The UK Social Investment Market

2012 The U.K. Social Investment Market: The Current Landscape and a Framework for Investor Decision Making

Noelle Laing Coleman Long Annachiara Marcandalli Jessica Matthews Ana Grahovac Joshua Featherby

Contents

Section I: The Landscape of the Social Investment Market in the United Kingdom 3 Section II: Barriers to the Growth of the Social Investment Market and Potential Solutions 6 Section III: Decision-Making Framework 11

List of Figures 1. Traditional Risk/Return Profile 16 2. Combined Risk/Return Profile 16

List of Tables 1. Representative U.K. Impact Investment Opportunities 4 2. Types of Nonfinancial Motivation 13 3. Example of Integration vs Carve-Out Approach to Social Investment Implementation 18

Appendices A. Guiding Questions 20 B. Comparison to Other Social Investment Markets 21 C. Glossary 23 U.K. Social Investing

t Cambridge Associates, we have been Impact investing is less familiar to many Aan advisor to mission-based non-profits investors than other social investment for over 37 years and have served the various strategies, and we focus on this strategy social investment needs of clients throughout in this report, while also discussing most our history. Our dedicated Mission-Related other social investment strategies available Investing Group began working more closely in the United Kingdom. We define impact with clients in 2008 and we have observed investments as investments made in enter- increased interest in the space over the past prises that offer market-based solutions to a few years. We have published three previous particular social or environmental challenge reports in the area of social investment, Social of interest to the investor; essentially, using Investing (2007), Investing in Clean Energ y and the market to create social change. Impact Technolog y (2007), and Environmental, Social, and investors invest in enterprises that proac- Governance (ESG) Integration: For Performance, tively use the business to achieve ‘good’, For Ethics, or For Both? (2010). however defined, at either a below market The goal of this report is to provide a new or market rate return (defined as one that perspective on the social investment market appropriately compensates investors for the in the United Kingdom and address the needs risks taken) with the intention of generating of both institutional and private investors. a social and/or environmental return. Three We have observed that investors often do not common forms of impact investing are know where to begin when they are asked clean tech, microfinance, and social finance about social investing. Admittedly, the term is or social enterprise investment. This third very broad and the market is always evolving. form of impact investing is common in the We define social investments as investments United Kingdom and refers to investments that generate a monetary return while also that provide capital to entrepreneurs and/ generating a social return or minimising a or entities that have the intent to create social risk. Social investing is a comprehen- a social impact (e.g., a loan to an entre- sive term meant to incorporate economic, preneur looking to create a business that environmental, health, moral, political, and/ solves a social problem like homelessness). or religious factors. Social investments can Throughout this report, we distinguish be made through a wide range of strategies, this type of investing from broader impact including negative/exclusionary screening; investing strategies by referring to it as positive screening, also called ESG integra- ‘social finance investment’. tion; and impact investing.

Examples of Examples of Social Investing Impact Investing

ESG Clean Integration Tech

Exclusionary Impact Micro- Social Screens Investing finance Finance

Organized into three main sections, this Finally, as any discussion of social investing report helps to demystify the growing social involves a myriad of new terms, organ- investment market and guide investors isations, and acronyms, the glossary in through some of the major steps in exploring Appendix C provides definitions of terms social investing and the opportunities avail- and descriptions of investments and organ- able. We discuss: isations mentioned in this report.  the landscape of the U.K. social investment market, with a focus on impact investing;  the barriers to the growth of the social investment market and potential solutions; and  a decision-making framework to help investors evaluate and implement social investments within a diversified investment portfolio. Three appendices provide additional information. Appendix A includes guiding questions for investors to use in conjunc- tion with the steps of our framework to help clarify their decision to make social investments. In Appendix B, we review the social investment markets in continental Europe and the United States. We would highlight that because U.K. foundations are not required to pay out 5% of their assets each year and U.S. foundations are, there are significant differences in how foundations in the two countries can think about investing and spending. Arguably, U.K. foundations have more flexibility to incorporate below market rate investments in their portfolios, as their spending for grant making is more flexible. U.S. foundations must consider the risk of losing purchasing power if below market rate investments are housed within the main endowment fund. This difference has also contributed to the relative popularity of programme-related investments (PRIs) in the United States. PRIs count towards a U.S. foundation’s 5% annual payout and are typically made from programmatic rather than endowment funds.

Section I: The Landscape of it as the most developed impact investment the Social Investment Market market in Europe. In the United Kingdom, in the United Kingdom impact investing is largely focused on social finance investment in locally based enterprises. In 2010, approximately £190 Current Market Size million was committed to social finance Many reports cite the United Kingdom as investments.4 To date, demand for capital the strongest market for acceptance of ESG by social entrepreneurs/social enterprises integration into investment decision-making exceeds the supply, as a limited number of processes and for engaging with companies on impact investors are active in the market. In ESG issues. At the end of 2009, £938.9 billion 2010, the top ten providers of social finance was invested in various traditional forms of invested 96% of the £190 million in capital.5 social investment (e.g., exclusionary screens, In a recent report, NESTA, an independent ESG integration) in the United Kingdom, charity, estimated that the demand for social accounting for approximately 28% of the finance capital over the next few years will £3.4 trillion in total assets managed in the be between £615 million and £820 million6 United Kingdom.1 According to one report, and the Boston Consulting Group estimated as of 2008 the assets invested in broad social a market of up to £1 billion by 2016.7 investing strategies in the United Kingdom represented 41% of total assets managed in In the coming years, the supply of capital Europe using broad social investing strategies.2 may catch up with demand, with the launch of Big Society Capital (BSC) on Two key developments have helped estab- 4 April 2012. An independent financial lish the United Kingdom as a leader in institution formed to develop a sustainable social investing. First, a law passed in 2000 social investment market in the United requires occupational pension funds to Kingdom, BSC was funded from £400 disclose the extent to which they incorporate million in dormant bank accounts and responsible investment policies. Second, in with £200 million from the four major July 2010, the Financial Reporting Council high street banks (Barclays, HSBC, Lloyds, published the U.K. Stewardship Code, and the Royal Bank of Scotland). Most of which aims to foster effective dialogue on BSC’s £600 million in capital is slotted for governance issues between investors and listed companies. The Code outlines how 4 The £190 million was determined from a survey institutional investors should disclose their of ‘social venture intermediaries’ conducted by the 3 Young Foundation. This number is exclusive of engagement and voting policies. opportunities available to retail investors, such as The impact investing side of the U.K. deposits in social banks like Charity Bank. Cynthia Shanmugalingam, Jack Graham, Simon Tucker, and social investment market is still young and Geoff Mulgan, Growing Social Ventures: The Role of undercapitalised, although many recognise Intermediaries and Investors: Who They Are, What They Do, and What They Could Become, NESTA and The 1 Eurosif, European SRI Study, November 2010, p. 53. Young Foundation, February 2011, p. 31. 2 International Decision Strategies, Environmental, 5 Ibid., p. 8. Social and Governance Investing in Europe: A Review and 6 Iona Joy, Lucy de Las Casas, and Benedict Rickey, Analysis, April 2009, p. 28. Understanding the Demand For and Supply of Social 3 For more on the history of the United Kingdom’s Finance, NESTA and New Philanthropy Capital, social investment market, please see the report Social April 2011, p. 9. Investment Ten Years On, which provides a concise 7 Adrian Brown and Adam Swersky, The First overview of the important milestones in the U.K. social Billion: A Forecast of Social Investment Demand, The investment market over the past ten years (available at Boston Consulting Group and Big Society Capital, www.socialinvestmenttaskforce.org). September 2012, p. 8.

