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On-Demand: What ESG & Impact Investing Mean for the Alternative Investment Sector

Jul 15, 2021

We discussed the latest developments and trends in ESG and impact investing in alternative investments.


Ana Hung:Good morning, good afternoon, and good evening to all our friends that are joining us today. I'm Ana Hung, a tax partner in the financial services group. I'm delighted to welcome you to today's program. Our topic of the day is ESG and impact investing in the alternative investment space.

Here at Eisner, we're committed to provide education to all our clients in regard to ESG, ESG policy, and practices. This webinar is part of our ongoing effort to provide assistance in this very important matter. Joining me today are my special panelists. Deborah La Franchi, CEO and president of SDS Capital Group, Josh Tanenbaum, managing partner of Rebalance Capital, and Allison Yacker, partner and co-chair of investment management and funds at Katten.

Before we begin, I would love to take a minute to set up the stage and define what I understand and what I know about ESG and impact investing and reshape my concept around what we learn from our experts. So what is my take on ESG? ESG is all about the measurement, the monitoring, validation, and verification of a lot of the works or claims that portfolio companies, funds, and maybe investors are making. We know that corporate responsibility has been out there for quite some time, even before some of us were born, even myself. And ESG is becoming a very, very hot topic since the 1980s.

Now, what is the acronym for ESG stand for? The E stands for your environmental. What is it on the environmental side? Your green energy, your environmental friendly people, your pollution, climate change, and others. The S stand for the social aspect, such as diversity, equity, and inclusion, which is a very, very hot topic, very important topic nowadays, employee relationship, and labor. And the G stands for governance, such as board of directors, quality of management, the SEC for example, conflict of interests, among others. Governing conservation has become very, very prominent in the investment landscape nowadays, and you will see why this plays an important factor in ESG.

Impact investing on the other hand is no more than an investment strategy that targets to achieve a special social or environmental benefit in addition to your typical financial profit. So the point of impact investing is to use money or investment capital to achieve a result. What kind of result? A positive result. In where? In your environmental, in your social aspect, using the overall governing guidance that we have. As you can see here, the whole acronym, the E, the S, and the G, are interrelated most of the time, or I can say always. Now, my 1 million question to you, Allison, Debbie, and Josh, from your point of view, can you tell me what is exactly ESG and impact investing and why is it such a hot topic nowadays?

Allison Yacker:I'm happy to take a stab at answering this. The good news is there is no precise definition of ESG investing. From where I sit, it really refers to a universe of investments based on an overall ESG performance, which is generally derived by using either internally developed criteria or third-party ratings. And those criteria and ratings are a guide to already existing research and your investment thesis. So in other words, there's no screening when you were talking ESG. We don't simply, I think, rule out things that don't fit our personal values or otherwise fit our mandate from an ESG perspective. Instead, we use these ratings as part of our overall investment thesis to drive a particular result. I think we already covered what the E, S, and G stands for, so I'll go to why I think this is such a hot topic right now.

As it relates to the E, I think BlackRock said it best. In a recent article, they said climate risk is investment risk, full stop. And I think that's a real signal that my generation, certainly the generation before, and even the older generation of the financial industry is finally becoming aware of the fact that climate risk is an undeniable risk for everybody, and I think a lot of investors are looking for companies to be stewards of nature in that regard and avoid investing in companies that don't adhere to appropriate policies and procedures with regard to climate risk.

As it relates to S, social, I mean, it's gotten easier to answer this question now, seeing where we are in the American landscape. I mean, this is a very divisive time in American history, and I think that consumers are looking to companies to take a much more public stance on some of the salient issues that have arisen, whether it be diversity inclusion or the like. And with regards to G, governance, I think there's been a lot of studies that show that diverse boards categorically perform better, but the paradigm shift has been incredibly gradual. Where does the G come into play? Well, I think this is finally an investor base and a consumer that's looking to expedite the process to see more diversity on boards and hold boards more accountable. Josh, what do you think? What does ESG mean?

Josh Tanenbaum:Yeah, I think you actually said it quite nicely. I'd expand the governance part of the conversation beyond just board diversity into thinking through things like compensation, and linkages, and incentives to drive company performance relative to top management, because there has been a division where banks have performed poorly, yet somehow their CEOs get massive paydays. I think that's certainly a part of that conversation. I think if I were to summarize, I guess, the distinction from ESG versus impact, it is, perhaps oversimplified, a function of inputs versus outputs. So the inputs being in your investment process, I'm looking at this deal, let's call it within the private markets realm. Let's say I'm looking at oil piping or downstream thinking through something to the effect of, I guess, oil mining and BP's oil spill and things like that. If I'm looking at that deal, is that ultimately a sustainable enough company or deal that's ultimately going to ensure my performance aligned with a financial model?

