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Impact investing: scaling with integrity
As the popularity of impact investing grows exponentially, maintaining standards is key, says Nuveen’s Rekha Unnithan.
What does impact investment mean for Nuveen and how does it fit within your broader investment strategy?
We define impact investment as the intentional investment practice of creating both risk-adjusted financial returns and measurable social and/or environmental outcomes. The focus of our impact investments in private markets is in private equity and real estate where there are significant capital gaps and where we believe we can actively invest in solutions to benefit people and the planet.
What investment themes are you focused on?
Our three thematic areas for impact investment are affordable housing, inclusive growth and resource efficiency. Affordable housing is a real estate strategy that’s focused on preserving affordable housing stock in the U.S., keeping rents affordable for existing tenants and implementing energy retrofits, for example. The idea is to provide stability of housing for the working American.
Inclusive growth is a private equity strategy. It is global in nature. We invest roughly half our capital in emerging markets and half in developed markets. The thesis is that low income customers are paying customers and that those customers are underserved. We look at areas like financial services – credit, savings, insurance, remittance – and find companies that are exclusively targeting that low-income demographic. The products need to be designed differently. The approach to customer acquisition needs to be tailored. But we believe these are profitable and sustainable business models that can have significant inclusive benefits.
Resource efficiency is a private equity investment practice, focused on bringing efficiency to value chains in multiple sectors from real estate and agriculture to manufacturing. It can either involve companies providing services to those value chains or disrupting the value chains themselves. It may be investing in companies improving energy efficiency in buildings, for example, or it may be about reducing waste.
How have the U.N. Sustainable Development Goals (SDGs) helped frame your investment approach?
We were investing for impact well before the SDGs were created, but many of the areas that the SDGs have identified as being important for investors and stakeholders to consider, are closely aligned with the investment areas we have chosen. Affordable housing fits nicely with the SDGs around sustainable cities and climate action. Inclusive growth fits nicely with reducing inequalities and eliminating poverty. Resource efficiency also fits with climate action because of the focus on waste reduction and CO2 emissions reductions in the metrics. Resource efficiency is tied to the circular economy and responsible consumption as well.
We also make investments in healthcare and learning outcomes, which marry with the SDGs too. This has been our approach since before the SDGs existed, but investors increasingly want to see their impact quantified in the context of the broader SDGs and our strategy translates very well.
How has your underlying investor responded to your impact strategy and has this changed over time?
Our primary investor today is our parent company, TIAA, a provider of financial services for non-profit organisations, and we are in active discussions about our portfolio with other long-term potential investors. We have built the portfolio over eight years and invested a little over $1 billion, and TIAA’s attitudes towards the portfolio have been positive. You have to remember that when we started to invest in this deliberate way, there was very little evidence that it would work. At that point, impact investment was just two years old. We were very much asking our investor to place their trust in us.
As a result, the investor was focused on process as much as on outcomes. They wanted to know what our approach to deal selection, risk mitigation and underwriting would be. To an extent, those conversations have now evolved because we have been able, not only to deploy capital successfully, but to quantify the investment returns, and more importantly the impact returns that have resulted. Those are all trending very favourably which means the underlying investor is bullish about the strategy and is deploying more and more capital each year.
So, what is your approach to investment decision-making and what are the challenges associated with assessing impact potential?
We have created an impact investment management system, internally, with the help of our ESG and sustainability colleagues. This gives us a roadmap to follow on an investment by investment basis, and also at a portfolio level. We have set portfolio level impact objectives, articulated our theory of change and considered what does, and doesn’t, qualify in each thematic. It’s very easy to say something is impactful based on gut feeling, but you need that management system to support consistent evaluation.
We try to quantify the depth, scale and risk of impact for every prospective investment. Each company will be different. A more mature company with an established product may have low risk and simply be looking for capital to scale impact. Another earlier-stage business may be entering a market that doesn’t have evidence of impact delivery. There the impact risk will be higher, but the depth of potential impact will also be higher, because the opportunity is completely untapped. Articulating those dynamics is important for investment decision-making and we are in the process of translating that into a scoring system.
That all happens at the outset. If a deal is approved, we will then typically take a board seat where we will be highly vocal about impact metrics and ensuring they are material to the business. If we invest in a company with a view to reducing waste, we will want to know the number of tonnes that have been diverted from landfills, for example. We do not think these considerations should be in any way distinct, or separate, from core business metrics. The company should be measuring them anyway.
What role does impact play in your preparations for exit?
Impact is integral to the way we think about exit. Typically, we buy multi-family properties in order to keep affordability levels in place, for example. But how can we be sure affordability will be preserved when we sell? Sometimes you can just have a long-term deed restriction that prohibits anyone from raising rents above affordable levels. That means that you are looking for an aligned buyer that knows that the existing business strategy makes sense. In other situations, you may be able to get government subsidies that enforce long-term affordability as part of a trade-off for tax abatement, for example.
This would ensure affordability post-exit and so is a failsafe method for preservation. With private equity, the science is a little bit less exact. When we first entered this area, we were concerned that a big bank might come in and buy a low-income product portfolio and change the business model. But the reality is that doesn’t happen. If a big bank is buying a financial inclusion lending company, it is because it wants access to that customer and so there is no incentive to mess with the product base. We also sometimes exit into the public markets, in which case there is a whole set of governance standards to monitor the company’s sustainability over the long term.
How do you approach balancing financial and impact objectives?
We only do investments that meet both. We do not look at investments that have the potential to generate fantastic returns but that may, or may not, have a positive impact. That’s not our remit. We will only invest in companies that have a clear impact thesis. But if that impact thesis does not translate into the financial returns that we need, we will walk away as well. We are extremely disciplined on both fronts.
To what extent have the SDGs helped to create a common language around impact, and to standardise impact measurement?
The SDGs have definitely given practitioners like us an additional ability to articulate what we have already been doing. But there is an argument that they may even have caught on too much from a marketing perspective. Everyone now has them integrated into their marketing deck.
In fact, I believe that the impact investment market is at an inflexion point regarding scaling with integrity. It is something that is really important to me personally, as well as to Nuveen. I am involved in an industry initiative to create a series of principles that define what is, and isn’t, an impact investment process, for example.
It provides a framework to help investors evaluate impact managers around diligence, underwriting, ESG standards, measurement and exit. It also demands third-party verification that can in turn offer investors comfort as they look to deploy increasing sums of capital in this area. I think this type of standard is absolutely critical.
How do you expect impact to evolve as an industry?
We are now hearing about billions of dollars moving towards impact, which is great. But I do think we need to be humble and to recognise that lots of problems cannot be solved purely in this way. Governments, or public sector stakeholders, really need to address these issues. Climate change, in particular, is not going to be solved through investment alone.
I also think that impact investors should consult more with universities and other research organisations about how we can make these vital changes effectively, to ensure that investment decisions are based on evidence and that our investment activities actually do have an impact. You need to know what the problems are and then go back and measure if you are actually making a difference. Just pushing dollars is not, in itself, a mark of success.
From PEI’s A to Z of impact investing, December 2019.