Impact Investing. The Future of Investing?

A Holistic Introduction

Seminar Paper, 2017

47 Pages, Grade: 1,0



List of Abbreviations

List of Figures and List of Tables

1. Introduction
1.1. Introductory Words
1.2. Course of the Investigation

2. Defining Impact Investing
2.1. What is Impact Investing?
2.2. Classification & Core Characteristics
2.3. Spectrum of Impact Investments & Case Example Global Warming
2.4. Contemporary Issues & Challenges

3. Framework for an Impact Portfolio
3.1. Organizational Structure
3.2. Impact Mission, Financial Parameters & Impact Policy Statement
3.3. Constructing a Portfolio Target Profile

4. An Approach to Portfolio Modelling
4.1. Assumptions Regarding an Investor’s Utility
4.2. Portfolio Maximization Problem: One Risky Asset
4.3. Portfolio Maximization Problem: Risky Asset Portfolio
4.3.1. Mean-Variance-Frontier, CAL & Two-Fund-Theorem
4.3.2. Modelling the Optimal Portfolio
4.4. Implementation of Constraints
4.5. Conclusion

5. Empirical Evidence on Performance
5.1. Socially Responsible Investing (SRI)
5.2. Impact Investing
5.3. Conclusion

6. Conclusion & Future Prospect



List of Abbreviations

illustration not visible in this excerpt

List of Figures

Figure 1 The Relative Size of Impact Investing

Figure 2 Impact Investing Asset Class/ Return Rate Spectrum

Figure 3 Portfolio Target Profile of a Risk-averse Investor

Figure 4 Markowitz’ Mean-Variance-Frontier

Figure 5 Risk-free Asset and Capital Allocation Line

Figure 6 Shifting the Mean-Variance-Frontier

Figure 7 Inclusion Criteria of the Impact Investing Benchmark

Figure 8 Relative Performance by Vintage Year

Figure 9 Performance by Vintage Year and Fund Size ≤ $100 Mio

Figure 10 Performance by Vintage Year and Geography: Emerging Market Funds

Figure 11 Performance by Vintage Year and Fund Size > $100 Mio

Figure 12 Performance by Vintage Year and Geography: Developed Market Funds

List of Tables

Table 1 Index versus Benchmark Performance: Overview

Table 2 Index versus Benchmark Performance: Regression-based Tests

Table 3 Joint Coefficient-Tests for Different Time Intervals Using a Single Benchmark Index

Table 4 Joint Coefficient-Tests for Different Time Intervals Using World-Wide Benchmark

1. Introductory

1.1 Introductory Words

We have the tremendous opportunity to not just keep pace with traditional markets, but to reinvent them entirely. The decisions we make today have the potential to shift attitudes, transform systems, and build the sustainable economy of the future.

- Amit Bouri, Co-Founder and CEO, Global Impact Investing Network

Throughout the last decades, the global society has increasingly been debating about our responsibility to act in a sustainable and socially acceptable manner, both from a private and a corporate point of view. Over the course of this very discussion, governments, organizations and numerous institutions began to, among others, advocate sustainable energies such as wind and solar power in order to counteract the destruction and global warming of our planet. Since then, also a large part of the companies around the globe have changed their self-concept, moving away from the conception of reckless businesses that are solely being after the maximum profit in everything they do, and striving after the perception of caring yet economically successful enterprises that support both their employees and their (social) environment. As a matter of fact, the so-called corporate social responsibility has become a major aspect on how potential employees or clients assess a company’s value nowadays. And as part of this development many enterprises – first and foremost banks and other financial institutions – have, at least to some extent, adjusted their investing behavior as well, representing social awareness and creating additional value through a wide variety of social and/ or sustainable investments. The concept of impact investing – providing a social value alongside a financial return – has, therefore, become a familiar face in the financial sector and might be a considerable help in realizing global sustainability objectives, e.g. the Sustainable Development Goals of the United Nations.

This analysis imparts a holistic introduction into the relatively young yet comprehensive topic and ultimately investigates the question to what extent impact investing could play a leading role in the future of investing.

1.2 Course of the Investigation

The following is divided into another 5 chapters that are organized as follows: Chapter 2 deals with the definition and classification, but also with contemporary issues of Impact Investing. Chapter 3 provides a general framework for defining and developing a personalized impact portfolio profile, whereas Chapter 4 makes an approach to model the latter while referring to traditional static approaches. Chapter 5 attends to the empirical performance of both SRI and impact portfolios in comparison with “traditional” benchmarks. Finally, chapter 6 concludes and, on the basis of this research, gives a future prospect.

