With more than a decade of experience in impact investing, what has motivated you in your ongoing work?
John Goldstein: Early in my career, I had spent quite some time observing what initially seemed like very different worlds: one, a set of investors that was using market mechanisms to invest across the asset class spectrum, and the other, folks who were looking to solve social and environmental problems, but were increasingly realising that philanthropic aid grant capital wasn’t enough. It was two worlds with interesting potential to collaborate, but which spoke very different languages. There really was both a need and an opportunity to bridge this gap.
Taylor Jordan: I’d add that whenever I’ve looked at the scope of the challenges we face, whether environmental or social, I’ve always felt that the rigour and scale of investment capital, alongside philanthropy, can help put a dent in these issues. And that’s why I believe in ESG and impact investing.
ESG and impact investing can mean a lot of things: there’s socially-responsible investing (SRI), there’s ESG, there’s investing with purpose, there’s values alignment. Tell us a little bit about the taxonomy.
Goldstein: This is one of the really essential points, which is parsing the word cloud and understanding that there are different disciplines that are implemented in different ways. We really divide it into three core disciplines. The first is values alignment, which is about asking: “How does an investor get their values reflected in a portfolio without affecting the financial characteristics?” In liquid markets, it’s really a matter of optimising units of alignment per incremental unit of tracking error relative to a standard benchmark.
The second is ESG integration. Whereas values alignment seeks to ensure that the impact of these considerations on investment returns is minimised, ESG integration is the opposite, asking: “How do I find a thoughtful investment manager that integrates ESG factors in an effort to outperform their peers and their market benchmark?” It’s about finding ways that ESG considerations can represent a material advantage to potentially drive outperformance in active strategies.
The third bucket is impact, which focuses on how investors can have more of a direct, measurable impact on the things they care about. This generally occurs in private markets, with strategies that have both an investment piece as well as an impact component that’s specifically aligned with a number of measurable and meaningful environmental or social outputs. Above all, it’s important to remember that all three buckets of “ESG investing” are simply “investing”, and not a special case.
Focus on ESG and impact investing has increased significantly. What are some of the drivers of this?
Goldstein: It’s a sea change that’s really accelerated markedly in the last 18-24 months, and I think it’s the intersection of three factors that feed on each other. First is the growing awareness that considerations that may once have sounded like idealistic, nonfinancial concerns may in fact be material to performance. Resource efficiency, for example, which did not seem investment related a decade ago, now seems like a fairly commonplace consideration to have as part of an investment process.
Jordan: As investors increasingly recognise that ESG factors could be material to financial performance, we’ve really seen a shift away from simply using negative screens to remove stocks from a portfolio towards fully integrating ESG as part of a holistic approach to investment management. This has helped attract mainstream capital in situations where investors are simply looking for quality investments, whether they’re expressly ESG-aware or not. And I think large financial firms, as well as SRI firms, are taking note and starting to respond by thinking more about ESG issues and developing their own products in this area.
Goldstein: The second factor we’ve observed regards consumer preferences, particularly of the millennial generation. They believe the financial thesis, but they also have a personal values thesis that motivates them – whether it’s who they work for, what they invest in or who they invest with. It’s a fundamental factor driving an ever more influential generation.
The third factor is growing stakeholder interest. Whether it’s public pension plans, foundations or nonprofits, their stakeholders are increasingly asking if they are thinking about these issues.
Some investors run into obstacles when first thinking about integrating impact into their portfolio. What is the typical learning process?
Goldstein: People often come to us because they’re stuck. They’re either actively stuck, because stakeholders disagree regarding different mental models, perceptions and understandings, or they’re passively stuck, overwhelmed by the variety of choices and potential entry points.
For us, step one is really about helping them understand the range of tools and disciplines. Investors need to understand the ESG investing landscape across asset classes and mission areas, as well as the variation in breadth and depth of quality managers in the market. When you bring those three things together, a crisp, executable entry point usually emerges, and I think that’s what people need first.
It’s also important to remind investors that this is an investing problem, not a philosophy problem. Dwelling on debates on “does this work” is not a particularly constructive conversation. You don’t ask if investing works; you say, it’s hard and let’s try to do it well. ESG and impact investing is no different.
