Interest in impact investing is
growing at an accelerated pace. Impact investors want their money to have a
positive social or environmental impact, but they also care about the risk and return of their investments. To this end, impact investors have three objectives
(risk, return and impact) rather than the two (risk and return) that
traditional investors care for. To determine the optimal trade-off between risk and return, traditional investors rely on portfolio optimisers. However, such optimisers
do not include impact. As a result, impact investors use ad hoc rules to
allocate to impact funds. Such allocation strategies are inefficient, as they
ignore the correlations between impact asset returns and traditional asset
returns. Taking these correlations into account allows for better portfolio
diversification.
We
developed a "three dimensional" portfolio optimiser which brings together impact funds and traditional
assets. By reflecting how impact and traditional assets interact, the optimiser finds the best trade-off between risk, return and impact.
Impact investing is developing fast, therefore tools to integrate impact funds into mainstream investment are especially timely. We expect asset managers to routinely use similar tools in the coming years.
Key Takeaways
- The 3D Impact Optimiser has three dimensions: risk, return and impact. Intuitively, returns from impact funds correlate with traditional asset returns. Taking such correlations into account allows for better portfolio diversification. That is, investors can achieve higher impact without hurting risk-adjusted returns.
- Diversification benefits can be large. Our optimiser allows an investor to increase impact by ~20% without financial sacrifice.
- Demand for impact investing is rising. Tools that help integrate impact funds into traditional portfolios are therefore useful and will likely soon become widespread.