2 Defining Impact Investing

Impact investing is quite a comprehensive topic, can be practiced in many different ways and forms and, therefore, not be easily broken down to a short definition. Hence, this chapter aims at imparting a holistic view onto the wide variety of the subject, including definition, characteristics and manifestations.

2.1 What is Impact Investing?

Generally speaking, impact investments signify investments made into funds, organizations or companies that aim to generate a positive social or environmental impact alongside a financial return, which can be either a return of or a return on capital. As the latter implies, impact investing can be targeted via both nonprofit – yet revenue generating – and bottom-line oriented companies with the desire to extend their business models by a social aspect.

As already mentioned in 1.1, banks and financial institutions constitute a large part of the potential investors, however, there are many other parties practicing impact investing, among others pension funds, religious institutions or even private foundations and investors that wish to align their portfolios with their personal values. Impact investments can be made in both emerging and fully developed markets and are subject to a wide range of asset classes and sectors – from renewable energy via education through to community development. Moreover, there are investment possibilities in sustainable agriculture, fair trade, healthcare, natural conservation as well as in small-business-financing and microfinance.[1],[2]

2.2 Classification & Core Characteristics

There are many concepts in the modern parlance that seem to be quite similar to impact investing, such as corporate social responsibility (CSR) or corporate philanthropy. The former, however, refers to the general orientation of an enterprise rather than solely its investment behavior and can therefore be seen as a collective term for various social practices that include impact investing and corporate philanthropy, whereas the latter denotes actions with no expected return at all (e.g. donations).[3] Impact investing, in contrast, can be viewed as a subsection of socially responsible investing (SRI) which, in turn, is part of CSR and advocates the avoidance of morally reprehensible asset classes or companies when it comes to investment choices. However, despite the fact that we are talking about a rather new form of investing[4], the market has already reached a remarkable size. According to the GIIN’s 2017 Annual Impact Investor Survey, almost 8.000 new investments with a total volume of over 22 billion dollars have been made in 2016, increasing the total volume of collectively managed impact assets to around 114 billion dollars. For 2017, the number of new investments is forecasted to rise up to around 9.500 with a total value of $25.9 billion, which means a 17% increase compared to the year before.[5]

A 2013 graphic from Arabella Advisors – an advisor for effective philanthropy – illustrates the size of the market, based on a 5-10-year projection:

illustration not visible in this excerpt

Figure 1: The Relative Size of Impact Investing

Nonetheless, impact investing is a discrete and well-defined field, distinguished by certain characteristics that have partly already been stated above:

The initial intentionality of investors to proactively contribute to the wellbeing of their (social) environment is a crucial, if not the most crucial, point considering the fact that traditional investors might unintentionally as well support their environment to some extent. Unlike corporate philanthropy, however, it is an investment and therefore geared to generate an excess return or, at least, a return of capital, whereas there is a broad range of both possible financial expectations and organizational forms (further explained in the following chapter (2.3)).

Last but not least, it is defined by an impact’s ability of being measured and the investor’s willingness to give account to the social and environmental performance of the capital under his management, assuring a high transparency especially to stakeholders. Typically, specific objectives regarding social and environmental performance and progress are set and monitored by the investor.[6]

2.3 Spectrum of Impact Investments & Case Example Global Warming

As stated in the previous chapters, impact investing does not only focus on certain, specific asset classes or objectives, but covers a wide range of both possible investment opportunities and expectations regarding financial gain.

Investors have the option to either directly invest into for- or non-profit companies respectively organizations or indirectly via specific funds that are dedicated to impact investing, whereas the variety of possible returns ranges from below-market to market-consistent or even –exceeding[7] and is closely linked to the asset class an investor chooses to target, as the following figure (Fig.2, GIIN) illustrates:

illustration not visible in this excerpt

Figure 2: Impact Investing Asset Class/ Return Rate Spectrum

As we can see, there are clearly assignable asset classes such as private equity investments, whose investors claim an excess return that, at least, matches the market rate of return. Otherwise, in case an investor seeks no or only a slight excess return, grant support might be the best option. However, there are also asset classes that are not unambiguously assignable, for instance guarantees (non-cancellable indemnity bonds) or cash.5,[8] The Case Foundation has segmented the field of “impact wielders” (both investors and companies) into the three categories impact motivated, impact committed and impact certified which are, proceeding from left to right, characterized by increasing levels of intention, transparency and measurement, whereas the former tends to have the highest focus on financial gain (see Greene, Sean, 2015).