Thinking about the output side of that continuum. If I'm going to actually look at the deeply fractured wealth gap we have in this country, and I want to create a more inclusive financial universe, ultimately, I'm going to look for tools that enable me to do that. As opposed to thinking about, "Is this deal sustainable and from a risk perspective," I'm thinking about what is the intentional output that I'm creating in this universe to have an ultimately positive position? Debbie, I mean, the impact universe is squarely in your wheelhouse. Do you want to speak to that?

Deborah La Franchi:Yeah, and it definitely is. When you look at the impact, as you said, it's the output that you're seeking. And for SDS Capital Group, the output we seek is to really reduce poverty in a community, particularly communities of color. And so impact investing, while our operations really encompass ESG and how we operate as a company that's embedded by being an impact fund manager, we're really looking at is this investment positively impacting this distressed community? Typically, we're investing in communities that have poverty above 30%, so highly distressed. So for instance, because that's sort of ambiguous, what does that really mean?

Well, so we have a fund up in Michigan, for instance, to make it real, and we launched that after the Great Recession. And of course, Michigan was ground zero for being pummeled with the auto industry and such during that economic crisis. Our fund, we had a $60 million fund there, invested in numerous buildings in downtown Detroit which had been hollowed out, buildings that have been vacant for 50, 60, 70 years, bringing them back to life. Part of getting that energy back into downtown Detroit. We have a fund in the south, 10 states, and we've invested in over 15 projects. And to give you an idea, the average poverty rate of the communities we're investing in is 36%. Just staggering. And the communities on average are 81% minority, 51% African-American. So really in today's age, where many corporations, pensions, investors, saying, "How can we have a positive impact on racial equity and poverty?" That's exactly sort of where we're zooming in.

We're investing in Selma, Alabama, a community that's been pummeled over the past 30 years, but it's at the heart of our civil rights trail. And most of the downtown for instance, is boarded up, yet we've funded one of the last pre-Civil war hotels right next to the Edmund Pettus Bridge. And now the 20,000 civil rights tourists who come in and out of Selma each year can stay in Selma overnight rather than blowing through and they can go to go up and spend their money on dinner, go to some of the small shops that we hope will take the boards off their front windows and local entrepreneurs will open up. We're going into shut down one refrigerator manufacturing facility. It shut down in 1990. 900,000 square feet. It is the entire block in San Antonio, and when it shut down 6,000 people lost their jobs and block after block just looks as if almost sort of Mad Max. It's just been boarded up and nothing happening, and we're going to bring back 350 affordable and workforce housing units there, and it's going to have a huge catalytic impact.

Those are the types of things that, that we look at making impact. And most recently we've focused on homelessness. I'm in California and we have over 180,000 homeless. It's a true crisis. I could drive 20 seconds in any direction and there's an encampment. It doesn't matter where you are in Los Angeles. And it's costing 500,000 to a million dollars to house a homeless individual in California, to build it. Mostly taxpayer subsidy. And we're using private equity. We've raised 130 million, and we are funding units of housing and apartment buildings that are costing 200,000, and providing our investors with the risk adjusted rate of return, using a private sector model, rather than a tax subsidy model. We're not tapping any public sector funding for land or construction, so it's a completely different way of looking at the most impoverished individuals in our country, those who are living on our streets, and how do you bring capitalism and private sector and not just rely on government subsidies because there's just never enough? So those are just examples of how, in our narrow impact industry, real estate going into poor communities, we're using private sector capital to make a difference.

Josh Tanenbaum:One quick thing I just want to piggyback on Debbie's point. What you heard was a mission for all these traditional investors that may be on the line. But in reality, you can think about it the asset class being distressed investing, whether it's private equity or real estate focus. So impact investing is not an asset class. I just want to dispel that quickly. Largely what we're doing is taking a thematic lens, applying proven traditional models to them, and basically thinking through a much more complex ecosystem, because you're dealing with deeply ingrained social systems, and figuring out how to bring the right parties to the show to ultimately create the outcome you want to see. So I think Debbie did a brilliant job of outlining examples, but just to quickly center the conversation in terms of how we think about impact investing.

Deborah La Franchi:Yeah, that's really true.

Ana Hung:Well, you guys did a great job. You guys did a great job defining your point of view on ESG and impact investment, and really, truly shaping what I think about that. Well, now that we have a very good understanding on ESG and impact investing, what are the typical trends that perhaps Debbie, Allison, and Josh, you have seen in ESG and impact investing?

Allison Yacker:I can speak to a very macro one, which is the spectrum of intentionality that I've seen over the course of my practice, where however many years ago, there was very little direct intentionality, and instead people avoided investments that didn't meet their personal values or other investment criteria that generally corresponded to what I think of socially responsible investing, whether you screened out alcohol or tobacco or the like, and just moving across the spectrum of intentionality towards B, benefit. That's where I see the greater majority of my hedge fund and many private equity fund investors now sit, where they're using ESG criteria in developing their overall thesis with the goal of driving benefit, but their primary intentionality. And I like the words that Josh, is not benefit. Instead, that really is where impact comes into play. I've seen a proliferation of impact funds over the last three years, which has been so great to see, and I'm hoping that the continuum keeps shifting in that direction.

