Investor Spotlight - JP Morgan & Rockefeller

INVESTOR SPOTLIGHT

Investor Spotlight: J.P. Morgan and Rockefeller Foundation NICK O'DONOHOE AND ANTONY BUGG-LEVINE DISCUSS A NEW RESEARCH NOTE TITLED, IMPACT INVESTMENTS: AN EMERGING ASSET CLASS.

11/30/2010

J.P. MORGAN AND ROCKEFELLER FOUNDATION

Global | Affordable Housing | BOP | Education | Energy Efficiency | Energy, Fuels & Generation | General | Healthcare | Microfinance | Small & Medium Enterprises

This month, we spoke with two impact

investors, J.P. Morgan and Rockefeller

Foundation, who recently teamed up to

produce a research note entitled Impact

Investments: An Emerging Asset Class. The

conversation below with J.P. Morgan Global

Head of Research Nick O'Donohoe and

Rockefeller Foundation Managing Director

Antony Bugg-Levine focuses on the findings

of this research. Visit the research page to

download the full report.

GIIN: Why are J.P. Morgan, a large financial institution, and Rockefeller

Foundation, one of the oldest American philanthropies, interested in

publishing research about impact investing?

Nick O'Donohoe, J.P. Morgan: From our chief executive officer down, there's a

strong sense at J.P. Morgan that banking institutions have the ability to make a

positive contribution to society. It's important to our stakeholders - employees,

clients, suppliers, and shareholders - that we take leadership and do the right thing.

Dedicating people and capital to support the evolution of the impact investing

industry is a positive contribution a firm like ours should be making.

Our interest in impact investing is not entirely altruistic. Over the last couple of

years it has also become increasingly clear that a major movement is taking place

around impact investing. As a large investment intermediary, it is good for our

business if we participate in thought leadership and the long term the development

of this industry.

Antony Bugg-Levine, Rockefeller Foundation: In the 20th century, the

Rockefeller Foundation was very successful using grant money, working with

government and nonprofits, to create a more equitable and just world. In the 21st

century, we recognize that philanthropy and government alone can no enable us to

fulfill our mission to at the scale we want. If the goal was simply to provide clean

water to a single village in Ghana, or to provide better education in a single

community in India, charity and government subsidy are up to the task. But if the

goal is to provide clean water to the billion people in the world who need it, or to

close the education gaps not just in one village, but in all the villages and slums of

the world, we don't have the luxury to work alone, without the private sector and

for-profit investors.

To achieve our mission today, we have to work in complement with the private

sector and private investors, which is why we see impact investing as a necessary

complement to philanthropy and government.

GIIN: What are the most significant findings of this report?

NOD: There are three key conclusions. First, impact investing is emerging as a

separate asset class. Second, the potential for invested capital in this market is

huge. Although we don't seek to measure every possible impact investing

opportunity, those areas we did choose to look at - affordable urban housing,

microfinance, maternal health, primary education, and rural access to water - could

represent invested capital approaching a trillion dollars, and that is just part of the

investing potential. Third, this report includes the first substantive survey of impact

investors' projected financial returns. In most cases it's too early to have realized

returns, and the range of projected returns is quite wide. But our survey results

show evidence that many investors project commercial or close to commercial

returns.

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ABL: The report also includes important refinement in the definition of what

constitutes an impact investment. We assert more clearly than ever before that the

intention to create social and environmental good is core to the definition of impact

investing. The report also clarifies the two primary ways that impact investment can

create social good alongside financial returns: first, through the production of

products that benefit poor people or the environment; and second, through business

processes that further social justice and economic development goals, such as hiring

low-skilled workers.

GIIN: What does it mean that impact investing is emerging as its own asset

class? What does this mean for investors?

NOD: This is an important question. Impact investing would not be considered an

asset class if we use the theoretical definition of an asset class, such as the one

provided by the CFA, but neither would hedge funds, private equity, or venture

capital, which are each considered an asset class by the investment community

today. The view we take in this report is that an asset class today is not defined

necessarily by the characteristics of the underlying assets, but by the way investors

organize around it. We asked questions like: Does impact investing require a

separate risk management skill set? Does it require a separate organizational unit to

accommodate this skill set? Does it need a separate group of industry organizations

and education entities? Does it require the development of new standardized

metrics, benchmarks, and ratings? In our view, these are the things that define an

asset class in today's investment world. For example, hedge funds typically invest in

equities and credit, but the way institutions have organized around them has

effectively defined them as asset class.

Defining impact investing as an asset class is important because we can then

organize around the unique investment skills necessary, and accelerate the growth

of assets in this market. We recognize that some people won't agree with this

definition, but it's our view that this definition as an asset class is essential to the

long term growth of impact investing.

ABL: As Nick has alluded to, defining impact investing as an asset class encourages

the emergence of a community organized around impact investing, which is

necessary for impact investing to realize its promise. For example, when someone is

making impact investments in education in Hyderabad and someone else is making

impact investments in water delivery in Nairobi, it is important that they recognize

themselves as part of a global impact investing community, rather than the water

industry and the education industry, nor are they simply a debt or equity investor.