In order to set a current example for how impact investing is actually able to make a difference, I would like to reference the issue of global warming and environmental protection. As we all know, humankind is, to a large extent, responsible for the destruction and persistent heating of our planet. Coal and petroleum burning as well as producing carbon emissions induce the greenhouse effect to boost, let the polar ice sheets melt and makes natural disasters do even more damage. Rainforests are globally lumbered and water pollution is an ongoing problem, especially in underdeveloped countries.

Nonetheless, governments and donors alone are not able to provide the huge amount of money that is needed to effectively face those global issues and estimated to be around 250 billion dollars a year, according to The Nature Conservancy’s[9] chief economist Eric Hallstein.[10] And this is where impact investing comes in:

In contrast to philanthropy, impact investing is not only providing a social but also a financial motive, tremendously increasing the pool of potential financiers. By supporting the financing of projects such as rainforest preservation, building of wind power plants and water turbines or abolition of coal power stations through loans, private equity or fixed income instruments, impact investing can actively support governments as well as organizations and be an effective way to contribute to the fight against the destruction of our nature, the global warming and hereby even prevent our economy from slumping.[11] In fact, the energy sector already is, after housing, the second most popular project type of impact organizations with a total volume of $19 billion and expected to grow rapidly, according to the GIIN.[12] In the form of corresponding exchange-traded funds (ETF) or municipal bonds[13], even private have the possibility to actively support the combat against climate change and nature preservation while still generating returns.

2.4 Issues & Challenges

Even though the market of impact investing is growing rapidly, it is still nowhere near its full potential, due to several challenges and problems coming along with a relatively young, emerging market in the financial sector. In the following, the most important ones are briefly addressed.

An issue that is often emphasized in the context of impact investing is the lack of an investment pipeline, according to which there are not yet enough possibilities in the form of social businesses or enterprises that dedicate themselves to this relatively new type of investment. Possible reasons for that could, in turn, be a lack of both corresponding business plans of the enterprises and education/ mentorship in that specific field. Accompanied by that, it appears that there is not a sufficiently large number of connectors that are in the position to communicate between and bring together the people in need and those who are potentially able to provide the necessary financial support.[14]

Moreover, many people claim that impact investing can knock organizations – first and foremost large-scale companies – off the course. The financial demands of those investors, so the critics, might influence those organizations in as much as they are pulling them away from their actual target market or population, where the help is mostly needed, and persuade them to address more affluent and therefore more profitable markets.[15]

Ultimately, and this might be the most crucial point, many investors are discouraged by the fact that the sector of impact investing cannot reference to a long history of financial success. The paucity of robust research and studies regarding the financial performance remains to be one of the market’s main barriers (see Cambridge Associates and GIIN, 2015). Thus, the majority of investors still associate it with, at least potential, financial losses or unbearable risks and therefore stick to traditional investing approaches. However, in chapter 5 of this investigation we refer to one of the very few studies that provides a comprehensive research on the relative performance of impact investing – and find, that the investor’s fears are mostly unfounded.

3 Framework for an Impact Portfolio

3.1 Organizational Structure

The first fundamental decision to be made by an impact investor concerns the organizational structure which, in turn, depends on the institutional form. Fund managers, for example, typically bring the whole institution into accordance with the impact mission, whereas financial institutions tend to establish a separate management team and portfolio alongside their “traditional” investments. Others pursue a “Hub and Spoke”- strategy where the impact assets are individually managed but still embedded into the institution’s overall portfolio and therefore only represent one of its many dimensions.

3.2 Impact Mission, Financial Parameters & Investment Policy Statement

After the structure is determined, an investor respectively the management team needs to shape its impact thesis which is, so to speak, the investment’s heart. It compromises objectives and individual values of the institution and ultimately communicates the social or environmental purpose that the investment is supposed to serve. It is therefore in the nature of things that impact theses differ from investor to investor, each representing a personal incentive; from combatting the climate change via business initiatives through to affordable housing or access to clean water in underdeveloped countries.