Josh Tanenbaum:I'm going to pick up right where Allison left off, which is the proliferation of impact managers. I'd say five, 10 years, we've seen that proliferation, but it's actually capped out. You have these $200 million asset managers that have just sit there on their private market space and they don't achieve any greater scale until four or five years ago. Four or five years ago, you started to see this really start to kick off, and you see your TPGs raise $2 billion fund off the bat in partnership with Bono. You had Bain Capital raise a $400 million initial fund. You had folks like Partners Group come into the play. And lately you're seeing your Blackstones and your Apollos, as of late, participating in this community.

And just to give you a sense of size now, TPG is about to go out and raise a $7 billion fund dedicated to climate. It is an impact strategy. And that would put them at a $12 billion standalone asset manager, which is bigger than most private equity firms that are mono line. So I would say we've truly started to click on the mainstream here, and I would say the accelerant over the past year and a half, two years is really the rise of social consciousness beyond consumers and mission-driven organizations. You could attribute it maybe to COVID, you could attribute it maybe to BLM, but we are seeing more money poured toward black and brown communities, whether it's individuals that are running businesses and just trying to distribute wealth more equally, or it's actually the beneficiaries of the businesses that they are building a product for. And I think if you think about the way students are learning in a COVID environment, that jumpstarted the ed tech market. The ed tech market is largely traded lower than it has today. If you look at evaluations on a multiple basis, you're seeing cash being poured into this, recognizing not just the future of education, but the future of work is being redefined by these remote settings.

I'd say a quick third point, recognizing this is an alternative investments discussion, I do just want to quickly call out the capital markets, because we've seen this evolution in fixed income in particular, in so far as you started with a very green bond centric economy, where without naming banks, one bank could even get their green bond filled without going to another bank. But now we've gone from green bond centricity to sustainable focused bonds, to social KPI linked bonds. And all of these are getting significant calls, in so far as you have a $2 billion affordable housing bond that's getting mass participation and it's no longer a niche product.

I would say by and large, those catalysts are what are really putting impact investing, and perhaps sustainable investing or ESG, into the mainstream. I think I'll say from a manager's perspective, if you are a manager on this call and you are claiming to be an ESG or impact manager, we'll talk about this a little bit later in the conversation, you are likely to receive a DDQ from an ESG perspective that says, "How many people of color or how many women are in the senior ranks of your firm?" Or you're going to look at how reliant are you on carbon resources for energy? You will see a greater deal of scrutiny in this space than you've ever seen before, and that's because the sophistication of the allocators has greatly improved relative to even two years ago.

Deborah La Franchi:I'm going to pick up on Josh's thread there relative to capital, because I do think, from where I sit anyway, capital has changed so much and that trend has really accelerated just in the past 24 months for our firm and what's happening, and the heightened awareness and perspective of wanting to make a difference when it comes to racial equity and poverty in this country has really impacted our firm, as you can imagine. I started SDS Capital Group back in 2001, and impact investing didn't exist as a term. And that was the sole purpose of our firm was to launch impact funds around the country, investing in the poorest communities. Our earliest funds, we were basically educating investors. Only a small sliver of the investment universe was looking at real estate funds that were trying to make an impact, so a lot of what we did was educating.

And really our investor base was 98% banks and 2% foundation capital. I mean, that was it. There wasn't much diversification, fund after fund, that we were involved with. That was the capital that we raised. And just to show you how much that has changed, over the time of COVID we launched our homeless fund in California. We're at 130 million. We'll be funding 1,800 units of housing with that fund. The capital mix is so different and it's because of this trend that's happened. The capital in our fund is 51% corporate investment, private sector companies that are not banks. Banks went from 98% in our earlier funds, they're now 44%. So a dramatic diversification of funders. And foundations are about 5%.

And our next fund, I think, we just had a first close on our Southern fund the other day, the second in the series, and that diversification is expanding even more. We think banks will drop down to 35%. Pension funds are now looking at impact vehicles. We could never even get meetings with them before. That is a radical change for an impact manager like us, and we're projecting about 35% of our capital coming from pensions, 15% from insurance companies. That's one really big trend is that the investor universe that is now looking at impact investing has gone from this small sliver of early believers to this much wider universe of corporations saying, "We need to be part of making a difference."

And that mindset has also transitioned to thinking that impact means below market yields, a haircut on your IRR. That's been a battle for the past 20 years getting rid of that conception that impact is the same as socially responsible investing, and it's okay to take lower returns because you're saving the world. That's not what impact managers today are about. They're out there competing with non-impact managers. You should scrutinize them the same, the same due diligence, underwriting, and as Josh said earlier, we consider ourselves a real estate fund. We're within the real estate category. We're not in some separate little bucket of special things that an investor should look at. Compare us with your other real estate funds. The difference is we're trying to make a difference, but we're hitting those same IRRs as the non-impact funds that are out there.

