Beyond Trade-offs is an ImpactAlpha podcast series, produced in partnership with Omidyar Network, in which impact investors look across the returns continuum at investment strategies to scale capital for impact.
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ImpactAlpha, May 13 – Per the Pareto Principle, most things in life are not distributed evenly. Think the 20% of the customers who account for 80% of the revenue, or the 20% of the bugs that cause 80% of the crashes.
In its near $1 billion impact investment portfolio, Prudential Financial has carved out 20% for investments with the potential for outsized impact.
The Newark-based insurance giant, one of the world’s largest institutional investor with nearly $1.4 trillion in assets, is demonstrating that is possible to incorporate impact strategies within the norms and constraints faced by institutional investors. Prudential’s $860 million impact portfolio is invested with a specific mandate to show measurable benefits in financial inclusion, affordable housing preservation, educational excellence, workforce development and sustainable agriculture and other areas.
The bulk of the impact portfolio, which is part of Prudential’s broader corporate balance sheet, is expected to generate the same kind of risk-adjusted market-rates of returns as the rest of the huge portfolio. These “impact-managed” investments help match the liabilities the insurance company takes on through its policies and get treated by regulators just like any other assets.
But Ommeed Sathe, head of impact and responsible investing at Prudential, has made sure to carve out 20% of the impact portfolio for investments that wouldn’t pass the typical test. Because the “catalytic portfolio” is not used for asset-liability matching, Sathe is able to take on a small amount of additional risk. Returns are expected to trail those of similar assets in the impact-managed portfolio by roughly 150 to 250 basis points (or 1.5 to 2.5 percentage points).
“More creative, more thoughtful capital can be really crucial in unlocking solutions at scale,” Sathe says in Episode Three of ImpactAlpha’s “Beyond Tradeoffs” podcast series produced in collaboration with Omidyar Network. “Having this resource that we can do things that are catalytic, that can change the shape of an industry or change entrenched patterns, is really, really important.”
“When you’re a life insurance company… we are very much thinking about the long-term,” says Sathe. “That actually in some ways allows you to take a little bit of R&D risk.”
Before joining Prudential in 2011, Seethe ran real estate development for one of the rebuilding agencies in New Orleans after Hurricane Katrina. What he saw, and what eventually led him to Prudential, was “how important it was to have the nuance and flexible impact-oriented capital that could really make a difference.”
Prudential’s 80/20 rule is a real-world implementation of a Beyond Trade-offs truism (introduced in Episode One): See the full continuum of capital and be intentional about where you play.
Prudential several years ago made a commitment to grow its impact investing portfolio to $1 billion by 2020, a milestone it expects to reach later this year. Sathe manages Prudential’s impact portfolio with an incredible amount of flexibility for an institutional investor. He invests across asset classes, in the U.S. and abroad. He targets an array of outcome areas including financial inclusion, affordable housing preservation, workforce development and more.
The bulk of the portfolio is made up of larger investments in which Prudential seeks market-rate or better levels of financial returns. In the past, these have included, for example, charter-school lending to help successful operators expand to serve more children. Prudential recognized that strong operations meant lower risks since student enrollment would drive loan repayments.
“Not all parts of the economy lend themselves to an impact orientation,” Sathe says. But “when you’ve chosen the sector right, and there is that strong alignment, then it almost becomes intuitive that doing well from an impact perspective would lead you to do well from a financial perspective.”
In another case, Prudential helped connect some of the job-skill providers it invests in with a new crop of education-finance firms to allow the company to reach under- and unemployed people that otherwise wouldn’t be able to pay for the training. “That has a huge impact value add but also expands the addressable market for these companies,” says Sathe.
To pension and insurance companies, sovereign wealth funds and other institutional investors skeptical that impact strategies can meet their expectations for ‘market-rate’ returns, Prudential’s catalytic portfolio is a way of saying, try it and see.
“In our eyes that’s a little bit lacking,” says Sathe. “Part of what’s necessary are people who are going to make the investments in things that wouldn’t happen if all people had was commercial capital.”
In some cases investments from the catalytic portofolio eventually cross over to the main portfolio, as the underlying business matures, or more data becomes available. In Washington DC, Prudential worked with NatureVest and used its ‘catalytic’ portfolio to seed DC’s cap-and-trade marketplace to help address stormwater runoff from its ‘catalytic’ portfolio. Prudential couldn’t underwrite the storm-water credits from the main portfolio before they priced on the market. Once the market established and there was pricing data, the firm better understood the opportunity.
“That’s something that can go in our main portfolio,” says Sathe. What began as a ‘catalytic’ pilot deal of a couple million dollars became $15 million deals in the main, market-rate portfolio. Says Sathe, “Both portfolios work in symbiosis, and both are crucial.”
In another recent deal, Sathe’s team made a $100 million commitment to Invest4All, an initiative to bridge capital gaps in underserved communities of color in Memphis, New Orleans and Atlanta. The Annie E. Casey Foundation and Kresge Foundation backed the portfolio with $20 million in investment guarantees (Prudential also participated in the risk tranche). The risk mitigation allowed Prudential to move the investment from its catalytic to its main impact portfolio, doubling the size of the commitment Prudential was able to make.
What lies beyond tradeoffs for Prudential is what Sathe calls ‘impact value-add.’ It’s what you do “during, before, and after the investment to actually increase the impact of the types of projects you’re invested in,” Sathe says. That means real diligence around the historic and proposed impact. “We try to work in collaboration with entrepreneurs and management to grow and build the impact side of the business.”
“The great part of so much of the impact investing landscape is that these are complicated sectors, complicated problems, government overlays, different and unusual forms of payment streams that have to be understood,” says Sathe. “If you’re willing to put in the time and energy and effort to understand those markets, we do think from an investment perspective you can generate good returns, if not slightly better than if you were in more of the vanilla parts of the economy.”