investments in social finance investment only 5% of social finance investments intermediaries and it is expected that many made in the United Kingdom were new funds focused on social investments categorised as equity or quasi-equity.8 will launch in anticipation of obtaining an Table 1 lists some of the current funds in investment from BSC. the U.K. impact investing market. The current intermediary/fund structures avail- Current Opportunities able to U.K. impact investors typically take Based on our research, we would make three one of the following forms: key observations about the current state of the U.K. impact investing market in the  Venture philanthropy funds, which United Kingdom. are similar to mainstream venture capital funds as managers provide both finan-  The current opportunity set of local cial and organisational support (such impact investing opportunities in the as management support and specialty United Kingdom is rather limited in expertise), but the focus in venture choice and in size. For example, CAF philanthropy is on social rather than Venturesome’s local impact funds have financial returns. We have observed that just £11.5 million under management. there are more venture philanthropy  Many of the impact investing opportuni- funds than market rate social venture ties in the U.K. market are currently capital funds in the United Kingdom. structured as individual deals to individual  Social entrepreneur funds that offer organisations (e.g., the Peterborough financing (both debt and equity) to social Prison Social Impact Bond and the Scope enterprises. Social enterprises are profit- Bond, further discussed in Appendix C), making companies whose products or whereas the global opportunities are typi- services are scalable and are designed to cally in diversified fund structures that produce a positive social impact. Our finance multiple organisations.  Impact investments in the United 8 Adrian Brown and Will Norman, Lighting the Kingdom are predominantly in the form Touchpaper: Growing the Market for Social Investment in of debt rather than equity. In 2010–11, England, The Boston Consulting Group and The Young Foundation, November 2011, p. 3.

Table 1. Representative U.K. Impact Investing Opportunities

Firm Product AUM (£ millions)

Bridges Ventures Bridges Ventures Fund III 100 to 150 Sustainable Property Fund 28 Social Entrepreneurs Fund 12

Big Issue Big Issue Social Enterprise Fund 9

CAF Venturesome Four Institutional Funds* 12

Social Finance Social Impact Bond (Peterborough Prison) 5

Notes: Assets under management reflect either the size of the most recent fund raised by the manager or the fund-raising target. Inclusion in this table does not represent a recommendation of a specific fund. * Includes the Community Land Trust Fund, Social Impact Fund, the Development Fund, and the Innovation Fund.

observation is that current social entre- Who Is Investing? preneur funds in the U.K. market do not As mentioned above, there are currently a offer the illiquidity premium expected by limited number of impact investors among most institutional investors. institutional investors. The government has  Funds offering recycled loans to chari- played a large role in the development of the ties. Investors only expect to receive the U.K. impact investing market. One report capital that was initially invested (a 0.0% estimates that the government has contrib- nominal return) so that the capital can uted £450 million in capital in the form of be used again similarly. grants, unsecured loans, quasi-equity, and equity.10 The government’s initiatives in  Community development finance the space include facilitating the creation institutions (CDFIs) and social banks, of both BSC and the Social Investment which are financial institutions that Business Group and investing directly in provide affordable finance to disadvan- funds, such as Bridges Ventures. Recently, taged communities. Impact investors the Department for Business Innovation invest in CDFIs or make deposits in social and Skills announced the start of the banks, and in return, earn a yield similar Regional Growth Fund (RGF), which was to other cash equivalent investments. created to help those areas of the country Many new organisations and platforms are most impacted by public sector spending under development, which should continue cuts. Between 2011 and 2015, the RGF will to foster growth in the social investment provide a total of £2.4 billion to businesses market and affect some of the observa- across the country that support projects and tions that we make above. Organisations programmes that use private investment such as ClearlySo, the New Economics to create economic growth and sustainable Foundation, and the Social Stock Exchange employment. are contributing to the infrastructure of To date, only a few pension funds, high- the market. In addition, many interesting net-worth individuals, foundations, and and innovative deals have been brought to universities have been active in social market or are in development, such as the investing. Current investors predominantly Scope Bond, the Peterborough Prison Social utilise traditional forms of social investing, Impact Bond, and Bristol Together, but such as shareholder advocacy, the use of lack scale. For example, the first tranche of negative screens in listed equity strategies, the Scope Bond raised £2 million and the or ESG integration. A few foundations, total pilot programme is only expected to like the Esmée Fairbairn Foundation, raise £20 million. The creation of diversi- have been important first movers in social fied funds, especially those offering market impact investing, but the aggregate level of rate returns, has seen the least amount of monetary commitment and investment from activity. Bridges Ventures is one of the these organisations is low. To give a sense current exceptions to the below market rate of the relatively small scale of commitment trend. More market rate and below market by foundations, U.K. foundations have rate fund offerings are expected as BSC invested approximately £50 million in continues to make commitments.9

10 JPA Europe Limited, Social Enterprise and the Social 9 For more information on the deals/organisations Investment Market in the U.K.: An Initial Overview, July mentioned in this paragraph, please see Appendix C. 2010, p. 22.

impact investments,11 while total foundation Section II: Barriers to the assets in the United Kingdom have been Growth of the Social Investment 12 estimated at £78 billion in 2010. Market and Potential Solutions13 The momentum in the U.K. social investment market is apparent and many of the While there have been many developments developments we have discussed in this in the social investment market in the report are bringing new investors into the United Kingdom, we have identified several space. However, as outlined in the following barriers to growing the field. Broadly, the section, there are still a number of barriers barriers can be grouped into four catego- to break down before social investing can ries: common misperceptions about social move into the ‘mainstream’. investing, implementation considerations, lack of suitable investment vehicles, and a need for supporting infrastructure to develop the field. We propose solutions to each of the barriers we have identified, though some barriers will of course be more challenging to overcome than others (e.g., a desire for longer track records cannot be solved in the short term).

Common Misperceptions About Social Investing Some of the common misperceptions about social investing we have identified include trustee confusion about whether fiduciary duty permits investing charity assets in social investments; a belief that social investing involves a trade-off between return and impact, even for funds targeting market rates of return; and a perception that it takes substantially more effort to research and make social investments compared to ‘mainstream’ investments. We break down each of these barriers in turn. First, regarding fiduciary duty, the Charity Commission recently released CC14, which offers decision-making guidance for investing charity funds. The guidance sets out various valid investment approaches and usefully introduces the categories of ‘programme-related’ and ‘mixed-motive’ investments. Both of these categories link investments to the direct furthering of a 11 ClearlySo, Investor Perspectives on Social Enterprise charity’s aims and mission, and are therefore Financing, July 2011, p. 27. 12 Ruth Sullivan, “Charities Take a New Look at 13 Based on the ideas of Cambridge Associates and Investment,” Financial Times, 3 April 2011. others.