What are some of the challenges you face when developing a broad and diversified impact portfolio?
Jordan: Some ESG and impact strategies are thematic, which can lead to sector concentrations. There are also some gaps in the market where there just aren’t sufficient opportunities for quality impact investments. But you don’t need to be 100 percent impact from day one. You can start “conventional”, then move into values alignment and ESG. And then, over time, as the market develops, you can really build out a fully diversified impact investment portfolio.
As you construct and manage these portfolios, how do you measure the impact they’re having?
Goldstein: Impact can be assessed at various levels, from a portfolio level to an asset class level, as well as to an underlying manager level. All of these are important. First and foremost, clients want to see their full portfolio progress towards what they care about. Within an asset class, they want to understand the capital efficiency of different capital tools to create certain environmental or social outputs. And then they want to know how managers are performing on impact metrics. This all goes into an annual impact report that needs to have the same rigor and robustness as financial reporting.
There seem to be two broad categories where investors can have an impact: people and planet. Can you share some examples of investments that you’ve made in each of those categories?
Jordan: In the people category, we look for managers and companies that are serving low-income populations in both developed and emerging markets. Initially these populations at the base of the economic pyramid need basic financial services, but there is also huge demand in adjacent areas like insurance, housing, etc.
On the environmental side, we made a number of investments in alternative energy, both in private equity as well as in real assets. Where we’re seeing real growth is in areas such as solar development, where the price point has come down such that it has become much more competitive with traditional fossil fuels, and there is the potential to drive real financial value.
Local expertise and know-how is presumably of paramount importance for such investments.
How do you think about evaluating impact managers in private markets?
Goldstein: As with anything in private markets, really good manager selection is absolutely paramount. For us, the common denominator is high-quality teams and focused strategies that can pass the full rigour of investment and operational due diligence, as well as engage in an institutional reporting and monitoring regime. It is important to look at teams and strategies that have a strong focus that correlates to a measurable social or environmental output. We look for where the investment thesis and the impact thesis are in sync with each other; it could be jobs created for low-income communities, megawatts of clean energy generated, land and forest preserved or restored – a whole list of very specific, quantifiable metrics that are material to the investment strategy.
Jordan: Evaluating impact managers looks a lot like evaluating conventional managers. If impact managers pass muster relative to the same criteria that guide regular selection, then we’ll invest in them. And if they don’t, we won’t. That said, many ESG and impact managers are younger and have less-established track records. This necessitates additional due diligence to understand the team and the strategy, as well as the operational risks associated with these managers.
Over the next five years, what do you think will be the biggest trend that we’ll see in ESG and impact investing?
Jordan: We expect ESG to continue to go mainstream and, over the long term, we think ESG will be fully incorporated into the investment due diligence process.
John Goldstein is a Managing Director at Goldman Sachs Asset Management, based in San Francisco. He co-founded Imprint Capital Advisors, a leading institutional impact investing firm acquired by Goldman Sachs in 2015, with Taylor Jordan in 2007 to help foundations, families and financial institutions create and manage impact investing programmes and portfolios.
Previously, he co-founded Medley Capital Management (MCM), a private investment firm, and before that he was a management consultant at Andersen Consulting (now Accenture). John has been an advisor or board member to a diverse set of organisations in the impact space, including the US National Advisory Board (NAB) of the G8 Social Impact Investing Task Force, the Global Impact Investing Network’s (GIIN) ImpactBase initiative, McKinsey’s working group on Social Impact Bonds, and the UN Capital Development Fund.
Taylor Jordan is a Managing Director at Goldman Sachs Asset Management, based in San Francisco. He co-founded Imprint Capital Advisors with John Goldstein in 2007 and, in his capacity as CIO of Imprint, designed Imprint’s investment programme and chaired its Investment Committee. Previously, he served as Director of Investments at RSF Social Finance, a San Francisco-based social finance organisation, where he oversaw capital markets and designed and managed a multi-asset class impact investment programme. Prior to impact investing, he served as the Executive Director of a nonprofit membership organisation and co-founded a multimedia technology company. He received a BA in Economics from Colorado College.
This article is sponsored by Goldman Sachs Asset Management. It originally appeared in Private Equity International's Responsible Investing Special supplement, published February 2016.