Allison Yacker: Just one more point on this. I mean, I think what's exciting is I'm seeing the same thing for my investor based clients, but it's really global. And when we've talked to significant institutional and other types of investors around the globe who have come to us, not just asking, I think softball questions, but asking us to look at their internal due diligence policies and procedures and their ESG policies and procedures to see how they can become better informed consumers with regard to the asset management community. I mean, I didn't get a question like that from these big guys until the last 18 months, so I think it's a really good signal that everything you're doing is working.

Ana Hung:Oh, this is very interesting to see from how impact investing is moving from a small population to a bigger, bigger picture. But however, I want to hear for now audience, and I want to run a couple of polling questions to feel what is the consensus out there?

Which asset class is most primed for ESG investment in the next three years? A, private equity, B, hedge funds, C, venture capital, or D, all of the above.

While we wait, Debbie, Allison, Josh, what do you think the answer could be? Can you elaborate on this?

Allison Yacker:Well, I'm hoping it's all of the above. I'm hoping it's all of the above. I have a feeling it will be more venture capital and private equity because they have a longer dated investment thesis cycle. And just psychologically, I could see how investors think and they might be right in thinking so that they can achieve more through those models. But I could be very wrong. That's it.

Josh Tanenbaum:I think from our perspective, hedge funds are a bit of a black box, in so far as what is their actual investment strategy does make a difference. If you are exclusively a public markets hedge fund, so long short or something to that effect, hypothetically, you've already integrated ESG methodologies into your investment practices, or you at least have a preliminary screener integrated. I think that private equity is probably the second most mature of that arena in so far as look how much infrastructure KKR or another type of firm have put around this. I think venture capital is, unfortunately, as a venture capitalist, the place that falls most short from an ESG perspective. And particularly for an impact manager, these are two very different things that require two very different sets of infrastructure. So I think if your question is what's most primed for ESG investment, and we're talking about sustainable investment, I think venture capital probably has the biggest curve to go up so far.

Ana Hung:Is this what you guys were expecting? All of the above? I think so.

Josh Tanenbaum:Yeah.

Ana Hung:All right, so let's do another polling question. I like this. I like the interaction between my audience and you guys.

What percentage of your portfolio is dedicated to ESG or impact investments? A, less than 10%, B, between 11 and 30%, C, between 31 and 50%, D, between 51 and 75%, or E, more than 76%?

So Debbie, what do you think?

Deborah La Franchi:Well, for our portfolio, it's a hundred percent, but we don't invest in it if it isn't in a deeply impoverished community and we have a tremendous amount of upfront review that we do to make sure it fits our criteria for that specific fund. So that's an easy one for us. 100%.

Ana Hung:How about you, Josh?

Josh Tanenbaum:We're also a hundred percent. We don't call ourselves an impact investment firm, but if you look into our diligence materials, we are very focused on ensuring an integrated, mutually scalable business and impact model. I won't speak for the audience. I'm very curious to know what everyone's positions are. And if the choir here can help people get over the line, we're excited to participate.

Ana Hung:Less than 10%.

Josh Tanenbaum:Wow. This panel just became real value add. You should've charged tickets.

Ana Hung:Maybe after a couple of this type of webinar, the result will change. All right. So we have heard about your portfolio, location, and the overall concept, the universal concept of ESG and impact investing. Now, can you tell me, how has the investor's perspective has changed relative to how they view impact investing now compared to years ago?

Deborah La Franchi:Sure, sure. It's been a tremendous change in a very positive way, for sure. As I mentioned, our battle, going back to 2001 when I launched SDS, was the perception. Socially responsible investing was known to people, SRI, and there were some mutual funds out there, but very often many of the products were put out there as, "It's okay to make a lower return if you're doing good for the world." And for many of our investors, that's what they envisioned impact investing. And we called it double or triple bottom line back then. Make money, make a difference. You're going to make a risk adjusted rate of return for your investor, but do good things. But SRI was really ingrained as a concept early on with so many investors. If I haven't walked in our team to pitch a pension fund, we'd almost have to scrub our pitch book for the word impact, or poverty, or anything.

And I felt like we had to not greenwash ourselves. Now you have an issue with firms greenwashing, making themselves look like they're doing impact and green investing. It was the opposite. We had to sort of pretend that we weren't trying to do good things and just look at our returns, look at our team, look at our strategy, and it was a tremendous barrier in certain industries because of this concept that you couldn't have strong returns and strong impacts at the same time. If you had impacts, you had to take that haircut I mentioned. And I think that that has really, really changed over the past five years, and now what you're seeing is that companies, not only is the mindset changing, but they are feeling more of a sense of responsibility to get in this game. Whether it's global warming, whether it's poverty, whether it's racial equity, and to not just sit on the sidelines and think that the government is going to fix it or figure it out.