constructive towards the development of section of this report, we propose a frame- a broader and more varied social invest- work to assist investors in their decision ment market. Specifically, CC14 states making as it relates to social investments. that “Trustees of any charity can decide Finally, investors should continue to to invest ethically, even if the investment network and share best practices related might provide a lower rate of return than an to their social investments to help address alternative investment. Ethical investment concerns regarding both the time commit- means investing in a way that reflects a ment and performance expectations of these charity’s values and ethos and does not run investments. The creation of case studies high- 14 As part of their gover- counter to its aims”. lighting successful social funds, for example, nance work, charity trustees can, therefore, would be instrumental in encouraging other evaluate the appropriateness of social investors that remain sceptical about making investments and work through the process such investments. In addition, many have of defining the types of social investments called for a U.K. version of the United States’ that reflect a charity’s values and ethos More for Mission Campaign15 to facilitate and using CC14 as guidance. Note that CC14 is expand the sharing of ideas and opportunities guidance rather than law, and some trustees more formally between foundations. While and advisors remain unclear about whether, such an entity does not yet exist, there are from a legal point of view, charities can groups with similar missions in the United invest for social impact rather than purely Kingdom. For example, the Global Impact pursuing financial return. Because of this Investing Network, which began in the United confusion, some in the field recommend the States, is currently expanding to Europe, and government introduce a reform of charity UKSIF (the U.K. Sustainable Investment and law that creates a clear legal and regulatory Finance Association) is already active in the environment for social investment. U.K. social investment market. Second, on the belief that social investments will underperform, it is difficult to make blanket statements about the likely performance impact of dedicating some or Barrier Solution all of a portfolio to social investments, as the Confusion regarding Look to CC14 for impact will depend on a variety of factors. fiduciary duty. guidance. However, we encourage investors to apply Belief that social Apply traditional risk/ the familiar risk-adjusted returns analysis for investments will return framework to social investments, just as they would for all underperform. performance analysis. investments in their portfolio. Though some Belief that social Education, sharing of social investments explicitly target below- investing is time best practices, and consuming. field building. market rates of return, we actively follow a number of social investing funds that target market rates of return within their respective asset classes and have posted competitive returns relative to their benchmarks. As with any investment, the availability of skilled managers will be a key determinant of performance expectations. In the final 15 More for Mission is now known as Mission 14 Charity Commission, Charities and Investment Investors Exchange after merging with PRI Makers Matters: A Guide for Trustees, October 2011, p. 8. Network in 2012.

Confusion Regarding Portfolio Lack of Suitable Investment Vehicles Construction and Implementation While progress has been made in the social Confusion as to where social investment fits investment market, many of the vehicles within the total portfolio context hinders are inappropriate for or unattractive to its growth as a market. Any decision to mainstream institutional investors, and the pursue social investments should begin with small universe of options provides little a dialogue about the organisation’s goals for choice for investors. The social investment its social investments that engages the lead- market needs to provide investors opportu- ership. Social investment opportunities can nities with no expected trade-off between either be housed in a carve-out pool of capital return and impact and where risk is miti- that resides outside the main corpus/endow- gated through the aggregation of multiple ment money, or alongside the mainstream opportunities. Institutional investors need investments of the portfolio, depending on opportunities to be provided in a diversified the investor’s preferences. We offer guidance fund structure for risk mitigation purposes. on the decision-making process in the final Also, many in the industry have discussed section of this report. the potential for products with tiered Confusion can also exist within an organisa- financing arrangements that allow inves- tion’s staff over who has responsibility for tors to choose the most appropriate level of and ownership of social investments, as financial return, risk, and impact. investing and charitable activities are typi- The current market for impact investing cally divided within a foundation. Given the funds is largely made up of new and unproven dual purpose of achieving a financial return opportunities. Without an adequate track while furthering the mission of an organ- record, mainstream investors may find it isation, organisations could assign dual difficult to approve an investment in the responsibility for the selection and moni- space. At this point, impact investments are toring of social investments so that both predominantly made by investors willing to sides are accurately monitored. Generally, be ‘first movers’. Angel investors can help members of the investment staff are more bring social enterprises to a level where they adept at analysing prospective investment are large enough to appeal to venture philan- returns, but they might miss the social thropy funds or social venture capital funds. If benefits of an opportunity. On the other institutional investors with an interest in facili- hand, grant-making staff might not be able to tating the market are willing to take the risk of understand and negotiate investment terms. investing in early funds, more opportunities Collaboration between the two sides is essen- will grow in size and develop established track tial. For example, several U.S. foundations records. To incent investors to be pioneers in with robust social investing programmes have first- and second-time funds, funds should created a collaborative model, with investment consider allowing investors to influence the and programme staff working side by side terms of the fund, and potentially offer a to source and underwrite social investments. discounted fee schedule to seed investors.

Barrier Solution Barrier Solution

Confusion regarding the Establish a clear Need for more market Create more market role of social investment decision-making rate opportunities. rate opportunities. in a portfolio. framework. Funds with unproven Incent investors to be Unclear directives for Encourage collaboration track records. pioneers in first- and implementation and between grant-making second-time funds. monitoring. and investment staff.

Need for Supporting Infrastructure investors. BSC is attempting to tackle this to Develop the Field challenge by collaborating with others in There is a clear need for supporting the social investment industry to create an infrastructure to develop the social invest- outcomes matrix that would allow mapping ment market. Some of the missing pieces and reporting on the social impact created include informed gatekeepers, common through the day-to-day business activities of social impact measurement standards, the a social enterprise.17 Using a tool like this, ability to price the risk and measure the an investor could embed social value into impact of social investments, and sufficient the investment decision-making process by tax incentives. None of these barriers are having a clearer picture of the impact gener- insurmountable, and we can make several ated by a business. recommendations to help overcome them. Pricing the risk of social investment is diffi- The current lack of knowledge and accep- cult at best. Most impact investments have tance of social investment by investment nascent track records, the business model consultants and advisors that are seen as of each social enterprise is unique, liquidity gatekeepers to capital in this space prevents varies, exit opportunities are unknown and widespread acceptance and investment on unpredictable, and it is difficult to measure the part of asset owners. Asset managers the expected and even realized social impact and consultants should engage in clear of an investment. The authors of the paper communication to ensure the products in In Search of Gamma challenge impact inves- development will appeal to institutional tors to establish key performance indicators investors. For their part, investors should within the investment thesis, allowing continue to put pressure on their advisors to the impact to be monitored and assessed review the opportunities in this space and throughout the life of the investment.18 The develop expertise in this field. expected impact can be incorporated into the return expectation. While this is not a While some funds provide reporting solution to all the issues related to pricing on the social impact of their underlying risk, measuring expected and realised social investments, there is little consistency impact may be one of the most challenging in the approaches applied by managers. issues for social investing. Clarity on the Accordingly, investors often find it diffi- other issues should be gained as the market cult to determine the aggregate social matures. benefit their investments generate, and the measurement of a blended financial and Finally, the United Kingdom has tax social return is nearly impossible at this schemes that were predominantly designed stage. A few organisations have devoted to encourage investment in mainstream resources to developing social impact businesses, but these do not translate to measurement tools, including the global most investment opportunities in social impact investing rating system, social return enterprises. A 2012 report from the NCVO on investment, and the investing for good Commission on Tax Incentives for Social impact rating methodology.16 The success Investment highlights the deficiencies of of these standards will be highly dependent on their acceptance and adoption by 17 Caroline Mason, Chief Operating Officer, Big Society Capital, interview, 5 October 2012. 18 Uli Grabenwarter and Heinrich Liechtenstein, 16 JPA Europe Limited, Social Enterprise and the Social In Search of Gamma: An Unconventional Perspective on Investment Market in the U.K.: An Initial Overview, July Impact Investing, IESE Business School University of 2010, p. 19. Navarra, January 2011, p. 54.

the four main tax schemes: Community at Cambridge Associates, Morgan Stanley’s Investment Tax Relief, the Enterprise Investing with Impact platform), and the Investment Scheme, Venture Capital proliferation of new funds seeking to Trusts, and the Seed Enterprise Investment generate both monetary and social returns. Scheme.19 The changes and improvements However, misperceptions and roadblocks suggested in the NCVO report should be still exist, and many investors remain on implemented to encourage further demand the sidelines as they grapple with how to for social investments. approach this somewhat new and unfamiliar field. In the following section, we provide a framework to help investors navigate some Barrier Solution of these issues. Lack of informed Increased pressure gatekeepers. from investors for their advisors to expand their social investing capabilities and research, as well as clear and targeted communication between asset managers and consultants.

Lack of common social Further development impact measurement of consistent social standards. impact standards and adoption by investors.