Once the objective is set, an investor now has to determine crucial parameters regarding the financial performance such as the targeted sector and geographical location, the market’s growth stage as well as his risk aversion. In case an investor pursues an indirect investment[16], an investment policy statement (IPS) is evolved in compliance with the respective advisor. The IPS may be considered as an agreement between advisor and client (investor) that provides a collaborative strategic objective and, moreover, a framework for a concrete investing and managing approach.[17],[18]

3.3 Constructing a Portfolio Target Profile

In traditional investing, an investor first and foremost cares about risk and return of assets while aiming at the highest possible risk-return-tradeoff. An impact investor, however, rather thinks in three than in two dimensions and takes account of an additional factor – impact. After determining the organizational structure as well as his impact thesis and financial parameters, the investor now has to define a target profile and balance its three dimensions risk, return and impact. In the following chart (Figure 5), I exemplarily modelled a possible target profile of a rather risk-averse investor that primarily seeks a high social impact but still wants to generate a moderate financial return.

Note, however, that portfolio target profiles are unique to every investor and can heavily differ from one another. Others might aim for the maximum possible return while generating only a small impact and still others might try to maximize both while taking considerably higher risks.

Abbildung in dieser Leseprobe nicht enthalten

Figure 3: Portfolio Target Profile of a Risk-averse Investor

The actual portfolio target profile of our fictive investor is depicted by the pink shaded triangle. As already mentioned above, it places value of a relatively high impact and low risk while still targeting a moderate (excess) return on capital.

The blue triangle, in contrast, could represent a single asset from the investor’s targeted market or potential asset pool. Apparently, the fewest out of all individual assets that come into question perfectly match the target profile, hence he should try to adjust the aggregate of all individual assets to the latter.

But how does an investor actually proceed in order to choose the “right” assets that are in accord with his personal preferences? A formal approach to portfolio modelling is given in the following chapter.

4 An Approach to Portfolio Modelling

From any investor’s point of view, no matter what his intention, risk preference or target-return might be, the asset allocation in his portfolio is of highest importance.

This chapter, therefore, aims at imparting an overview of static portfolio modelling approaches[19]. First of all, we will determine necessary assumptions with regard to the investor’s behavior and deduce his portfolio maximization problem for the case of one risky and one risk-free asset. Subsequently, we will expand our model by the more realistic possibility of investing in many risky assets and determine the optimal asset allocation both graphically based on Markowitz’ mean-variance-frontier and formally. Finally, we will implement constraints and make a reference to socially responsible and therefore impact investing (in accordance to Chiarella et al, 2016 and Ang, 2012). For the sake of clarity and simplicity, however, I will abstract from long formal derivations and lay my focus on the core principles.

4.1. Assumptions Regarding an Investor’s Utility

As indicated above, the guiding principle of static portfolio theory is the relation of mean (expected) returns and variance. Investors strive after maximizing their returns while taking account for their personal risk preference. Due to the fact that their utility normally decreases as risk increases, we can assume a concave, quadratic utility function such as

illustration not visible in this excerpt

with the utility under consideration of risk aversion (note, however, that quadratic utility functions are not a necessary condition for maximizing utility in the mean-variance context, according to Markowitz (see Chiarella et al, 2016, ch.3.2)). Hence, we obtain a time-related maximization problem

illustration not visible in this excerpt

with as the expected value of utility and as the portfolio return in period . The absolute level of wealth in is therefore determined by the latter and the level of wealth in ,

4.2. Portfolio Optimization: One Risky Asset

Now that we have defined the maximization problem of an investor’s personal utility, we can as well determine the former for his portfolio, starting with the case of one risky and risk-free asset each. As also stated in Ang (2012, ch.3.1 and 3.2) and Chiarella et al (2016, ch.3.2), we obtain:

illustration not visible in this excerpt

whereas depicts the risky asset’s weight and serves as an investor’s individual measure of risk aversion.

From the expected portfolio return

illustration not visible in this excerpt

whereas is the expected overall portfolio return in , is the expected return of the risky asset with its weight and is the return of a risk-less asset[20], one could now formally derive the optimal weight for only one risky asset in combination it with a risk-less one (for an extensive explanation see Chiarella et al (2016, ch.3.2)). For this investigation, however, it is sufficient to know that the optimal weight of the former is inversely proportional to both an investor’s parameter of risk aversion and the actual level of risk, as well as directly proportional to its expected excess return[21] and the portfolios Sharpe ratio, whereas the latter is depicted as:

illustration not visible in this excerpt

or, to put it into words, the risky asset’s risk premium per unit of risk.

