The new IRR - 4 ways to define impact

blog - July 2016

The new IRR - 4 ways to define impact

Last year I posted a blog called “The new IRR - Impact, Risk and Return”. With almost 900 viewers, this blog is my best read post to date and triggered many enthusiastic reactions. In essence, I advocated a new IRR: looking at every investment taking into account its Impact, Risk and Return.

Yvonne Bakkumblog originally posted on LinkedIn

Since then, this same point of view was eloquently expressed by Sir Ronald Cohen at PRI in Person 2015, the largest responsible investing conference of the year. He described the 19th century as the era of investors seeking return, the 20th century as the time when the risk component was added, and the 21st century as the time that impact became relevant.

This year, what strikes me in many discussions about impact investing are two things: 1) the non-specific approach to impact and 2) the apparent notion that the market would need one definition of impact investments. 

How can it be that everyone appreciates that each investor has its own return targets and its own carefully defined risk appetite, whereas impact should be defined as one generic concept applicable to all investors? It is just not that simple and to be honest nor should it be!

Let me share with you some of the many inspiring examples of impact investing I’ve seen, all quite different: 

  • By choosing a specific sector like renewable energy a Danish pension fund contributes to a cleaner environment and the mitigation of climate change, improving access to energy in emerging markets in one go. 
  • By targeting a specific theme such as poverty alleviation a large Dutch pension fund considers various sectors that make sense. Education is an obvious choice, but also healthcare or again access to energy can give people better chances of improving household income.
  • Job creation is a good example of an output target associated with impact investments: one decent job can often make the difference to an entire family. In fact, jobs are the major channel through which economic growth uplifts the poor. Of no less than 60,000 poor men and women in the World Bank’s and Gallup’s “Voices of the Poor” survey, 70% believe that a job is the best way to escape poverty. For those who debate broad definitions of impact investing and wish to narrow it down to social enterprise only: think again before discarding the enormous effect of ‘just’ job creation. 
  • Investment outcomes, though less easily measured, are very inspiring and provide obvious linkage to specific charitable goals. A Dutch family foundation focuses on the empowerment of vulnerable children, enabling them to take control of their own future. 

Real impact is the positive effect of outputs and outcomes: happier and healthier people with more opportunity.

These examples illustrate that an investor can choose between sectors, themes, outputs and outcomes in order to have a positive impact on people’s quality of life. So in essence four ways to define impact. The additional layers of asset classes and geography add complexity to the impact puzzle.

The apparent complexity of impact investing seems to block many investors from getting started. These investors miss out on a substantial opportunity set. Not only the opportunity to have an impact, but also the opportunity to improve portfolio diversification and discover new investment products and markets. And the opportunity to engage their staff and stakeholders with a new inspiring aspect of investing.

Keep it simple, be inspired, get started!

If you are a professional investor who is serious about impact, decide what type of impact you want to realize, how you are going to measure it and – ideally – against what benchmark you will evaluate the impact results. Targets, measurement and benchmarks, familiar concepts when looking at returns and risk – and not so familiar yet when looking at impact. I have learned that the more advanced impact investors are not necessarily the more detailed in formulating their impact targets! Keeping things simple is a key success factor, and each investor should decide for itself what the critical components of its desired impact are.

All considered, I am convinced that setting impact targets adds value to any investment portfolio. That simplicity of impact targets helps quality. And that the new IRR makes impact a key investment consideration highly particular to each individual investor - just like risk and return, and even more inspiring ;-) 

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