Difficulty pricing social Establish key investments. performance indicators for impact investments prior to making an investment.

Insufficient tax Implement changes to incentives. current tax schemes.

Overcoming These Barriers While the list of barriers may seem long, many of these issues can be readily addressed, and responsibility for these solutions should be shared by all market participants—investors, advisors, and fund managers. Significant progress has already been made in the past several years, as seen through the development of various social and impact investing networks, the establishment of social investment–focused groups at mainstream investment firms (e.g., the Mission-Related Investing Group

19 National Council for Voluntary Organisations, NCVO Commission on Tax Incentives for Social Investment, January 2012. See Appendix C for more information on these schemes.

Section III: Decision-Making in underserved areas. This organisation will Framework achieve its objectives in two ways:  by earning a financial return that can In this section, we provide an overview of a be used to fund grant making on social framework we have developed to help inves- objectives (e.g., making grants for job tors evaluate and implement social investments creation programs in underserved areas). into a diversified investment portfolio.  by earning a social return from the In our recommended approach, evaluating underlying investment assets (e.g., social investments is an extension of the impact funds that take equity stakes in familiar risk/return analysis applied to all new businesses that are creating jobs in investment assets. In this case, however, underserved areas). ‘risk’ is expanded to ‘combined risk’, which incorporates both financial risk and The combined return accounts for both social risk, while ‘return’ is broadened to the investment’s financial return and any ‘combined return’, which incorporates social return that is relevant to the investor’s both financial return and social impact.20 objectives (in this case, job creation). It should be noted that traditional portfolio For example, an investment with an impact construction best practices still apply when fund that creates a below market rate finan- incorporating social investments into the port- cial return could still have a compelling folio. For example, there should be a clearly combined return for this particular organ- defined role for each type of social investment, isation because the impact fund also creates sufficient diversification among higher-risk jobs in underserved areas. opportunities like equities, and an evalua- The important concept here is that the tion of returns relative to the risks taken. combined returns of all investment oppor- We begin by defining ‘combined return’ and tunities are compared starting from the ‘combined risk’ as these concepts underpin organisation’s objective (in the example, job this decision-making framework. creation). The ranking and ordering of the investment opportunities is then similar Combined Return to what any traditional investor would do. Investment funds are not ends in them- The difference with the combined return selves, but are a means to achieving an approach, however, is that investors with institution’s financial or social objective. distinct objectives and missions will end up Investment assets can help the institution ranking investment opportunities differently. achieve its social objective in two ways—by earning a financial return and by earning Combined Risk a social return, the sum of which is the Similarly, the objective of the combined combined return of an investment. To better risk measurement is to provide an assess- illustrate the concept of combined returns, ment of investment risk that includes the we use as an example an organisation that social/reputational risk of alienating key has the objective of increasing job creation stakeholders. Specifically, we define an investment’s combined risk as the sum of financial risk and social risk. 20 Cambridge Associates explored the combined return concept in our 2007 paper Social Investing. In Financial risk refers to an asset class’ vola- that paper, we described an investor’s “Holistic Total tility (as measured by standard deviation of Investment Return” as being equal to the Social returns). This is a fairly standard measure Return + the Monetary Return.

of investment risk used by many investors The combined risk of this type of invest- when evaluating risk-adjusted returns. ment is therefore higher than a competing Financial risk is considered a compensated risk investment with the same financial risk as investors expect higher long-term returns (i.e., volatility) that avoids the social risk by in exchange for increased volatility. It is excluding tobacco. also important to highlight that financial The remainder of this section describes the risk measured solely by volatility does not steps we recommend that investors take capture all aspects of investment risk and to effectively evaluate social investment does not address risks that are more difficult options within a combined risk to combined to quantify. return framework. Social risk refers to the risk that an institution’s investments might alienate key Step 1. Assess Investor Motivation stakeholders and/or compromise the values of for Considering Social Investments the organisation. This is considered an uncom- Clearly articulating the rationale for social pensated risk as there is no increased expected investments is an important first step. return when exposed to this type of risk.21 This will help the fiduciary focus on the strategies that are most relevant to the insti- Combining financial risk and social risk into tution’s objectives and will allow for a more one risk figure is difficult because social risk robust analysis of the social investment is not easily quantifiable. When a relevant opportunity set. In Appendix A, we have social risk is identified for an investment created a series of ‘guiding questions’ to opportunity, we recommend that the help fiduciaries think through these issues combined risk measure be increased so that by addressing the following topics: it is meaningfully higher than the financial risk measure. This will make it clear that a  the organisation’s objectives and the role strategy with exposure to social risk is less of the investment in achieving those attractive from a risk/return standpoint objectives, than a similar approach that is not exposed  the stakeholder implications of allo- to the social risk. cating capital to social investments, For example, a health care foundation  the guidelines the organisation will use that has a goal of maximising returns to in making social investments, and support charitable spending might perceive  the available universe of social invest- an investment in equity funds that include ments (funds and direct investments) tobacco companies as an uncompensated that are relevant given the organisation’s risk. This exposure has the potential motivation. to alienate key stakeholders and runs counter to the organisation’s objectives. In general, we have observed that social investors tend to be motivated either by a 21 Just as volatility does not capture all aspects of investment risk, social risk, as defined here, does desire to maximise social impact or by a not capture all types of social risks. For example, desire to minimise social/reputational risks. when making a social investment, there is the risk More specifically, we have found that the that the investment may not produce the desired four ‘investor motivation’ categories depicted social outcome (e.g., jobs may be lost rather than in Table 2 capture the majority of scenarios created). However, this social risk and others may be captured within the combined return framework. where social investments are implemented When an expected social outcome is not achieved, into a broader portfolio. For each one the ex post combined return would be lower than of these motivation categories, Table 2 the expected combined return.

Table 2. Types of Nonfinancial Motivation

Maximise Impact Minimise Risk

Maximise Impact Locally Minimise Risk Through Exclusion Examples: Examples:  Local organisation wants to coordinate invest-  Religious organisation with clear guidelines on a ments with its grant-making to maximise impact. range of investments to avoid that are considered  A foundation that would like to be a ‘first mover’ contrary to its principles (e.g., avoiding weapons, to help grow the local market for social impact gambling, pornography, etc.). investments.  Private foundation has decided to support cancer research and would like to avoid investments in tobacco that would be seen as compromising the Types of Investments: intent of its donations.  Social PE/VC Funds  Social Impact Bonds Types of Investments:  Impact Funds  Screened Equity Funds  Social Bank Deposits  Screened Bond Funds

Organisation:  The Esmée Fairbairn Foundation

Maximise Impact Globally Minimise Risk Through ESG Integration Examples: Examples:  Global organisation seeking to coordinate its  Large pension concerned about the risk of alien- investments with its spending/donations to ating stakeholders across a variety of issues. maximise the reach of its impact.  Environmental organisation wants to limit  Large public investor wants to use its size to exposure to investments that could compromise actively influence/change corporate behaviour of its mission or hurt its reputation. its portfolio companies through engagement as  A university concerned about student body part of its responsibility to its stakeholders. reaction to investment in emerging markets across a range of issues (e.g., labour standards, Types of Investments: human rights, environmental).  EM Development Funds  Impact Funds Types of Investments:  Environmental Equity Organisation:  ESG Screened Equity Funds  Council for World Mission Organisation:  Royal Society for the Protection of Birds

An investor is not limited to just one of the four categories depicted in this table. For example, the same religious foundation seeking to “minimise risk through exclusion” by investing in a screened equity fund that avoids gambling, alcohol, and tobacco might also “maximise impact locally” by investing in a social impact bond that is aligned with its charitable donation efforts.