4.3. Portfolio Optimization: Risky Asset Portfolio

4.3.1 Mean-Variance-Frontier, CAL & Two-Fund-Theorem

Before formally deducing the optimal weight for a portfolio of risky assets in an overall portfolio with a risk-less asset, I would like to impart the corresponding concept of Markowitz’ mean-variance-frontier (following Ang, Andrew (2012, ch.3)) which I illustrated in Figure 3 below. We first graphically derive the optimal risky portfolio and subsequently include the risk-free asset so as to get to the concept of the capital allocation line (CAL) and therefore Tobin’s two-fund-theorem.

illustration not visible in this excerpt

Figure 4: Markowitz’ Mean-Variance-Frontier

The y-axis depicts the expected mean return on assets, normally in percentage terms, and the x-axis shows the corresponding amount of risk measured in standard deviations. The black graph, or MVF, symbolizes all possible combinations of individual, risky assets (red dots inside the frontier) in the observed market(s), that I have – for the sake of clarity – exemplarily limited to two markets, demonstrated by the green and yellow bullets (note, that this is a constraint itself). The bottom part of the MVF, and therefore the “100% yellow portfolio”, is inefficient, which means we can obtain a higher expected reward or return for a given level of risk (σ). In order to do so and get to the upper part of the MVF that represents all efficient combinations, among others our “100% green portfolio”, we need to diversify our risky portfolio. If markets are not perfectly correlated (coefficient of correlation <1), we can make use of diversification benefits, according to which markets might move differently over time, and hereby prevent our overall portfolio from possible massive losses. Hence, the lower the correlation or, in other words, the less similar our markets are, the larger our benefits from diversifying will be.

By solving a minimization problem

illustration not visible in this excerpt

whereas is the portfolio weight of asset and the return on our (valid) overall portfolio, we obtain the minimum variance portfolio (MVP) on the left-most point of our MVF (pink bullet) which has the lowest possible risk (of all potential risky portfolios. Starting from a 100% yellow market-portfolio, a rational investor would therefore add assets from the green market in order to improve his risk-return-trade-off and make his portfolio an efficient one, which means there is no other asset-portfolio with the same amount of risk that has higher expected returns. By shorting[22] the yellow market and investing its returns in a (leveraged) green portfolio, one can as well obtain portfolios to the green bullet’s right.

But which portfolio along the efficient frontier is optimal? The answer to that is, once again, given by an investors mean-variance utility that is determined by his individual risk aversion . Each investor’s utility levels can be seen as indifference curves and, in order to maximize his utility, he chooses the tangential point of the highest indifference curve and the efficient frontier. We can, analogous to the case of one risky asset, also write this formally as

illustration not visible in this excerpt

according to which the investor maximizes his expected return by choosing each asset’s weight while taking account of his individual risk aversion.[23]

Up to this point, we have only been looking at the risky part of our portfolio. Now, we also want to take our risk-free asset into consideration and scrutinize its effect on our optimal portfolio choice. Risk-free assets are typically government bonds that have a negligible default risk and a return that could, for instance, be somewhere between 1% and 5%. The inclusion of the latter changes our allocation inasmuch as we do not select the individual, optimal risky portfolio along the MVF anymore but determine the unambiguous minimum variance efficient portfolio[24] (MVE), which is the portfolio with the highest Sharpe ratio, and mix it with our risk-free asset that, in our case, has a return of 2%, as illustrated in Figure 7 below:

illustration not visible in this excerpt

Figure 5: Risk-free Asset and Capital Allocation Line

The black bullet on the y-axis represents a 100% risk-free position[25] with , whereas the blue dot depicts a 100% MVE portfolio consisting only of risky assets from our observed markets and providing and expected return of around 12%. They are connected by the capital allocation line (CAL), which is representing all possible (and efficient) combinations of risky and risk-free asset(s). The optimal position on the CAL, in turn, depends on the investor’s willingness to take risk: The less risk-averse, the higher the portfolio weight of the risky MVE portfolio and the higher both risk and expected return. Due to the fact that every investor holds two identical portfolios – risky (MVE) and risk-less – and only decides about their allocation, this model is oftentimes called the two-fund-theorem.[26] However, we will later discuss why this assumption lacks practical relevance and which implications follow the foregoing.

