CONDITIONS are ripe for impact-inspired investors in the United States and other developed nations to earn attractive risk-adjusted returns by making even small allocations to reputable Caribbean-based emerging alternative investments managers. Doing so will unlock accelerated and broad generational wealth creation in this chronically underinvested and economically disadvantaged region.
Private sector-led investments in the Caribbean that meet impact-first criteria would result in outsized socio-economic transformation given the accentuated gap in gross domestic product (GDP) per capita of all Caribbean states, with Puerto Rico and Barbados holding the top ($31,429) and second ($16,318) positions in 2020, respectively, compared to the United States' $63,027, according the World Bank.
While the global impact investing market has grown substantially over the last few years, little of that capital has been channelled to the Caribbean by institutional and other investors, but its potential is enormous. The International Finance Corporation's latest estimate shows a market size of $2.3 trillion in 2020, of which $636 billion has an impact management system in place. On the other hand, based on a 2020 impact investor survey, Global Impact Investing Network (GIIN) estimates a $715 billion market, up from $502 billion in 2019.
According to the US SIF Foundation's 2020 report on impact investing trends, one of every three dollars under professional management in the US, or $17.1 trillion, is managed in accordance with sustainability metrics.
Furthermore, in its "Annual Impact Investor Survey 2020, the GIIN reported that an overwhelming majority of the investors surveyed said their impact investments met or exceeded their financial expectations (88 per cent) as well as their social/environmental impact expectations (99 per cent). According to a study by the International Finance Corporation (IFC), private equity impact investments can deliver high returns, outperforming the S&P 500 index by 15 per cent.
Millennials are key impact investors and will become increasingly influential in institutional investors' investment allocation composition which bodes well for Caribbean communities.
Because they are passionate about social and environmental causes, millennials are leading the charge when it comes to impact investing. The oldest people in this generation are just turning 40 and reaching their peak income-earning years. Their spending power and zeal to take a stand on a number of issues make them the ideal impact investors.
Combining their increasing share of wealth with their generation's heightened focus on social change, 61 per cent of millennial investors say they currently participate in impact investing, according to a 2022 study by Fidelity Charitable, a Boston-based independent public charity and grant-maker that in 1991 launched the first national donor-advised fund program. According to the study, 62 per cent of millennials believe that impact investing has greater potential than traditional forms of philanthropy to create long-term positive change. They also believe in the long-term financial viability of the strategy, with two-thirds saying that impact investing is a smart investment.
Millennials are significantly more attuned to socially responsible investing (SRI) than their older counterparts, according to a Spectrem Group report on the investing preferences of different generations. More than half of millennial investors, 52 per cent, see the social responsibility of their investments as an important selection criteria, compared to 42 per cent of Gen X investors and less than 30 per cent of baby boomers.
Millennial investors contributed $51.1 billion to sustainable funds in 2020, compared with less than $5 billion five years ago, CNBC reported. About one-third of millennials often or exclusively use investments that take environmental, social and governance (ESG) factors into account, compared with 19 per cent of Gen Z, 16 per cent of Gen X and 2 per cent of baby boomers, according to a 2021 survey conducted by The Harris Poll for CNBC.
The difference in asset allocation between the generations can be attributed to availability and access. Millennials are hitting their prime investing years at the same time that ESG investment options are becoming more plentiful than ever, Morningstar reported. In 2019, almost 500 actively managed US funds added ESG criteria to their prospectuses.
Millennials have also grown up with easy access (via the Internet) to information about sustainable funds, and their portfolios are nimbler, meaning that they probably don't have as much invested yet as older investors, so it has been easier for them to invest sustainably from the start, CNBC reported.
With millennials set to inherit some $30 trillion over the next few decades — according to "Swipe to Invest: the Story Behind Millennials and ESG," a report by global investment research firm MSCI — more and better impact investing options are expected to emerge in coming years.
Tenets of impact investing
The GIIN has identified the characteristics of impact investing:
● Intentionality: an intention to have a positive social or environmental impact through investments.
● Investment with return expectations: a desire for financial return on capital or, at least, a return of capital.
● Range of return expectations and asset classes: target financial returns from below market to market rate across asset classes.
● Impact measurement: commitment to measure and report social/environmental performance and progress of investments.
Based on its extensive experience conducting due diligence on hundreds of investments, The Bridgespan Group, a Boston-based nonprofit organisation that provides management consulting to nonprofits and philanthropists, uses five criteria to define impact investment, three related to the investors and two related to the investments.
● The investor intends the impact, articulating particular outcomes that will be pursued through the investment and specifying who will benefit from these outcomes.