Note: A fund’s inclusion in this matrix is not intended to represent a recommendation to invest.

identifies examples of these nonfinancial sufficient financial return for the amount motivators, lists organisations currently of financial risk taken. Investments falling investing in this manner, and provides outside the dotted lines are not adequately examples of funds in each category. compensating investors with a high enough Using Table 2 along with the ‘guiding ques- financial return given the financial risk tions’ contained in Appendix A should help taken. investors identify the ‘motivation category’ When looking at social investments using and the social investment strategies that are this ‘traditional’ reference point, we would most relevant to the overall objectives of make the following observations. the institution’s investment pool. We would  There is no ‘free lunch’. This frame- note that an investor could fit into more work assumes that asset classes with than one category. lower risks have lower expected returns Step 2. Evaluate Options within the and asset classes with higher risks have Combined Risk to Combined Return higher expected returns. As a result, Framework there is no inherently ‘superior’ asset Once the investor’s nonfinancial moti- class that delivers outsized returns at a vation has been identified, the social lower level of risk. We also assume that investment strategies should be evaluated a social public equity strategy (e.g., one within a ‘combined return’ (financial incorporating exclusionary screens, ESG return + social return) to ‘combined risk’ integration, or best-in-class criteria) and (financial risk + social risk) framework. an unscreened public equity strategy This approach starts with mapping invest- that have a similar level of financial ment options onto the traditional financial risk will have a similar level of expected 22 risk to financial return framework and return. then makes adjustments to account for any  But there may be some ‘expensive potential social impact or social risk that lunches’ (i.e., below market return may be relevant to the institution’s non- strategies do exist). There are some financial objectives. social investment strategies, however, that have expected financial returns that Step 2.1. Start with the Traditional are, by design, lower than other asset Financial Risk to Financial Return classes with comparable financial risk. Framework. In Figure 1 we have mapped This implies that investors that decide various social investment categories onto to allocate to these types of funds the traditional financial risk to financial are placing some type of value on the return framework. The objective of the fund’s social return/social impact in traditional framework is to assess expected addition to its expected financial return. financial return against expected financial However, this extra source of return is risk. The circles depict social investments not accounted for in the traditional risk while the triangles depict conventional and return framework of Figure 1. asset classes that do not have any explicit social objective. The vertical axis represents If an investor were to look at the universe expected financial returns, while the hori- of investment categories from solely a finan- zontal axis represents financial risk (e.g., cial risk to financial return perspective, the volatility). Investments falling between 22 Note that this does not take a view on any the dotted lines are considered market rate expected extra return based on manager skill (i.e., in that investors are compensated with no ‘alpha’ is assumed at this stage of the evaluation).

social investment strategies would not be adjust its assessment of this investment particularly differentiated from the nonso- when considered from a combined risk cial investments. In addition, the strategies to combined return perspective. In this with below market rates of returns would example, an investor believes that an probably not receive serious consideration investment in a below market rate social from fiduciaries using the traditional finan- impact bond will create a social outcome cial risk to financial return framework. As a that is in line with the organisation’s result, an adjustment needs to be made from objectives, therefore creating a compel- this reference point. ling ‘combined return’ (financial return + Step 2.2. Adjust the Framework to social return) relative to the risks taken. Account for Combined Return and  For investors motivated by mini- Combined Risk. The traditional risk/ mising social risk, adjustments may return framework is then modified to create need to be made to the ‘combined a combined risk (financial risk + social risk) risk’ to account for the added social to combined return (financial return + risk of investing in an unscreened social return) framework to better evaluate strategy, which would highlight the the social investment options. In Figure 2, relative advantage of investing in a we depict the adjustments that would be fund that explicitly screens on social made to the traditional risk/return model. issues relevant to the organisation.23 The extent to which investors decide to In Figure 2, the unscreened equity adjust either the expected ‘combined return’ fund has moved to the right relative or expected ‘combined risk’ of a particular to its place on the traditional risk/ social investment strategy will largely return chart, depicting how an investor depend on the investor motivation category primarily motivated by a desire to identified in Step 1. minimise social/reputational risk might adjust its assessment of an investment When social returns are factored into an when considered from a combined risk assessment of combined return (vertical to combined return perspective. In axis), some asset classes will have a combined this example, when the social risk of return that is higher than their simple investing in an unscreened equity fund financial return. Similarly, when social risk is is considered, the expected combined accounted for in the combined risk measure- return is no longer compelling because ment (horizontal axis), some of the traditional its combined risk is too high. asset classes may see their combined risk increase above their financial risk measure. Once the investor has narrowed the universe to those strategies that meet  For investors primarily motivated by the combined risk to combined return a desire to maximise social impact, threshold, the next step is investment selec- there may need to be an upward adjust- tion and position sizing. ment to the expected ‘combined return’ of certain impact-oriented investments 23 In this context, any adjustment to the ‘combined’ if the nature of the impact is relevant to risk does not assume that the social strategy is changing the financial risk of a strategy. The social the institution’s objectives. In Figure risk adjustment is based on whether the strategy 2, the social impact bond has moved addresses (or fails to address) the social/reputational upward relative to its place on the risk that is relevant to the investor’s nonfinancial traditional risk/return chart, depicting motivation. In this framework there is not a view how an impact-oriented investor might about ESG integration lowering the downside risk or volatility of a particular fund.

Figure 1. Traditional Risk/Return Profile

High

PE/VC Social Fund PE/VC Fund

Unscreened Equity Fund Screened Equity Fund

Unscreened Bond Fund

Financial Return Screened Bond Fund

Social Impact Bond

Low

Financial Risk Low High

Social Investments (e.g., negatively screened public equity fund, microfinance fund, etc.) Traditional Financial Investments (e.g., bond/equity funds with no application of social/ESG criteria)

Figure 2. Combined Risk/Return Profile

High

Unscreened Equity Fund (Adjusted by Social Impact Bond investor focused (Adjusted by on minimizing risk) investor focused on maximizing impact) CombinedReturn (Financial + Social)

Low

Combined Risk (Financial + Social) Low High

Social Investments (e.g., negatively screened public equity fund, microfinance fund, etc.) Traditional Financial Investments (e.g., bond/equity funds with no application of social/ESG criteria) Dashed-line shapes show original position of investments within traditional risk/return framework (financial risk/return) The arrow illustrates the repositioning of an investment within the combined (financial + social) risk/return framework

Step 3. Select Investment and  Illiquid and smaller scale. Impact- Determine Sizing oriented strategies are more likely to be As with any prospective investment, selecting illiquid and smaller scale. For example, the most appropriate social investment will a locally focused impact investment require further assessment of the strategy, strategy may have a limited number of team, and organisation. Investors should underlying opportunities to put capital understand the investment’s competitive to work. As a result, smaller, less liquid advantage, its likely performance in different impact investments may have a limited market environments, and determine how amount of money that they can accept investment and social performance will be given the nature of their underlying evaluated (and over what time frame). opportunity set. These investments are also likely to have higher limited partner The sizing of the selected investments in concentration. the portfolio will likely be influenced by the size and characteristics of the opportunity,  Limited number of relevant invest- which can vary considerably for each type of ments. For impact-oriented investors, investor motivation category (Table 2). the actual number of investment opportunities meeting the institu- For investors motivated by ‘minimising tion’s combined social and investment social risk’, individual position sizing is not objectives may be quite small. The likely to be particularly constrained as a result Social Investment Business Group’s of two characteristics of the opportunity set. 2011 report Making Good in Social Impact  Liquid and publicly traded. Many Investment found that there were only of the exclusionary-screened and about 12 social impact intermediaries ESG-integrated funds trade in very and fund managers in the United liquid, publicly traded markets. From Kingdom at that time.24 This small the manager’s perspective, investing number may make it difficult to build a in these very liquid markets means sizable allocation to the category. that these funds are less likely to be  Potential for concentrated financial capacity constrained and should be able risk at the manager level. These strate- to handle sizeable inflows from large gies may also be quite concentrated (i.e., investors. less diversified) and many investors may  Diversified holdings. Funds that apply want to limit any individual holding in either exclusionary screens or qualita- such a strategy to a certain percentage of tive screens incorporating ESG tend to total assets purely from a risk-manage- have more diversified, core exposure (in ment perspective. general). The opportunity set of available While manager-sizing constraints will vary funds will likely include both active and by strategy, it is also important to consider passive diversified options that can be how these strategies will interact with the held as a relatively large ‘core’ holding in broader portfolio’s asset allocation targets. the portfolio. For investors motivated by ‘maximising social impact’, position sizing in the portfolio may be more limited due to three characteristics of the opportunity set. 24 Rupert Evenett and Karl Richter, Making Good in Social Impact Investment, The Social Investment Business and TheCityUK, p 25.

