It is still a disjointed sector that is struggling to compete with traditional finance. What avenues are open to family offices in particular to make different choices, and where is the sector seeing the most momentum? This article covers some of that ground.

The dual realities of the pandemic and climate change have shone a light on impact-first investing. But the question is whether the category “will remain a small, disorganized, underleveraged niche or whether leaders will come together to fulfill the industry’s clear promise.” That was the quandary posed by pioneers of the industry over a decade ago, but how much of it holds true of the sector today?

A main sticking point has been convincing private investors entrenched in market-seeking returns to take some gains off the table in the cause of addressing social and environmental problems that are increasingly rattling the public consciousness.

Boston-based consultancy Bridgespan Group advises high net worth individuals and family offices to invest in the impact space as the market matures and presents more opportunities.

We spoke to partner Michael Etzel, who says clients are wanting to exert more influence across all the big investment categories, not just philanthropy. The firm has also seen an acceleration of family offices coming together to collaborate on larger investment projects. “It’s a striking change from three or four years ago when co-impact investing barely existed for family offices,” he said, talking to this publication about what opportunities make the most sense for HNWs and family offices.

“Our work is to help them find the tools available and to go a little bit faster,” he said.

Despite numerous surveys expressing interest, family offices invest around 9 per cent of their investment capital on impact projects, according to research from Campden, and financial return remains their top priority. At the same time research shows that over 80 per cent of wealthy families believe the wealthiest (themselves) should be tackling social issues and playing a bigger role in reducing inequality.

Impact-first investments are those specifically designed to tackle issues such as poverty, disease, inequality, social injustice, and environmental degradation, and must be able to demonstrate a positive environmental or social impact. This accountability is where the toughest critics of ESG investing insist on clarity between the two. Depending on whose figures you digest, the global market for impact investing is worth around $700 billion, according to The Global Impact Investing Network (GIIN)'s latest survey, and increased by more than 40 per cent in 2020.

How does Etzel’s team approach getting more families channeling investment into well-governed responsible enterprises? Where is the pushback?

“It depends on whether you are talking to the CIO or the principal as they tend to be very different conversations in a family office structure. For the CIO, a lot of talk is about incentive structures and how the office has been built. This is because what they have been asked to do historically is protect and grow the wealth of the family office.

The first pushback is: 'Wait a minute, is this going to slow down our goals? Is this going to challenge us and work against our incentives as an investment team?'” he says.

However, family offices are becoming more flexible in their approach to social impact, he says, with bolder ones opting to have an impact team over a philanthropy team in place.  

“In those cases the barrier we tend to hear is usually just a mindset,” he said.

“They are aware they have accumulated wealth using two different pockets – a check book over here, which is how I’ve made my money and been a good steward of my wealth; and a check book over there for how I give back and contribute responsibly. But now you are telling me there is something in the middle. How do I do that?” Etzel explains.

Once wealth owners pass that first hurdle and move into the specifics, the next hurdle is, “‘Gosh that seems really hard’,” he says.

The group’s report Back To The Frontier: Investing That Puts Impact First, published earlier this year, highlights how the sector is becoming more mobilized, collaborative and standardized in terms of measurement and best practices, with ample case studies to suggest that getting started “is not as hard as you think.”

“For family and multi-family offices, the options have really grown quite a bit,” Etzel said.

For those wanting more exposure, one path is to completely outsource, either working with an outside advisor or an intermediary.

“That’s where we are seeing some of the multi-family offices and wealth management teams building rapid capacity, because they are getting the demand.”

Millennials
Millennials in intergenerational family situations are also exploring the space. “We are starting to see a response from wealth managers saying we really need capacity here,” because the dynamics in families are changing, Etzel said.

As the major beneficiaries of an estimated $30 trillion the next few years, Millennials are statistically more likely to seek out responsible investment choices.

Organizations such as Jordan Park, spun out of Goldman Sachs a few years ago, are part of a new breed of manager building dedicated impact teams that are targeting this changing behavior. Jordan Park was founded in 2017 and now manages around $16 billion for 80 families.

Tiedemann Advisers, Align Impact, and Avivar Capital are other larger providers offering families access to impact-first investments. Tiedemann works with HNWIs and families to develop impact investment portfolios.

Single-family offices such as Sobrato and Dalios (led by US hedge fund manager Ray Dalios) are two Etzel mentions that have opted to hire one or two people responsible for impact-type activity instead of building a dedicated team.

Another theme stoking growth in the sector is the climate threat.

“From an intergenerational stewardship prospective, and what you are leaving to your kids, grandkids, climate has become a salient issue for a lot of families.”

Vehicles such as the Prime Coalition or Break Through Energy Ventures are "ideal initiatives" for family offices to channel investment that did not exist 5 years ago, Etzel says, whereby they can invest in a limited partner or general partner capacity in a host of companies in the innovative transition industries.

The overall picture shows that private markets continue to raise a majority of the capital for impact investing. Private equity is the largest asset class taking around half the total allocation, and private debt and infrastructure are the second and third largest allocators, according to 1,600 funds monitored by the Impact Database that tracks allocation.

Bridgespan has also seen a lot more hunger for information and understanding of the organizing principles and metrics that are developing the market.

The UN Sustainable Development Goals rolled out in 2015 have become the bedrock of the global challenges investors are aligning themselves with. A second relatively simple set of standards for impact measurement is the Impact Management Project. Around 2,000 stakeholders compiled the standards as a baseline for the questions and characteristics that potential investees should meet.

