Optimizing for impact with private equity and real assets

Plotting the most efficient path to achieving impact 

Traditional portfolio construction techniques can be adapted to create portfolios with impact objectives. 

Measuring impact 

To do this, investors must be clear on the impact they are aiming to achieve and be able to measure it. Perhaps their impact goals align with the United Nations’ Sustainable Development Goals (SDG), as they do at Nuveen. Leveraging the UN’s framework, we have developed our own metric – a net impact score for specific investments and portfolios – that can be used in standard mean variance optimization modelling. 

Other metrics for different impact goals can also be used. Carbon emissions data, for example, can be used for investors with environmental objectives such as net zero carbon targets. 

Solving for impact

Using the appropriate metric, we can solve using mean variance optimization. The solution (illustrated in the figure) is a set of efficient frontiers representing portfolios that maximize expected returns across the relevant range of risk budgets and for every possible level of net impact in our example. Each efficient frontier reflects a unique constraint on the portfolio-level net impact score and gives the set of best possible portfolios for the specified level of impact.

Frontiers on the right have the highest portfolio net impact score, and those to the left have lower scores. Moving from right to left improves risk-adjusted return, but at a certain point (beyond a portfolio average net impact score of 7), allowing for more net impact does not provide any additional return or risk benefit. 

Pursuing additional net impact up to a score of 7 does not sacrifice return or incur more risk – two objections often levelled at impact investing. This tells us that portfolios with certain levels of positive net impact outperform, on a risk-return return basis, less impactful portfolios. Over this range of net impact, investors can make greater contributions to the UN SDGs while also improving risk-adjusted returns.

Achieving impact goals and financial returns 

By quantifying risk-return-impact trade-offs, we are able to do two things. The first is to identify the range of portfolio impact that is achievable without affecting risk-return efficiency. The second is to support the design of portfolios that minimize the reduction in risk-return efficiency required to achieve a targeted level of impact. 

The important takeaway is that impact needs to be evaluated and considered in the investment process with the same rigor and prudence as financial performance. 

By applying an increasingly robust set of impact metrics to a standard optimization modeling framework, investors can evaluate trade-offs across risk-return and impact, allowing them to construct portfolios that optimize for total performance.