Step 4. Implement Social risk/return characteristics of the overall port- Investments into the Strategic folio (social and nonsocial investments) may Asset Allocation change depending on the composition of the We conclude our portfolio construction social investment portfolio. framework process by describing two ways to To compare how the two approaches would incorporate social investment strategies into differ in practice, we use as an example an the portfolio’s long term strategic asset alloca- investor that currently has a strategic asset tion policy. One approach fully integrates allocation policy of 60% equities, 30% fixed social investments within the asset allocation, income, and 10% alternatives. After going while the second approach treats social invest- through Steps 1–3, this investor has identified ments as a separate carved-out asset class. two ‘core’ social investments—one social Under the integration approach, the equity fund and one social bond fund—and overall portfolio’s asset allocation targets are plans to make a 10% allocation to each. In maintained when adding a social investment Table 3, we depict how the two approaches strategy. In this case, investors would typi- would incorporate the new social investments cally fund a new social equity investment by into the strategic asset allocation. reducing an equal amount of equity exposure From a practical perspective, the ‘integra- from another strategy to maintain the overall tion’ approach tends to be more useful for target exposure to equity. Similarly, to add investors focused on minimising social a social fixed income investment, inves- risk. The more diversified, liquid social tors would reduce exposure to other fixed investments associated with this motivation income assets to maintain the overall target category can be integrated into the relevant exposure to fixed income. traditional asset class categories with Under the carve-out approach, social minimal impact on the expected risk and investments are viewed collectively as a return of the overall portfolio. separate asset class. In this case, the social The carve-out approach tends to be more investment allocation would be funded pro relevant for investors looking to maximise rata from across the nonsocial investment social impact, as these funds tend to have asset class allocations. As a result, the relative a more unique risk/return profile and are weights (and risk/return characteristics) of more difficult to integrate into traditional nonsocial investments are retained, but the

Table 3. Example of Integration vs Carve-Out Approach to Social Investment Implementation

Current Asset Allocation Integration Approach Carve-Out Approach

50% Equity 48% Traditional Equity 60% Equity 10% Screened Equity

20% Traditional Fixed Income 30% Fixed Income 10% Screened Fixed Income 24% Fixed Income

10% Alternatives 10% Alternatives 8% Alternatives

20% Social Investments

asset classes without distorting expected performance characteristics. Carving out impact funds may simplify performance measurement as the portfolio investment performance could be evaluated on an ‘ex social investment basis’ while the social impact allocation could be evaluated using a combined financial and social return analysis. We would note that an investor’s spending policy and overall liquidity constraints are also important factors to consider when determining the most appropriate implementation approach. For example, if a very large carve out to illiquid impact investments is being proposed, implications for how this might affect the overall spending/ distributions from the total investment pool should be carefully considered.

Conclusion

The momentum in the U.K. social investment market is notable and we have observed many interesting investment opportunities that are either available today or in development. This report aimed to guide investors through some of the major steps in exploring social investments. The sections describing the landscape of the market and the barriers to its growth provide background and perspective for investors new to this market. Once investors decide to commence social investing, they can use the decision-making framework to help assess and implement social investing opportunities. ■

Guiding Questions  Who are the organisation’s key stakeholders? What are their views on using 1. What is the objective of the nonfinancial criteria (social, environ- organisation, and what is the role of mental, governance, etc.) as part of the the investment pool in achieving it? investment decision-making process? Do any of these stakeholders have  What should the relationship be opposing views? between investment assets and spending policy/grant making? Is the role of  Are there types of investments that the investment assets purely financial could alienate a key stakeholder? If so, (i.e., maximise risk-adjusted financial what would the consequences be if such return so that the amount available for an investment were made? Is this type spending is maximised), or could the of risk being factored into the invest- investment assets supplement/add to ment evaluation process? the social impact of the organisation’s grants/distributions? 3. What guidelines is the organisation following?  If an investment could deliver a social  Is there any existing language in the return that is aligned with the social/ organisation’s Investment Policy environmental objectives of the organ- Statement relating to the consideration isation’s distribution/spending policy, of nonfinancial criteria when making how should the social impact of the investment decisions? investment be measured?  What is the understanding of the  Is the social objective of current grant current rules on fiduciary responsibility making/spending policy focused on as they relate to the consideration of local impact or is the objective to have environmental, social, and/or governance a broader, more global reach? Should issues in the investment decision-making topics/issues that are broader in scope process? than the stated social objective of the asset pool’s spending policy be consid- 4. What is the investment opportunity ered when assessing an organisation’s set that incorporates the issues/ potential social impact? objectives that are relevant? 2. What are the stakeholder  Are there funds/investments available implications for these types of that minimise exposure to social/reputa- investments? tion risks we are concerned about? Are they of institutional quality?  Who has raised the possibility of integrating social/nonfinancial factors  Are there funds/investments available into the investment decision-making that could help us achieve our social process? What is their relationship to impact objectives? Are they of institu- the organisation? What issues are they tional quality? concerned about/interested in?  Does the organisation have sufficient  Is the desire to integrate these factors in-house talent to source direct social due to concern about a particular risk? investments? ■ Or to a desire to generate a positive social impact?

Comparison to Other Social small business owners also have greater Investment Markets access to alternative forms of finance such as peer-to-peer lending. In general, U.K. small businesses have a harder United States time obtaining outside capital.2 Many draw comparisons between the U.K. and U.S. social investment markets.  Bond Markets Are More Conducive to However, drawing comparisons between Community-Oriented Investments. the two may not be worthwhile, as there are The fixed income market in the United many structural differences in the capital States is conducive to community- markets, legislation, and government of each oriented investments. There is a robust country. These differences have resulted in mortgage-backed securities market and the formation of different social investment a large municipal bond market that opportunities in each country. For example, supplies mission bond managers with the following list outlines some of the high-quality low- and moderate-income major catalysts to the U.S. social investment single family mortgages, affordable rental market. As these are unique to the United housing (multifamily) mortgages, and States, the opportunities that stemmed from other bonds targeting urban revitalisa- them are not likely to be replicated in the tion and rural development. The United U.K. market. Kingdom has neither a robust mortgage- backed securities market nor a large  Community Reinvestment Act muni market. 1 (CRA). The CRA has supplied the U.S.  More Privately Owned Affordable social investment market with oppor- Housing. While social housing in the tunities in fixed income, social venture United Kingdom is supplied by local capital, and affordable housing real authority public housing and nonprofit estate funds, among others. Since CRA housing association dwellings, approxi- credits are in demand by large banks, mately half of the affordable housing the products available tend to be more stock in the United States is owned by viable strategies due to the institutional profit-making companies and individ- client base and level of assets. uals that receive a government subsidy  More Support for Small Businesses. for offering rent at a below market price. In the United States, the Small Business Since the private sector owns much of Administration facilitates capital to the social housing stock in the United small businesses through financial States, there are more opportunities for intermediaries and acts as an advocate market rate affordable housing invest- for entrepreneurs. In the United States, ment funds.  New Markets Tax Credits. The 1 The Community Reinvestment Act is intended United States started the New Markets to encourage depository institutions to help meet Tax Credit (NMTC) program in 2000 to the credit needs of the communities in which they operate, including low- and moderate-income neigh- help revitalise low-income communities. bourhoods, consistent with safe and sound banking NMTCs give individual and corporate operations. The CRA requires that each insured taxpayers a credit against federal income depository institution’s record in helping meet the taxes for making qualified equity credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution’s application for deposit 2 Hannah Kuchler, “Poor Access to Cash Limits facilities, including mergers & acquisitions. SME Growth,” Financial Times, 11 March 2012.

