Morgan Stanley and the California Public Employees Retirement System (CalPERS) have taken important first steps to institutionalize a role for capital that, above and beyond maximizing financial returns, includes delivery of measurable, positive social and environmental benefits.
The importance of the developments cannot be understated. Morgan Stanley is one of the largest wealth management companies in the world, with over $1.7 trillion in client assets. CalPERS is one the largest five pension funds, with over $235 billion in assets.
Morgan Stanley made a big splash back in April when the firm unveiled its “Investing with Impact” platform. The platform includes a broad range of options for clients, from negative screening for “objectionable” companies; to positive screening where proactivity on Environmental, Social and Governance (ESG) issues creates value; to investment in sectors targeting specific benefits; and finally to “impact investing”, or the participation in funds “focused on providing capital directly into private enterprises structured to effect positive social or environmental change,” according to Audrey Choi, Morgan Stanley's managing director and head of Global Sustainable Finance, and Hilary Irby, executive director and head of the Morgan Stanley Investing with Impact Initiative.
But something was missing from the announcement: this is just the beginning. Big decisions are still being evaluated, particularly with respect to the impact investing piece of the puzzle. A commitment to measurable social impact can come with a variety of challenges, not least of which includes relatively untested financial performance. How will the firm prudently offer impact investing products to customers with diverse needs? How will the firm provide access to funds large enough to absorb significant sums of capital while still being demonstrably and meaningfully impactful?
The first question is a matter of client interest. According to Irby, Morgan Stanley’s platform is initially focused on broad market products that offer a risk-adjusted market-rate return. However the firm is considering a number of options for customers interested in a more focused investment thesis or willing to make financial trade-offs for social or environmental impact. For these clients, Morgan Stanley is weighing a customized approach to matching investments and values, likely carving out small parts of a portfolio for targeted impact investing, and is evaluating donor-advised funds as a logical place for impact investments that offer a concessionary return.
The sequencing here is especially important for Morgan Stanley, which is why the initial emphasis is on educating advisors and clients using more familiar terrain. With impact investing they are taking a deliberate approach.
The second question is about product selection. Funds in impact investing tend to be younger, with limited performance track records, shifting the emphasis to the prior experiences of key managers. And funds are smaller, limiting the amount of capital that Morgan Stanley can deploy at any one time, for the same amount of due diligence. Morgan Stanley is committed to finding products with a track record of performance and the scale to invest a sizable amount of capital, but is being challenged by a process that requires additional creativity, time and effort.
At CalPERS, the System has quietly launched a new Targeted Investment Programs unit, consolidating efforts to deploy capital in a manner that supplements excellent financial returns with positive, ancillary social benefits.
With a focus first and foremost on opportunities for investment out-performance – consistent with fiduciary obligations to over 1.6 million California public employees and retirees and 3,000 employers – the unit’s responsibilities include:
- Coordinating all CalPERS in-state investment initiatives designed to earn a market rate of return and boost economic development locally;
- Implementing the System’s “emerging manager” programs and strategies, which are investments in relatively new or minority- and women-owned intermediaries.
The CalPERS strategy is one of the most concerted initiatives in the United States, but it is far from exceptional, as the recent report Impact at Scale makes plain.
Just last month the Indiana Public Retirement System issued an RFP for a third-party manager of $150 million in private equity capital pursuing opportunities with funds and businesses with a significant “nexus” of activity in Indiana. The Colorado public employees pension system issued a similar RFP targeting in-state investments in March.
While global markets become increasingly borderless and faceless, the developments at CalPERS, and in Indiana and Colorado, demonstrate that capital has a home and a value that is less anonymous than it once was.
Impact investing is surprisingly prevalent in mainstream capital markets. To be sure, the term itself makes many investment professionals nervous, mired as they are in the view that, by definition, even half an eye to creating ancillary social benefits undermines financial performance. The emergence of new terms that demystify and discredit this notion is welcome. This framing includes “investing with impact” and investing with a “nexus” to a place, as described above. Another important recent contribution is the Bridges Ventures idea that financially-driven impact investments are better described as “thematic”.
Whatever the lexicon, the case for impact investing in the halls of Morgan Stanley and CalPERS is unmistakable: Impact investing is likely to be difficult. It may even be costly, requiring the support of dedicated internal resources. But it is prudent and it is worth every dime. Clients are demanding it. Fund beneficiaries, and their communities, are counting on it.