Because if we take that stand, we're all in big trouble, because they're not going to fix poverty on their own. They're not going to fix global warming. The private sector has to be part of this change that needs to be made, and the private sector is so powerful. I mean, the capital in the private sector, whether it's venture, private equity, real estate, it's a tremendous resource for change if you can harness it. I'm just thrilled with what has been happening more recently, and we feel it in every part of our business. As an example, we have always funded real estate developers. Our real estate funds look for the best developers doing good things in these poor communities and we give them money. This is the first time on our homeless fund, a real estate developer, Hudson Pacific, big national firm, does a lot of the tech industry headquarters and campuses. They invested with us in our fund. A real estate developer invested in our fund because they're in LA, they see the homeless problem, and they said, "We want to make a difference." Kaiser Permanente, we've never had a health care company invest. They invested 50 million in our homeless fund because they said, "We need to change homelessness if we're going to impact health outcomes, so we're investing in innovation." And that's really a mindset change that's happening in corporate America, which is wonderful.

Allison Yacker:I mean, quite frankly, I think people have just become so much more educated on it, and I think, probably to the credit of people like you Debbie, from where I sat when I was working with investors who were considering ESG impacts, socially responsible, I never heard the first term you used with double line. They really thought they would take a loss, and they were worried, quite frankly, to some degree, asset managers, about fulfilling their fiduciary duties. It was never at the forefront, managers weren't educated. And quite frankly, now there are so many ESG resources and metrics available. Almost too many, and I'm sure we'll speak to that a bit, that allow consumers, whether they're individuals considering investment in funds, or funds considering investment in various issuers or companies, as to how they can evaluate a company's ESG efforts, again, whether it's the E, S, or G. I mean, I think there's probably, what, over a hundred voluntary standards or criteria that go just towards measuring climate issues. I think the efforts of the community have really let us do a better job at educating people, seeing that we're going to make money in this and seeing that we can make a real difference.

Josh Tanenbaum:I kind of benchmark this question against history in a way. I think, you mentioned the 1980s, that's definitely a good benchmark around the ESG side of the house. From an impact investing perspective, there really wasn't a cohesive, accepted thesis until much later. And if you notice, that thesis, or the coining in a way, was done by the Rockefeller Foundation, which is probably one of the most impactful organizations in the world. But it is also a foundation. So regardless of how well they define this universe, it is still a foundation that really drove this forward. It's not unsurprising in a world where there wasn't any acceptance of the impact investment thesis that people would think there's a trade-off in money, versus if you have impact that you're trading off returns.

I'd say we have this meaningful evolution where now we've moved past that. We still take the Trojan horse method, by the way, because we know there's still a significant portion of the institutional investor base that doesn't necessarily understand this, and the education hill to climb is too high. So the fact that we're a technology-focused VC with very specific specialties in FinTech, EdTech, and mobility solutions, means that's how we're positioning ourselves first and we are having the impact agnostic of that. But that being said, a disproportionate amount of the community has really come around recognizing there isn't that trade off. I think that is an exciting change of perspective that we've seen in this marketplace.

Ana Hung:Right, so it is a really different environment out there, and everything is trending from nothing to a lot. Now, for fund managers like you guys, where you're at a hundred percent in impact investing, can you tell me, how can you measure the performance on your investment, on your ESG investment, impact investment, and what are the type of key performance indicators you typically see in your funds or in your industry?

Deborah La Franchi:Yeah, I'm happy to start on that one. Monitoring, measuring, and reporting the impacts are central to our role as an impact fund manager, and our reporting is as deep on the financial side to our investors on all the quarterly, annual reporting, on the financial metrics, as the impact metrics. And for us, just to give you an idea, because we invest in a lot of different property types. So we might fund a hospital in rural Louisiana. And on that project, we're going to look at the poverty rates of the community, we're going to look at the patients served, how many of them are low income or extremely low income. We're going to look at, if it's a grocery store we're funding in a food desert, we're going to do the same thing, but we're going to look at those customers and how many of those customers are low income from that community? We have a homeless campus we funded with one fund in San Antonio. We look at the number of individuals served each year and how many of them come out of homelessness, not just that they're given a bed, but they actually move on and transition their lives.

And we also look at the tax implications of the revenue. A lot of times we're investing in buildings that have been vacant for 40, 50 years, old textile mills that get brought back to life with jobs in them and other assets, and we look very closely at the local state and federal tax revenues that will be generated over 20 years. And we literally show the Congress people these in those districts to say, "You should support impact funds, impact strategies in general, because we are creating more revenue for all levels of government." And I think that's another important thing that impact managers, it's always good that the policy makers understand the implications beyond the jobs, or the customers, or the patients being served. And we put all of this in very detailed, we do project by project profiles on the specific impacts, and then we also do the whole portfolio and summary impacts. We distribute that, every quarter we update every project in that fund and it goes out with our financial reporting as well. It's very regular and it's very detailed. And that's what our investors expect as being in an impact fund.