“By simple, 'Who is being affected? What is the effect? How big is the effect? What is the risk it might not happen? How much are you contributing to that as an investor?'” Etzel asks.

Another resource for family offices comes from the International Finance Corporation, the private equity arm of the World Bank, which has produced the Operating Principles For Impact Measurement, used by large global asset houses and private equity firms to assess impact.

An academic consortium led by Wharton is also gathering data on the financial performance, due diligence and governance of the sector globally.

For FOs operating their own due diligence on companies, look at what incentives entrepreneurs and companies are working to and share those metrics with the portfolio team, investors, and asset owners as a reminder that somebody’s compensation is on the line all the way through the chain, Etzel suggests.

“Compensation is a powerful incentive in capital markets, so tying impact to some of those financial incentives is a reasonable way of ensuring that everyone is aligned with the same set of goals,” he said.

FOs with an endowed private foundation or a donor-advised (DAF) account still provide the easiest areas to get families engaged with an impact-first approach.

“Product innovation in both segments allow families to take assets they have already committed to charitable purposes and, instead of just leaving them in an index account, redeploy some of them into impact-first opportunities,” Etzel counters. “You take on a little bit more risk but also pursue some outsize impact."

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Donor advised funds
DAFs have gained in popularity but are still a largely untapped capital pool for impact-first investing that firms in the space are attempting to change.

The donor advised market is currently worth around $140 billion, where capital largely sits in traditional market-rate investments rather than ones mandated to generate positive social outcomes.

The Initiative To Accelerate Charitable Giving is leading “common-sense” reforms of DAFs on the back of public criticism that current incentives only encourage donors and foundations to hoard their wealth.

“Right now, more than $1 trillion is sitting in private foundations and donor-advised funds (DAFs). Existing laws deliver significant tax breaks on initial funding, but do not provide sufficient incentives or requirements to ensure that these funds will ever be distributed to working charities,” the group said.

It wants donor-advised funds to disperse funds to charities within 15 years and free up tax benefits at the time of contribution as well as tax incentives for foundations to accelerate distribution and payouts. It also wants to prevent private foundations from granting money to donor-advised funds to satisfy federal requirements to pay out 5 per cent of assets each year.

Impact Assets, RSF Social Finance, and the Tides Foundation are among several Bridgespan reports that are offering DAF donors "a relatively easy" investment route into impact-first companies. The Tides Foundation manages roughly 400 DAFs, according to its industry report.

Where else is there resistance?

With frequent arguments that fund managers and advisors are more wedded to financial returns than their clients as a measure of success, what are the chances that advisors are going to recommend impact-first products to families that have outsourced their investment strategy?

Brian Trelstad, a partner at Bridges Fund Management, is one among a chorus who believes that professional fund managers are a major barrier to more impact investing happening within family offices.

“The more you professionalize the staff of the family office, the more you recruit from traditional asset management, and the more you incent them with traditional returns-based compensation, the less risk-seeking the family office is likely going to be,” Trelstad said.

Mindset
Etzel agrees that the advisor/manager mindset is a “structural issue” for the industry raising questions of “how you organize and incent advisors when at some level the services are commoditized.”

There is also the issue of advisor compensation often being tied to a benchmark performance. “Ninety-nine per cent of advisors can’t believe you’d want to do this: ie, demand that part of the financial upside of intermediaries and fund managers (like the carry) is tied to achieved impact,” Charly Kleissner, cofounder of Toniic, a global network of impact investors, told the report.

Etzel’s firm has “seen a trend, particularly among next-gen wealth owners, who are thinking, "‘Well if you are not willing to do this, I am going to go somewhere else.'”

There is a willingness to fire fund managers, but it is not the easiest solution, he argues.

“Uprooting your assets and switching managers is a big change, particularly if multi generations are involved. Our recommendation is don’t fire the manager, bring them along so they might open their ears to considering, 'Is this an opportunity my firm should pursue?’”

The next chapter is very much about product, he believes.

“What needs to come next is product development that really centers on the trusting relationships of the principals themselves to enable them to come together and move their assets more quickly in service of these big social problems," Etzel said.

“One of the critical ingredients for family offices coming into anything about philanthropy, charity or impact, is trust. And that is where today not all the products in the market have access and trust and visibility for family offices.

"We have seen innovation on the philanthropy side, where peer networks and closely trusted groups of families and family offices are coming together to collaborate."

He suggests that Silicon Valley venture capital over the last 12 to 18 months has really woken up to big impact opportunities.

They are saying, “'Wait a minute, private equity is doing it. How can we contribute? And what does that look like?’”

Where does he see the traditional philanthropy that many family offices are accustomed to competing with the impact-first investment pool?

“It is not a barrier as much as a different tool for a different job. There are some problems that you can solve really well with philanthropy. It is flexible. It’s fast. It doesn’t need any return. Whereas there are other problems where return-seeking capital is actually pretty critical to the equation.

"If you are trying to revitalize a community or neighborhood you are going to run out of philanthropy before you get the job done. All but the very deepest pockets can provide that.”

More important for families approaching impact-first is knowing how you define success, he says.

"If they are really clear about what that is from the beginning, they will know whether it is a great philanthropic grant or a great impact-first investment."

“It is all about putting that yardstick out there in advance and being willing to hold yourself accountable.”