● The investor contributes to the impact, articulating a credible narrative about how the investment will help achieve the intended outcomes. The investor's contribution can be financial (eg, flexible capital) or non-financial (eg, portfolio support).
● The investor measures the impact, putting in place a system of measurement to link intent and contribution to actual improvements in social and environmental outcomes.
● The impact must materially advance progress toward meaningful social and environmental goals — for example, the 17 UN Sustainable Development Goals (SDGs) — giving due consideration to all of the most important potential impact pathways for a given investment.
● The realised impact should be integral to the company's business model.
Bridgespan stresses the importance of rigorously testing whether an investment will advance progress, not by relying on instinct but rather through analysing company data and available social science research.
"For example, an investment in an edtech platform focused on improving the math outcomes of underprivileged students would qualify in advancing progress toward SDG 4 [quality education] if the evidence shows that those student outcomes do improve. Meanwhile, a similar ed-tech platform focused mainly on affluent students would not advance progress toward these goals (as these students already have access to quality education), even if the evidence of improved performance were compelling," Bridgespan explains.
Performance of impact investments
Does impact investing work? Yes. Impact investors generally obtain returns that are comparable to market rates.
Impact investing funds outperformed traditional funds and reduced investment risk throughout 2020, according Morgan Stanley's "Sustainable Reality Report". US sustainable equity funds outperformed traditional peer funds by a median of 4.3 percentage points—the largest difference in performance recorded since 2004—in a year marked by uncertainty amid the pandemic, Morgan Stanley reported.
Impact investments across asset classes in private emerging (EM) and developed (DM) markets have generated strong realised returns over time, according to GIIN's 2020 impact investor survey.
●Returns from market-rate private-equity impact investments averaged 18 per cent (EM) and 16 per cent (DM).
● Returns for below market-rate investments averaged 11 per cent (EM) and 10 per cent (DM).
● Returns on market-rate private-debt investments averaged 10 per cent (EM) and 8 per cent (DM).
● Below market-rate returns in this asset class averaged 8 per cent (EM) and 7 per cent (DM).
● Returns on market-rate real-assets investments averaged 8 per cent (EM) and 13 per cent (DM).
Impact Investing: A Sound Business Strategy
Doing the right thing drives profit, according to Porter Novelli's 2020 "Executive Purpose Study". Nine-in-10 (89 per cent) of the business leaders surveyed believe purpose-driven companies have a competitive advantage, and 85 per cent agree it drives profit.
Beyond higher profitability, most executives identified other business benefits of supporting social and environmental causes:
● Reputational advantages: 99 per cent
● Employee recruitment and retention: 95 per cent
● Increased customer trust: 93 per cent
● Increased customer loyalty: 93 per cent
● Likelihood to recommend: 92 per cent
● Likelihood to purchase: 91 per cent
● Differentiation from peers and competitors: 88 per cent
● Improved financial performance: 83 per cent
● License to operate: 65 per cent
Survey respondents said business leaders and companies should address the following issues:
● Sexual harassment: 97 per cent
● Employee health and safety: 95 per cent
● Racial equality: 93 per cent
● Women's rights: 89 per cent
● Access to healthcare: 87 per cent
● Domestic job growth: 86 per cent
● Privacy and internet security: 84 per cent
● LGBTQ+ rights: 78 per cent
● Immigration: 63 per cent
● Climate change: 61 per cent
● Voting rights/access to voting: 55 per cent
● Cost of higher education: 43 per cent
● Fake news: 37 per cent
● Gun control: 31 per cent
McKinsey & Company cites more than 2,000 academic studies that concluded that better ESG scores translate to about a 10 per cent lower cost of capital.
Businesses that fail to consider ESG metrics can experience a financial downside. A study by MSCI found that companies with high ESG scores experience lower costs of capital, lower equity costs and lower debt costs compared to companies with poor ESG scores.
The transformative potential of impact investing is inspiring investors throughout the world, particularly in the developed and wealthiest markets where there is a growing awareness and call to action to address extreme socio-economic wealth disparity.
Impact investing is about creating wealth and delivering socio-economic returns that benefit disadvantaged communities. It is a means for the private sector to cease being a spectator and a critic and become a parallel force along the public sector in propelling broad economic betterment in underdeveloped communities and countries.
The Caribbean region is ripe for the emergence of the fund management sector as the credible and nimble force with the potential of luring and deploying impact-mandated capital at scale and addressing the chronic underdevelopment and economic disenfranchisement of most of the population.
James Connor is co-founder and CEO of Acrecent Financial, a Sygnus Group company based in San Juan, Puerto Rico. He has nearly 30 years of experience in commercial credit and investments and holds an MBA from Columbia University and a B.S. from Purdue University.