4.3.2. Modelling the Optimal Portfolio

In the previous chapter, we made use of Markowitz’ mean-variance-frontier to graphically show how diversification can make an investor’s portfolio efficient. In this chapter, we want to take a look at the corresponding technical aspect behind optimal portfolio choices for the case of many ( risky assets (in combination with a risk-free asset).

In order to formally derive the optimal weight respectively allocation of the risky part in a portfolio, we put the vector notation to use and first define the following:

, ,

whereas depicts the risky asset’s mean vector, a vector of one[27] and the

weight vector of the risky asset portfolio.[28] Moreover, and in contrast to the case of only

one risky asset, we have to consider not only the variance and therefore individual risk (volatility) of the latter, but also the respective covariance between expected returns of all of our risky assets.

The latter is defined as follows:

illustration not visible in this excerpt

according to which one determines the covariance between two assets by multiplying the product of each of the asset’s standard deviation with their coefficient of correlation, We then define the emerging variance-covariance matrix[29] of all of our risky assets as .

Hence, we can depict an investor’s resulting portfolio maximization problem as

illustration not visible in this excerpt

Maximizing and solving for reveals the optimal weight vector :

illustration not visible in this excerpt

which, in turn, formally depicts what we have already graphically illustrated in (4.12): An investor’s individual measure of risk aversion () is inversely related to the amount of risky assets in our mixed portfolio. The larger , the smaller the quotient and hence the smaller the optimal weight vector . Also, note that the value of the variance-covariance-matrix or, put differently, the level of risk is inversely related to the latter. Apparently, this is exactly what we demonstrated above: The more risk-averse an investor or, in other words, the larger his individual measure for risk aversion, , the smaller the risky part of his portfolio respectively the further to the left his position on the capital allocation line (see Figure 7, p.14).

Hereby, as emphasized by Ang, investors can as well hold a 100% risk-free (totally risk-averse) respectively risky (totally risk seeking) position (2012).

4.4. Implementation of Constraints

So far, our approaches to portfolio optimization were only considering risk and the corresponding return and hence applying to each and any portfolio. In this chapter, however, a connection to the special case of socially responsible respectively impact investing is made. Mainly referring to Chiarella et al (2016, ch.3.2) and Ang (2012, ch.2.4) again, I am emphasizing the consequences and implications that follow an investor’s decision to generate a social or environmental impact alongside a financial return.

As we have seen in the previous chapters, the most effective way to reduce risk is to diversify a portfolio. Figure 6 illustrates how we can get from an inefficient position (yellow market) to an efficient one, solely by extending our investing-horizon by another market (in our case the green, efficient one). Thus, we can even reach higher benefits of diversifying by adding more and more markets to our potential asset-pool. The latter, once again, might be subject to different movements and developments and can therefore further improve an investors risk-return-tradeoff. In theory, a rational[30] investor would therefore consider the whole asset market for his portfolio, leading to the capital asset pricing model[31] (CAPM) (for more information see Sigman, Karl, 2005).

In reality, however, this theory is of low practical relevance since many investors make their portfolio choices, at least to some extent, based on individual geographical, market-related or personal preferences that conflict with the principle of economic rationality (homo oeconomicus). The latter, as a matter of fact, also compromise the concept of impact investing, whose advocates accept to considerably limit their potential asset-pool and therefore lose benefits of diversifying. The process of constraining the asset market and its effect are scrutinized in the following.

Once again, it makes good sense to start with a graphical illustration. Figure 8 below illustrates the effect of adding or dropping markets or, generally speaking, assets to the pool of potential assets:

illustration not visible in this excerpt

Figure 6: Shifting the Mean-Variance-Frontier

The black graph represents our initial state, the dashed blue one an increase in potential assets (e.g. by considering an additional market) and the dotted red one a decrease in potential assets. As we can see, adding new markets or assets results in a broader MVF and vice versa. Also, we can observe a slight shift of the frontier towards the left, when increasing respectively to the right, when decreasing the number of assets. Does this mean that each and any socially responsible investor suffers huge diversification losses? Definitely not. Similar to typical microeconomic utility assumptions, the principle of diversification is subject to decreasing marginal benefits, which means that our diversification benefits become smaller and smaller as we add assets to our pool. On the other hand, investors will not suffer substantial diversification losses, if their portfolio is already well diversified in the first place. Also note, that the above figure exemplarily shows substantial shifts of the MVF which is, in turn, only reasonable for an initial state of very few markets (and therefore high marginal benefits and losses). Nevertheless, by a priori restricting oneself to or categorically excluding certain markets – and this is what many impact investors, amongst others, do – an investor will, strictly speaking, end up with a worse risk-return-tradeoff in comparison to the whole market or, in other words, a lower (expected) return for a given level of risk (see Ang, 2012).