This sense of community can accelerate how we work and learn together. Because

of the diversity of impact investors, this impact investing community will include not

only traditional investors, but also nonprofits, government, and foundations, all of

whom will need to develop distinct skills, disciplines, instincts, and networks.

GIIN: What types of investors are making impact investments today? What

are their motivations?

NOD: A very broad range of institutions and individuals are making impact

investments today, including development finance institutions; private foundations

like Rockefeller Foundation and Omidyar Network; large-scale financial institutions

like Citigroup, Deutsche Bank, and Prudential Insurance; an increasing number of

private wealth managers like Capricorn Investment Group and New Island Capital;

dedicated commercial banks, like Triodos Bank in the Netherlands and Charity Bank

in the UK; retirement fund managers like TIAA-CREF in the US and PGGM in

Holland; boutique investment funds such as ResponsAbility in Switzerland and Root

Capital in the US; increasingly companies like General Mills and Starbucks; and

community development finance institutions in the US.

ABL: At Rockefeller Foundation, we have been leading an initiative since late 2008

to harness the power of impact investing. As part of this initiative, we have engaged

with more than 1,500 investors around the world, and we have learned that the

motivations for impact investing are not limited to one niche. Some impact investors

have a strong focus on social impact, and are willing to take lower financial returns

or higher risk. Other impact investors, like pension funds, are legally required to

make investments at the risk/return frontier.

Surveying this landscape of diverse participants, we are particularly encouraged by

the leadership role that wealth advisors, family offices, and private banks are

beginning to play in advancing the impact investing industry from a phase of

uncoordinated experimentation to a more coherent marketplace. Interest among

this group has been core to financial services innovation in the past. For example,

venture capital was pioneered by family offices and private banks that have a

greater capacity and appetite to embrace innovation. Generally, institutional

investors wait until innovative models are improved to deploy substantial capital.

GIIN: This report includes the first analysis of impact investors' financial

return expectations. What does this analysis show?

NOD: When looking at return expectations, we segregated the results into

developed markets, emerging markets, debt and equity so that we could compare

the expected impact investment returns to established benchmarks in comparable

asset classes. Our analysis shows that, on average, there appears to be some

financial trade-off in developed markets, but in emerging markets there is very little

expectation of trade-off between expected profit and social good. In an appendix of

the report, the International Finance Corporation, which was set up to make impact

investments and has been doing so for decades, shares a comparison between their

returns and comparable benchmarks, and they appear to be earning profits in

excess of commercial returns.

GIIN: Behind these average return expectations, the report indicates that



GIIN: Behind these average return expectations, the report indicates that

impact investors have a wide range of financial return expectations. What

do you make of this?

ABL: This range indicates a willingness among some investors to take lower returns

or more risk if doing so will expand their investable options to include deals that

create substantial public benefit not achievable through other means. Many of those

impact investors come from private foundations where they have already focused on

the idea of using capital for good through grant making, which of course gets zero

financial return.

GIIN: The report also includes an analysis of the impact investing market

opportunity. How did you evaluate potential market size? What are the

major take-aways from this analysis?

NOD: We try to estimate just a portion of the impact investing market opportunity

in this report using a framework that helps to identify business sectors around the

world that can provide affordable services to people in the base of the economic

pyramid. We are clear about the assumptions that we make, specifically around the

transferability of business models across regions and the number of people globally

who can benefit from these businesses. Applying this framework, we did a detailed

analysis on five business sectors - affordable urban housing, rural access to clean

water, maternal health, primary education, and microfinance. We estimate that

there is potential for as much as $1 trillion to be invested for social good in these

areas over the next ten years. Obviously this opportunity is huge, and we hope that

this analysis will begin to mobilize capital in those areas and encourage investors to

explore additional opportunities in impact investing.

ABL: Not only does the market sizing in this report make clear the substantial

opportunity for investors, but it also sheds light on the massive opportunity to

improve the lives of poor people.

In an ideal world, these basic services like clean water, education, and healthcare

would be provided to all citizens by governments for free or at very affordable rates.

If governments become more effective at offering these services to more people,

they could reduce the opportunity for impact investors. But the reality today is that

most poor people are buying basic services from the private sector, and they do so

while incurring a huge penalty, in the prices they pay and the quality of services

they receive. There is a real opportunity for impact investors who can deliver

components of these services more efficiently and effectively, and this opportunity

has tremendous social and environmental benefits as well.

At the same time, there is a role for philanthropy and government to complement

investors by subsidizing and the creation and growth of innovative business models

that bring better services to poor people and concentrating their capital on the

poorest communities who will not be able to benefit from market-based solutions.

GIIN: How do impact investors today evaluate their social and

environmental performance? Do you expect that they will become more

sophisticated as the market advances?

NOD: There is a need for more rigorous social impact measurement. In many cases

today impact investors are using anecdotes, instead of quantitative measurements.

Of those who are measuring their social and environmental impact, the

overwhelming majority are using proprietary systems.

