The decision to shift from a traditional portfolio to one with a greater impact focus is one of the most exciting decisions an investor can make. But transitioning into this kind of diversified portfolio also entails a number of questions and challenges. After all, it’s one thing to decide that you want your dollars to have a positive effect on the world and another to make that actually happen.
The best way to start is with a thorough program of education about impact investing and all that it involves. Luckily, others have already been down this path, so those new to the impact sphere can learn a lot by listening to other investors’ experiences—both the good and the bad. A detailed description of how one investor transitioned a portion of their portfolio to more mission-oriented goals, for example, has been produced by the Surdna Foundation, a $1 billion New York-based foundation that began shifting its focus toward impact investments in 2014.
One key decision an investor must make is whether to shift their entire portfolio into impact investments at once or to layer in investments more slowly over several years. According to Casey Clark, Director of Sustainable and Impact Investing at Glenmede, an investment and wealth management firm serving endowments, foundations, and high-net-worth individuals, this decision should proceed from an understanding of how to align both the financial and impact goals an investor wants to accomplish. While experienced investors often understand what their financial goals entail, assessing the level of commitment to an area of interest on the impact side can prove more difficult.
“The best approach is one that gives our clients the highest probability of reaching both investment and impact goals,” Clark said. “I don’t think one is better—inching your way in or doing it all at once.”
He added that if, for taxable investors, minimizing taxes is vital to the equation, the decision is clear: It pays to layer impact investments into a diversified portfolio over a period of years in order to reduce capital gains. While, of course, foundations are rarely constrained by tax questions, the decision about whether to proceed slowly or all at once is specific to each board.
Clark believes that one of the most effective implementations of the slower approach is to build a plan whereby a family office or foundation board allocates 5-10% of their portfolio to impact investments in the first year, followed by similarly sized allocations in years two and three. “All the while, we’re determining how this is affecting the risk and return of the portfolio, while the investor is gaining familiarity with what impact is and what it isn’t.”
If picking the layering approach, a decision must be made about which assets to shift over to impact investing first. In facing this dilemma, Clark said he has seen the most success by recommending that the first layer consists of large-cap public equities that incorporate environmental, social, and governance—or ESG—factors. Bond allocations can also be shifted.
These are often the most liquid assets in an investor’s portfolio. Even though the manager has impact goals, it’s best for the risk profile of the new asset to be similar to that of the one it is replacing, with similar returns.
The next step is to begin considering private equity investments with appropriate investors. These are not recommended first because they have long lock-up periods when the funds are not available—often up to 10 years. “I like to build a rapport with the board and have a dialogue before we say, ‘Let’s start getting into the more illiquid assets,'” Clark said.
Another important consideration when selecting an investment is the chosen organization’s policies on shareholder engagement. “Shareholder engagement can be an important aspect of impact investing,” Clark added. As shareholder initiatives are often crucial in driving organizations toward better ESG performance.
While weighing all these factors takes time and care, the potential rewards—both impact and financial—depend on the effort. Having a strong vision and a strong plan of action can help ensure that those efforts pay off.