investments3 in qualified community reports.5 Many mainstream investment development entities. This program has managers in France have begun to been successful at generating invest- include environmental, social, and ment into low income areas. The New governance company analysis into their Market Tax Credit Coalition reports that research. This law served as a catalyst NMTCs have created or retained up to for managers to start including this 500,000 jobs and generated almost $50 ‘extra financial’ analysis, as the data was billion in financing to businesses in low made easily accessible. 4 income areas.  The Green Funds Scheme. In  Programme-Related Investments the Netherlands, individuals are (PRIs). Since U.S. foundations are eligible for a tax credit for investing required to pay out 5% of their assets in specific green funds at designated each year PRIs count towards the banks. According to the European 5% payout, below market rate return Commission, the Green Funds Scheme products have a designated ‘bucket’ in has contributed more than €6.8 billion U.S. foundation portfolios, which elimi- since 1995 for financing of 5,000 nates the question of where a below projects that may not have existed market rate social investment belongs in otherwise.6 an institutional portfolio. These are just two of many important incentives developed by European nations to Continental Europe encourage further social investment. ■ The social investment market in continental Europe has a strong foundation as well. Traditional forms of social investment are well established in many countries and impact investing opportunities in areas such as microfinance, cleantech, and social finance are gaining traction. It is difficult to make generalisations about interest and activity in the broader European market as tax law, culture, and some legislation is unique to each country. However, it is worth noting a couple of the influential regulations and tax schemes.  The New Economics Regulation Law. This law was passed in France in 2001 and requires listed French companies to publish social and environmental information in their annual

3 To be considered a qualified equity investment, substantially all of the equity investment must be 5 Eurosif, Socially Responsible Investment among European used to provide loans to, or make investments in, Institutional Investors: 2003 Report, September 2003, p. 47. low-income communities. 6 European Commission, “State Aid: Commission 4 New Markets Tax Credit Coalition, The New Approves Dutch Green Fund Scheme for Markets Tax Credit 10th Anniversary Report, December Environmentally-Friendly Investment Projects”, 2010, p. 2. press release, 14 October 2009.

Glossary unemployed people (socially excluded popu- lations). Properties in need of refurbishment This glossary defines terms used in this report are purchased and restored by the targeted and also provides additional background on groups. To minimise the need for specialist and descriptions of the deals, managers, and help, properties requiring low-skilled work organisations mentioned in the text. are purchased. Once the refurbishment is Below Market Rate Investments have complete, the properties are marketed and expected financial returns below risk- sale proceeds are used for the purchase of adjusted market rate levels. new properties for renovation, creating more employment opportunities. Best-in-Class refers to the investing approach that seeks the best companies in CAF Venturesome provides unsecured each sector relative to peers along pre-deter- loans (of up to five years) of between mined environmental, social, and corporate £25,000 and £250,000 to charities, social governance (ESG) metrics. enterprises, and community groups that have been operating for at least one year. Its Big Issue Invest is the social invest- investments are designed to meet a range ment arm of The Big Issue, a magazine that of financial needs, from working capital supports homeless people. Big Issue Invest for cash flow support to growth capital for provides loans and investments (not grants) transition or development. from £50,000 to £1 million to social enterprises, charities, and businesses that are A Carve-Out Approach refers to an asset socially driven. allocation approach to social investing. In this approach, social investments are Big Society Capital (BSC) is an inde- viewed collectively as a separate asset pendent financial institution formed to class. The social investment allocation is develop a sustainable social investment funded pro rata from across the nonsocial market in the United Kingdom. BSC was investment asset class allocations. As a funded from £400 million in dormant result, the relative weights (and risk/return bank accounts and with £200 million characteristics) of nonsocial investments are from the four major high street banks retained, but the risk/return characteristics (Barclays, HSBC, Lloyds, and Royal Bank of the overall portfolio (social and nonsocial of Scotland). Most of BSC’s £600 million investments) may change depending on in capital is slotted for investment in social the composition of the social investment finance investment intermediaries. portfolio. This approach tends to be more Bridges Ventures is a private investment relevant for investors looking to maximise firm founded in 2002 focused on making social impact as investment opportunities investments that achieve both a financial used within a carve-out approach tend to return and a social/environmental return. have a unique risk/return profile and are The firm has three sustainable growth more difficult to integrate into traditional funds, two property funds, and a social asset classes without distorting expected entrepreneur fund totalling approximately performance characteristics. £275 million in assets under management. CC14 is guidance provided by the Charity Bristol Together is a social enterprise Commission, the regulator of charities in based on the provision of construc- England and Wales, which covers the legal tion work, experience, and training for and good practice framework for the invest- ex-offenders, the homeless, and long-term ment of charity funds. It sets out various

valid investment approaches and introduces The Community Reinvestment Act is a the categories of ‘programme-related’ and U.S. federal law that provides a framework ‘mixed motive’ investments. for financial institutions, state and local The Charity Commission registers and governments, and community organisations regulates charities in England and Wales. to promote banking services to all members of a community. The CRA prohibits Clean Tech can be categorised into three redlining (denying or increasing the cost main sectors: clean/alternative electricity, of banking to residents of racially defined clean/alternative fuel, and other clean neighbourhoods) and encourages efforts technologies. Renewable clean/alterna- to meet the credit needs of all community tive electricity sources include geothermal members, including residents of low- and power, hydropower, landfill gas, solar moderate-income neighbourhoods. power, and wind power. Nonrenewable clean/alternative electricity sources include The Enterprise Investment Scheme (EIS) coal gasification plants and other clean provides some tax relief to individuals that coal technologies, natural gas, and nuclear purchase new shares in higher-risk trading power. Clean/alternative fuel sources are companies, potentially helping such compa- renewable or emit fewer greenhouse gases, nies raise capital. The tax relief is available including biodiesel, ethanol, and hydrogen. only to individuals and is 30% of the cost Other clean technologies are varied, but can of the shares, which is set against the indi- be split into two categories: clean industrial vidual’s income tax liability for the tax year process technologies and environmentally in which the investment was made. preferable processes. ESG Integration refers to the practice ClearlySo is a broker that connects social of integrating environmental, social, and enterprises and impact investors. corporate governance factors into the investment decision-making process. ESG Combined Return, in a risk/return frame- factors can include a wide range of indica- work, incorporates both financial return tors pertaining to a corporation’s impact on and social impact. its various stakeholders—those affected by a Combined Risk, in a risk/return frame- corporation’s operations. work, incorporates both financial risk and Exclusionary Screens describe social or social risk. environmental criteria that, if not satisfied, Community Development Finance eliminate companies from consideration in Institutions (CDFIs) lend capital to busi- an investment universe. Some of the more nesses, social enterprises, and individuals, widely used screens include ‘sin stocks’ typically those who are unable to get (tobacco, gaming, and alcohol), significant financing from high street banks and loan polluters, weapons manufacturers, religious companies. screens, and companies doing business in Sudan and/or Iran. The Community Investment Tax Relief (CITR) scheme was devised in 2002 to The Global Impact Investing Network encourage private investment into CDFIs. (GIIN) is a nonprofit organisation working The CITR scheme encourages investment to increase the scale and effectiveness of in disadvantaged communities by giving tax impact investing. Founded in the United relief of 25% over five years to investors who States, the GIIN builds infrastructure and invest in accredited CDFIs. supports activities, education, and research that help accelerate the development of a