Josh Tanenbaum:I'll kind of articulate a bit more on our diligence side, and then also speak a bit to how that translates into KPIs, because it's actually one linear process. When we start to screen companies, we look to see, do they fit the upward mobility thesis? That's what our fund's about. We are focusing on addressing the upward mobility crisis in this country and beyond. And so when we look within financial services, we have very specific questions or problems we're trying to tackle. Is this increasing lifetime earnings? Is this increasing access to capital? Is this making education more affordable rather than taking on crippling debt? Those are the types of questions we ask upfront in our diligence screen. And then we actually have a pretty robust point system across the board that looks at their capacity to actually have an impact in a scalable way relative to their business model.

And if there is no trade off, or if we think there's no trade off, or limited, then we'll progress the company into actual diligence from our screen call. Once we're in diligence, then we're looking at a multi-stakeholder analysis. We're talking to policymakers, we're talking to customers, we're talking to various types of institutions, just to validate the thesis and to see what we could do as a VC to accelerate this company's growth in light of the problem they're trying to solve.

So ultimately, what ends up happening from a performance perspective, because we are actually so hands-on in our investments, we are catalyzing the company's growth and are basically taking responsibility for a small portion of their top line. And then the second piece of it is the performance that we are reporting from an impact perspective, which are specific KPIs to the original question we were trying to address or the problem we were trying to solve. And we report that to our investors on a quarterly basis. And for us, somehow, we've outperformed, from a performance perspective, even though we have not been in this business certainly as long as Debbie and Debbie is a much more proven commodity, I think in my perspective, we're still hitting 80 plus percent IRRs on our first fund. That gives you a perspective on is there a tradeoff between impact and returns? And our investors are equally excited about our impact performance as they are our financial performance.

Deborah La Franchi:And maybe I'll just add on to that, as I definitely agree with everything Josh said. Pretty much all of our investors, when they're doing their due diligence, they dig into our impact report. It's something that they want to see. They want to see how we've done it on past funds. They want to see how we're going to do it for that specific strategy. In the fundraising process, showing, if you're out there as an impact manager, that you have a really strong methodology in place and you're walking the walk. You're not just talking the talk. If you're a new manager going into this space, it's really central. You're not going to get a free pass on that front if you're putting that impact moniker on your fund.

Allison Yacker:Can I just ask you a question? Are the tough questions coming directly from the investor base or are they coming from consultants retained by the investors? Or a mix?

Josh Tanenbaum:Both. Very much both. Cambridge has had a mission-related investments team, a dedicated unit, to really just dive into both sides of this equation, as has Mercer, as has all of the institutional consultants. But equally, as particularly family offices and foundations become increasingly sophisticated and they have a more personalized mandate, they will ensure they're getting what they need out of this manager to know that they're fulfilling their own purpose. It's a little bit different than just having core tile performance metrics, obviously. What I will say, and where I think we have room to grow, there are certain individuals that would due diligence and they ask their questions just to make sure they're checking off boxes, but if they don't get a perfect answer, they'll be like, "Okay, we'll do it anyway." We are certainly still seeing some of that from our peer group. And so I think it is extra work if you're going to be an impact manager. It's extra infrastructure, it's extra questions, but there's two sides to the coin. You really want, ideally, your investor to be as serious about your mission as you are. Just to give some context, there's two sides to this coin, and the sophistication's there from a due diligence perspective, but I think it's still kind of hit or miss whether that's really going to signal, "Yes, I'm going to deploy," or "No, I'm not."

Ana Hung:Let's go back to Debbie. Debbie, you have a lot of social impact fund. How do you measure those type of metrics to have your successful, a hundred percent, good, excellent impact fund?

Deborah La Franchi:Yeah. The way we make sure we hit 100% is that really, it starts in the origination process for us. For instance, our Southern fund, we have our originators in Atlanta. And on the financial side, he goes out, he visits the sites, he talks to the developer, he looks at the state of the community, blighted, boarded up, and then looks at what's the market? If we build multi-family housing here, he looks at the financial side. What's the demand for this region for low-income or workforce housing? But while he's doing that financial review, we have a very deep assessment that he's doing on the impact side as well. Every week, the projects get brought back to the principles as well as the staff and we vet each project and we dig down to make sure, right up front, is this meeting our impacts? Because it's so much work to underwrite and do the due diligence on a project. We don't even want to go there if the project first and foremost, doesn't meet our impact criteria.

Then if it meets our impact criteria, we bring it to the, we call it just our working group, and the originator presents the project, how it met the impacts, high-level underwriting, before we really do a deep dive. For us, we find that the impact piece is central because we don't want to get to the end and realize we just spent four months on this project and it doesn't meet our impact criteria. It's really a threshold question, and then we look at on the deep dive on the financial side. "Okay. It meets our impacts now. Can it hit the risk adjusted rate of return that we need based on what the risk of this project is?" We really use impacts as a screen to make sure we're not wasting an immense amount of resources on a deal that's not going to hit our thresholds for impact.

