision-making easier to do.”

A Qualitative Approach to Social Impact

So how do you measure impact? How does a person look at their portfolio with an eye towards creating impact? It’s an interesting question, and one that’s not simply limited to the sort of family offices with millions of dollars in assets under control.

“We see a lot of our clients also taking a bit more of a qualitative approach, saying, ‘I’m going to make some of my own assessments and determine the social impact of various companies,’” says Bookstaber. “So, for example, you may look at oil companies and say, ‘I believe that any companies that are in the oil exploration production, or oil service space, have a negative environmental impact. And as a result, I’m not interested in investing in any of them or certain ones like the Canadian tar sands. They have especially bad environmental impact.’ That’s a qualitative assessment. You might not know exactly how much carbon they emit or how badly they’re impacting the environment. But qualitatively, you’re saying, ‘Look, I believe these have negative impact, so I’m not inclined to invest in them.’”

“It can get even more nuanced than that,” he continues. “You might look at someone like Google (GOOG), who is investing in self-driving cars and say, ‘The long-term social impact of self-driving cars, either from a safety perspective as there’s less drunk drivers on the road, or from an environmental impact because we’re utilizing less cars over time and it’s more efficient, that has very high social impact. And therefore, I’m going to buy Google, not only because they’re attractive on a P/E ratio but because I have this qualitative thesis that there is social impact to what they’re doing.’

That’s a completely reasonable way to try and construct a portfolio that not only provides attractive returns but has positive social impact.”

Building a Portfolio with an Eye Toward a Brighter Future

Building a portfolio has always been about the future. Usually, it’s about the people who own the portfolio’s financial future, and impact investing isn’t really about changing that in any meaningful way. It’s about beginning to factor in a brighter future for more people than just the owner of the assets that make it up.

However, even with the shift to open up the focus of the process of investing, Bookstaber would argue that impact investing is also personal in a similar way. At the end of the day, the nature of impact investing is defined by the investor.

“I think that there’s no right or wrong way to do impact investing as long as you’re interested,” says Bookstaber. “The two most important ways to go about it are to define your approach and then measure it. I think that’s true with most types of investment styles. If you’re a value investor, there’s a lot of different ways to define value and there’s a lot of different ways to pursue that investment strategy. Probably the most important way is to say, ‘This is how I want to define or think about value, and then this is the way that I’m going to measure it to ensure I’m following that strategy.’ Impact investing is similar.”

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.


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