Before empirically scrutinizing potential financial implications for impact investors, we will first determine the meaning of constraints for our technical optimization approach.

In chapter 4.1.4, we have determined the optimal weight for the risky part in an overall portfolio by formally maximizing our excess return while taking account of both personal risk aversion of an investor and the asset’s actual risk levels (variance-covariance-matrix). However, we can as well express our problem as a general minimization problem in the following way (correspondent to Chiarella et al, 2016):


[1] See Greene, Sean, 2015.

[2] Global Impact Investing Network, 2017.

[3] See Council of Foundations and Figure 1.

[4] The term ‘impact investing’ was first defined by the Global Impact Investing Network (GIIN) in 2007, however, funds with corresponding characteristics existed before (see also chapter 5).

[5] GIIN Annual Impact Investor Survey 2017.

[6] See GIIN, 2017.

[7] According to the GIIN Annual Global Impact Survey 2017 (p.1), about a third of all listed impact investors are intentionally targeting below-market returns.

[8] See Jüngling, Noelle, 2015.

[9] The Nature Conservancy is a nonprofit organization for nature protection based in Arlington, Virginia.

[10] See Schiller, Ben, 2017.

[11] According to a recent study by UC Berkeley researchers (see Maclay, Kathleen, 2017), the US GDP could drop by 0.7% for every one-degree Fahrenheit increase on the global temperature scale, with the worst-off US countries losing around 20%.

[12] See Wickler, Alden, 2017.

[13] Debt security issued by a state or municipal with the intention to finance its capital expenditures.

[14] See Devex, 2015.

[15] See Starr, Kevin, 2012.

[16] For instance, in form of an investment into a corresponding fund or simply an extern portfolio manager / advisor.

[17] See Saltuk, Yasemin, 2012.

[18] See Emerson and Smalling, 2015.

[19] The concept of static, or strategic, asset allocation is – just as dynamic (tactical) asset strategies are – based on modern portfolio theory (MPT), as pioneered by Harry Markowitz (1952). It assumes the case of a portfolio consisting of a risky and a risk-free part and makes use of diversification benefits in order to reach the highest possible return for a given level of an investor’s risk acceptance or, vice versa, determines the lowest attainable risk for a defined target-return (see Chambers, Donald, 2010).

[20] An example for a risk-free asset might be a government bond that has a negligible default risk.

[21] The excess return, or risk premium, is defined as the risky asset’s return over the risk-free return.

[22] Short selling, in that context, means to sell (and later rebuy) stocks that are not in the investor’s possession in order to make profits with dropping prices.

[23] See Ang, Andrew, 2012.

[24] The MVE, or tangency portfolio, can be seen as the objectively best risky asset portfolio and is also called tangency portfolio.

[25] A 100% risk-free position is only held by investors that are totally risk-averse (and vice versa for MVE).

[26] The two-fund-theorem goes back to James Tobin (1958), US-American economist and Nobel Prize winner.

[27] Vector refers to the risk-free asset that provides a predetermined, assured return without or with a negligible default risk.

[28] See Chiarella et al, 2016.

[29] Generalizes the influence of the variance of a unidimensional stochastic variable on a multidimensional one (stochastic vector).

[30] Rational, in that context, means to maximize the own economic profit and to abstract from other forms of utility (Homo Oeconomicus).

[31] According to the CAPM, all investors hold the same risky market portfolio (every asset is included, even though some have very small weights) and only decide about their asset allocation. It also allows to classify/ price different, individual assets by their correlation with the whole market (see Sigman, Karl, 2005).

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Impact Investing. The Future of Investing?
A Holistic Introduction
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Impact Investing, Investing, Investments, Socially Responsible Investing, SRI, Portfolio Management, Portfolio Optimization, Impact
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Max Luca Wiegand (Author), 2017, Impact Investing. The Future of Investing?, Munich, GRIN Verlag,


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