Josh Tanenbaum:It's funny, because I see a great deal of commonality, despite being very distinct asset classes, between Debbie and myself. It's still very much a threshold question before we put a lot of resources behind it. I would add, as part of our deep dive diligence, we think a lot about externalities. Oftentimes, you can think of a Toms Shoes example for instance, where there were mixed results in terms of what they sought to do. And when you think about, "Am I really solving for more job creation? What am I displacing in that process?" And that full impact logic continuum is really important, and it's not something we actively report to investors. It's much more for the GP, but we do have those conversations with investors when they say, "Hey, I noticed you did this deal or that deal. Can you please walk me through the analysis you did from an impact perspective and why it met your quotient?" If you go down the rabbit hole of providing the externality analysis as well, you're going to be spending all your time on reporting, but it's something that we do think about as far as our diligence.

Ana Hung:Since a lot of talking about reporting, my next session will be dedicated to Allison. But Josh, Debbie, feel free to chime in whenever you want. So Alison, from a legal standpoint, when a fund is really a hundred percent committed to ESG and impact investing, what are the typical, or the must disclose information in the offering document? And typically, what are the communications that you have seen that needs to be sent out to the investors?

Allison Yacker:Well, fortunately or unfortunately, there are no ESG specific regulatory standards here in the US for private fund offerings. There is some guidance we can extrapolate from public company guidance, such as requirements on how to disclose for diversity efforts and diversity inclusion, but they have very little direct impact on what we can and cannot say in a private fund context. Historically, the SEC's focus, with regards to ESG and investment advisors, has been on how an investment advisor fulfills its fiduciary duty. And more specifically, in the context of ESG, much like other efforts, the regulators are focused on ensuring that all the offering documents and other disclosures have information that represents accurate and adequate information in all material respects about ESG efforts and the risk and reward of each.

Now, I would think that in the coming future, very recently, I think very soon, the SEC will have increased scrutiny on ESG disclosures. The Biden administration has said this many times. Gary Gensler has spoken on this many times. There's been any number of recent developments on this topic. Most recently on July 7th, the asset management advisory committee AMAC disclosed that they'll be forming a subcommittee to come up with recommendations on this topic. So I would say almost weekly there's a regulatory development signaling increased scrutiny on this topic. Generally speaking, right now, my recommendation for funds would be to make sure that your offering documents have all the appropriate ESG and impact investing related strategies accurately described together with appropriate disclosures about the risk and control in place associated with making sure that the representations in your offering documents are adequate. I think funds can be doing a lot to prepare for the increased scrutiny that we anticipate will be coming from regulators such as the SEC in the coming months.

Particularly, if a fund holds itself out as an ESG or impact related fund, I think, as I said earlier, the fund should have in place documented policies and procedures regarding how ESG factors are defined, how they're measured, and importantly, how they're weighed against other investment objectives so that the consumer, the investor, can make an informed decision. And then the fund should address with specificity what the goals are and what the risks are in the fund's offering documents, and have in place due diligence policies and procedures to make sure the representations we're making don't move over time. It's really not all that different than what I tell investors when they're making concrete statements about anything else. Make sure you have files that support the statements you're making to your investors.

Josh Tanenbaum:I think one thing that will be a key catalyst for the space, perhaps it will be a source of increased costs, but perhaps not, is just the Biden executive order, basically, to do two things. One, look at the financial system's climate risk, so working with treasury and the federal insurance office and such to ensure that there is truly minimized climate risk embedded across all of our infrastructure. And that likely will trickle down into fund managers, particularly regulators that are having to deal with it. Again, noting this is speculation opinion. This is exclusively based off of articles written and people with whom I'm engaged. But I would say on the back of this also, Biden did challenge the DOL to pull back, revise their approach to ESG, and basically say to that regulatory body, "You should not be stopping ERISA plans from participating or considering ESG risk factors." So I think we've seen this is an incredibly impacted investment and ESG friendly administration and the trickle down effects that come from that.

Allison Yacker:I agree.

Ana Hung:Debbie, anything to add?

Deborah La Franchi:Yeah. Similar ERISA guidance came out a few years ago that was focused a little bit more on impacts that those did not have to be. In the past, especially the pension fund industry has sort of been a little bit allergic to impact funds, because of the regulations they were under. And so similar changes were made a few years ago that did open the door for the ERISA community to not feel they had to stay away from impacts because that diverted from their fiduciary responsibility, and that was something that we viewed really positively. It does seem that some of these regulations are moving in a direction that supports bringing more capital, keeping it off the sidelines, and allowing it to come into this space and not be worried that they're overstepping their fiduciary boundaries if they take an impact fund into consideration. We're happy to see those changes.

Ana Hung:Wow, this is a lot of insight. I'm sure our audiences are taking notes, making sure that they are compliant and now they'll revise their documents and talk to their attorneys. But thanks for all of this. Just to recap, during the presentation today, we touch upon the concept of ESG impact investing, the trends that you probably have seen in the market, investor focus, performance key indicator. We just talked about legal and regulatory consideration, but there's one point we haven't talked about yet, which is how can ESG investing impact capital raising, and how would you advise a fund manager or general coordinator who wants to commit to ESG or impact investment for the first time as their investment strategy? But before you take this, I want to run a quick polling question to set up, again, the stage for your answer. Let's do a quick polling question.