Using a standard measurement system is important because it allows us to

understand the impact we're having as an industry by aggregating comparable data,

rather than relying on fragmented anecdotes. Common standards also give us a

basis to create benchmarks that can help us understand, for example, whether an

investment into a water delivery system in one country is as effective as a similar

investment in another country, not just in terms of financial returns, but also with

respect to basic social outcomes.

NOD: The lack of clear social performance metrics is a major barrier to impact

investing. If investors are not using a third-party independent measurement system

- for financial statements or social impact reporting - their results are going to be

treated with skepticism by the investor community. Reporting standards like IRIS

and third-party ratings systems like GIIRS are fundamental to mainstreaming

impact investment.

GIIN: The report includes a section on risk management and overall

management of impact investments. What is different about managing

impact investments?

NOD: Traditional investments are made along two dimensions - risk and return -

and both are relatively easy to measure. Impact investing introduces a third

dimension of social and environmental impact. With this comes new risks, and chief

among them is reputational risk, as we are seeing in Indian microfinance now.

Impact investors have to understand how they are creating impact, and they have

to make sure that do it ethically and sustainably.

ABL: Effective impact investors must do all the things financial professionals do and

also be more savvy about the ways their investments intersect with the broader

society because the basic services they may be providing - education or healthcare,

for example - are important emotional and politically-sensitive topics. Successful

impact investors must also understand how to navigate a relatively complex set of

institutions, including development finance institutions, government, nonprofits, and

foundations. Being able to measure our social impact, and to communicate it clearly,

will be crucial both to improve the productivity of impact investments and to



will be crucial both to improve the productivity of impact investments and to

preempt the pressure that can come from the many people who are inherently

skeptical about the ability of for-profit investment to support equitable economic

development.

GIIN: You mentioned that the lack of consistent social performance

reporting is a major barrier to the growth of impact investing. Are there

other barriers that need to be addressed?

NOD: The notion of fiduciary responsibility among traditional investment managers,

pension funds, and other asset trustees is another barrier to impact investing.

Fiduciary responsibility is traditionally defined as a maximization of the risk-adjusted

returns, and there is no room in that definition for positive social outcome. We are

beginning to see some progress in Europe, for example, where investors are

beginning to integrate social factors into their thinking about fiduciary responsibility.

But real change will be very difficult and will take a long time.

ABL: Pioneering impact investors have had to spend a lot of time and effort

explaining and defending the concept that for-profit investment can be a tool for

achieving positive social and environmental outcomes. This research note

complements other reports, most notably the Monitor Institute's

Investing for Social and Environmental Impact, that have clarified how impact

investing can be both a morally legitimate and economically effective way to address

global problems. The less time people have to spend defending and defining impact

investing, the more time and energy can go to addressing the challenges of making

impact investments work.

GIIN: There is a decades-long movement around socially responsible

investing. How is impact investing different from socially-responsible

investing?

ABL: Impact investing builds on the idea created by the socially responsible

movement that asset owners can approach their investments not only asking how to

maximize financial return, but also considering the social impact of their invested

capital. However, socially responsible investment has mainly focused on the

avoidance of investments in companies that generate negative social effects. While

techniques such as shareholder advocacy and management engagement are starting

to blur the lines, impact investing, in contrast, focuses on capitalizing projects and

enterprises that create social and environmental good.

NOD: Another difference between socially responsible investing and impact

investing is that impact investing is typically done in debt or private equity markets,

while socially responsible investing has focused on creating demand incentives for

publicly-listed companies to focus on good corporate citizenship. This is because we

think of impact investing as the provision of new capital to businesses that create

social or environmental benefit. Public equities are not excluded from impact

investing per se, but normal day-to-day equity trading is essentially an ownership

transfer of shares, rather than the infusion of new capital to a business.

GIIN: How has your organization benefited by taking a leadership role in

the development of the impact investing industry?

NOD: Impact investing resonates strongly with our employees which is important

because investment banks succeed when they have the best people. Contrary to

public opinion, getting and keeping the best people is not just about how much

they're paid, it's also about initiatives like impact investing that enable them to feel

good about working for this firm. When we first launched the Social Finance group,

we received emails from a thousand employees asking how they could help.

Employee engagement has benefited tremendously because of our involvement in

impact investing.

GIIN: What did you gain from collaborating?

ABL: Investment banks and private foundations have traditionally operated on

separate sides of a world that has been organized around two basic assumptions:

that the only purpose of for-profit investment is to make money, and that the only

way to solve social problems is through philanthropy and government. At its core,

impact investing is a challenge to both of those assumptions and to the idea that we

can continue to operate in separate worlds.

For impact investing to be successful, organizations like J.P. Morgan and Rockefeller

Foundation are increasingly going to have to work together. Working together on

this report has forced both our teams to push our thinking further by working

through our ideas and communicating with people who have different perspectives.

It is only by overcoming the challenges of working across this previous divide that

we can deepen the bonds required for impact investing to realize its potential to

deliver both financial profit and global solutions at the pace and scale necessary in

the 21st century.

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Investor Spotlight - JP Morgan & Rockefeller

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