coherent impact investing industry. The GIIN key indicators, the outcome of which is a appointed two European liaisons in 2012 Confidence, Return, and Impact (CRI) rating. to deepen its local presence to help support Market Rate Returns appropriately Europe’s impact investor community. compensate investors for risks taken. The Global Impact Investing Ratings Microfinance targets the economically System (GIIRS) is a system for assessing disadvantaged who, under normal condi- the social and environmental impact tions, would have no access to financial of companies and funds with a ratings services. These microfinance ‘clients’ are and analytics approach analogous to given access to loans through microfinance Morningstar investment rankings and institutions. Microfinance includes a broad Capital IQ financial analytics. GIIRS is a range of services, such as savings, insurance, project of the independent nonprofit B Lab. payment transfer, and remittance services. Impact Investing generally describes Mission-Related Investing/Mission- investments made in enterprises that offer Connected Investing generally refers to market-based solutions to a particular the practice of using investments to directly social or environmental challenge that is of achieve, or be aligned with, an institution’s interest to the investor. mission goals; it is a term commonly used The Integration Approach is an asset by foundations. allocation approach to social investing that Mixed Motive Investments are defined by maintains the overall portfolio’s asset alloca- CC14 as investments that trustees can justify tion targets when adding a social investment making on the basis that they combine strategy. In this case, an investor would a financial return with a contribution to typically fund a new social equity invest- furthering their charity’s aims. These are ment by reducing an equal amount of equity investments that cannot be wholly justi- exposure from another strategy to maintain fied as either a financial investment or a the overall target exposure to equity. Programme Related Investment (PRI). Similarly, to add a social fixed income investment, investors reduce exposure to The More for Mission campaign was intro- other fixed income assets to maintain the duced by three U.S. foundations in 2007. The overall target exposure to fixed income. goal of More for Mission is to catalyse foun- The Integration Approach tends to be more dations into mission investing and offer access useful for investors focused on minimising to research on the field, implementation tools, social risk. The more diversified, liquid and links to potential investment opportuni- social investments associated with this ties. In 2012, More For Mission merged with motivation category can be integrated into PRI Makers to create a new organisation, the the relevant traditional asset class categories Mission Investors Exchange. with minimal impact on expected risk and NESTA is a U.K.-based charity that return of the overall portfolio. seeks to advance the study of innovation The Investing for Good Impact Rating by providing investments and grants and Methodology was developed by Investing for supporting or publishing research. NESTA Good, a specialist social finance intermediary, has published a number of reports on social to measure the social and environmental investing, particularly impact investing. impact performance of an investment. The The New Economics Foundation is an process involves qualitative analysis of independent ‘think-and-do’ tank that aims

to improve the quality of life by promoting their families. The Scope bond will be offered innovative solutions that challenge main- in sterling bond tranches at varying nominal stream thinking on economic, environment, amounts, maturity dates, and coupon rates. and social issues. Scope partnered with Investing for Good, New Markets Tax Credits provide a credit a specialist social finance intermediary, to against U.S. federal income taxes of 39% launch the programme, which aims to allow over seven years to taxpayers who make quali- the charity to generate more unrestricted fied equity investments (investments where voluntary income to expand activities. substantially all of the equity investment is The Seed Enterprise Investment Scheme used to provide loans to, or make investments (SEIS) launched in April 2012 with the aim in, low-income communities), in a community of stimulating entrepreneurship and kick- development entity (CDE). CDEs use the starting the economy. Investors are offered capital from investors to provide financing to tax breaks of up to 78% on £100,000 invest- businesses located in low-income communi- ments in earlier stage companies raising ties. The program was authorised by the equity. The scheme is for companies raising Community Renewal Tax Relief Act, which no more than £150,000 and is expected to was signed into law in December 2000. be used by ‘friends and family’ of existing The Peterborough Prison Social Impact entrepreneurs. Bond launched in September 2010 and Social Enterprise is a broad term used to is the first social impact bond (SIB). It was describe a business operating for a social created to decrease recidivism rates among purpose. The business reinvests its profits short-sentenced prisoners in Peterborough for that social purpose instead of redistrib- prison. SIBs are payment by results contracts uting them. Certain social enterprises are that are designed to increase funding for also registered charities. preventative services that improve social Social Finance/Social Enterprise outcomes. The financial return is dependent Investment is a sub-category of impact on the degree to which outcomes improve. investing that refers to investments that Positive (ESG) Screens used by invest- provide capital to entrepreneurs and/or ment managers generally favour companies entitues that have the intent to create a and sectors that score positively in environ- social impact (e.g., a loan to an entrepeneur mental, social, and governance (ESG) areas, looking to create a business that solves a such as emissions reduction, human rights social problem like homelessness). issues, and labour practices. Social Investing is a broad-based approach Programme-Related Investments are to investing that considers both the inves- investments made with the intention tor’s financial needs and an investment’s to further a charity’s goals while also impact on society. producing some financial return for the The Social Investment Business Group is charity. If a charity can show that an made up of a charity, the Adventure Capital investment is a PRI, it is not bound by the Fund, and a social enterprise, the Social principles or laws that apply to traditional Investment Business. The Social Investment financial investments. Business is one of the United Kingdom’s The Scope Bond is a £20 million bond largest social investors, having made over programme initiated by Scope, a U.K.-based 1,300 investments in civil society organisa- charity that works with disabled people and tions ranging from £5,000 to almost £7

million. SIB invests in viable, non-bankable individual income tax liability, as well as projects. Most of the current capital being relieving the income tax burden on dividend invested is from government entities. income. Social Finance Investment Intermediaries Venture Philanthropy Funds are funds attract money from social investors and use it that work to build stronger social purpose to make direct investments in social ventures. organisations by providing them with The Social Return on Investment (SROI) both financial and nonfinancial support to is a principles-based method used to account increase their societal impact. The venture for the social, environmental, and economic philanthropy approach includes both the value of an organisation’s outcomes. It helps use of social investment and grants, thus organisations determine how to measure targeting below market rate returns. ■ value and forecast social returns. The Social Stock Exchange’s aim is to become an FSA-authorised and regulated investment exchange for trading in securities of social enterprises and other social purpose businesses. The targeted sectors are smaller, high-growth companies in the health, educational, and environmental markets, including social and affordable housing, social transport, green and ethical consumerism, clean tech, green-tech, waste, water, recycling, regeneration, education, public health, sustainable forestry and organic agriculture, and ‘base of the pyramid’ interventions. The Stewardship Code, published in July 2010, outlines how institutional investors should disclose their engagement and voting policies, with the aim of fostering effective dialogue on governance issues between investors and listed companies. The U.K. Sustainable Investment and Finance Association (UKSIF) is a membership network for sustainable and responsible financial services in the United Kingdom. The organisation promotes responsible investment and other forms of finance that support sustainable economic development, enhance quality of life, and safeguard the environment. The Venture Capital Trust (VCT) is a tax incentive that allows investors to offset 30% of the cost of shares in a VCT against