What is the biggest barrier in implementing ESG? A, dispelling the notion of poor returns, B, regulation, C, lack of standardized reporting and data sets, or D, sourcing a quality investment opportunity?

I mean, certainly all these topics are very, very interesting and we're really having fun with my great panel and the audience.

Wow. Lack of standardized reporting and data set. This is true, because ESG and impact investing hasn't been as popular as it is in Europe. What do you guys think?

Deborah La Franchi:I agree. There's not the standardization, and it's difficult, frankly. I'm sure what we're reporting on our impacts are just so different from what Josh's firm. Sometimes there's this effort to try to put everything in one standard box for impact reporting, and it's quite different depending on what the strategy is, what the outcomes are that you're seeking, and we're a real estate fund. I think that this is an area that's going to just really continue to evolve over the coming years, and there's going to be a lot more pressure on managers to do a very good job if they are in fact out there marketing themselves as an impact fund. And they sort of ignore it at their peril because investors are getting more sophisticated about greenwashing, and funds saying something but not really doing it. I think this is definitely a big area that we'll see continued improvement and change in the coming years.

Allison Yacker:I'm going to jump in because I have to jump off pretty soon, but I would say for asset managers that are considering getting into the space that haven't yet, I mean, you should, for any number of reasons, but not the least of which is that this is where the capital is going. I mean, I'm not going to recite all the statistics on this, but the amount of funds that have been directed towards ESG and impact funds is double, triple, quadruple, tripled over the last two years to six months. It's just been incredible. But that has to be balanced out with a legitimate path towards doing it. We've heard the term greenwashing already. We can't have any more exaggerated claims. We need to stay clean in this space, no pun intended. So if you're going to get into it, you have to really align your personal values with your investing thesis and make sure you have the data to support exactly what it is you say you're going to do.

Ana Hung:Right. Our time is really coming to an end, but before we end, I have hundreds of Q and A in my box. So at least I'm going to take one, and for those that we didn't touch, we will respond to you directly. I think this question is to Debbie and Josh. Many of the ESG initiative are long-term aspect. What is the tradeoff behind short-term and long-term returns, and how are you addressing this with your investors?

Deborah La Franchi:Yeah. So I guess from that, that's a very good question, and when we make an investment, we are looking at the long-term and that those impacts continue. On the other hand, our funds are only in for a very short time as real estate funds. We're providing the equity the real estate developer needs to acquire the land and construct the building and get the tenants in, whether it's a hospital, grocery store, charter school, low-income housing. And once the tenant's in, and the project stabilized, which is usually year two, three, or four, we exit, and there's a takeout. We are short-term money, but we're evaluating the long-term. Is this asset that we're funding going to remain a charter school for the next two, three, four decades? Is it going to remain a hospital? Is it going to remain a grocery store?

We don't really have a trade-off on the shorter long-term. We just have to make sure we know that what we're funding is going to stay that way. And that usually comes into play more with housing, multi-family housing. If we fund a developer to do low income housing, we have to make sure we don't exit and then they bump up the rents to high-income affordability. That's really where we have our greatest risk and we usually put requirements on those developers or really make sure that they're aligned in our mission and have a track record of staying low income rather than bumping up to market rates. But there's not a big trade-off for us because we're already evaluating the long-term.

Josh Tanenbaum:I think similarly, we're a VC strategy. We have locked up capital for duration and we are charged with putting money to work in a timely, but thoughtful fashion, and then for the remaining period focused on harvesting those investments. But it is long-term. You don't get your money back in two years. For us, there is an alignment between the long-term impact horizon as well as the actual strategy itself. I can extrapolate this out to actually a macro context, though. It is a function of what you're trying to solve for from an ESG perspective, so again, a sustainable risks perspective.

When you think about, "Am I going to invest in a nuclear power plant somewhere in California next to an area that is constantly under wildfires?" I mean, that's a pretty short term risk, not necessarily long-term risk, sadly, but you have to think about ESG within both the short-term and the long-term. And if you think about wildfires actually setting off and what that's done for businesses on the ground, that is very much a financial risk as it is an environmental risk. If you want to think about it in the long-term though, similarly, what is going to be the rising tide of water relative to Miami if I'm doing real estate investments in Miami? You do need to think both short-term and long-term. There's ESG tilts that apply to both short-term and long-term. The return proposition and the ESG proposition are in fact aligned if you think about it through that lens.

Ana Hung:Right. Thank you so much. This has been a very, very interesting and insightful conversation. I mean, if we had more time, we'll keep it going, but we are running out of time. A round of applause to my experts, to my panel, and to my audience. Thank you so much for joining us today and I will pass it to Lexi to close us out.

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Ana Hung

Ana Hung is a Tax Partner focusing on private equity funds, funds of funds, venture capital funds, broker-dealers, hedge funds, and management companies where she provides tax compliance and consulting services to the a broad range of clients.

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