Over the last few years I have often been asked by capital allocators “how to adjust for impact when allocating capital?” and “if risk drives returns, what drives impact?” Many of these allocators have maintained their 2 dimensional Risk/Return Capital Allocation Line Framework when recommending or executing for impact, while others like myself have taken a leap into a third dimensional approach to answer the above questions. What we see with 3D lenses is very revealing indeed. Today I will make a humble attempt to share that 3D view.
Defining And Measuring Impact?
Unlike objective financial returns, the definition and utility of impact is subjective and can vary from investor to investor. For the sake of simplicity, we see externalities both positive and negative from a profit making enterprise as it’s impact. As a wise friend recently said “impact is in the eye of the investor.” However, it’s when impact becomes a social/legal consensus that it starts finding an objective measure, like returns. As an example, Co2 emissions are finding national and regional pricing consensus thus giving them an objective value (cost) relevant enough for investors. In the coming decade we will see more and more negative externalities and positive actions being objectively measured, monitored and accounted for. Watch this space….
What do I mean by impact in capital allocation?
There are two ways impact is being incorporated into decision making by allocators. The first is where “impact investing” is seen as a separate asset class by allocators, both in the private and public space. This approach has the allocator identifying mostly positive impact opportunities and then use the traditional Risk/Return approach taught in capital asset pricing and efficient portfolio theory to allocate capital to it. This approach generally assumes (wrongly in my humble opinion) that impact investments have lower returns for the same level of risk as a non-impact opportunity.
The second approach is one we take at Panarchy Partners and many other capital allocators are considering, which is “investing with impact” not just “impact investing.” What might sound like wordsmithing is actually a different approach with a broader perspective. At Panarchy Partners we use Panvesting as our philosophy to help deploy this approach, which is to ensure that all capital allocated is done with impact as part of the overall risk/return framework. This is where the 3D vision is needed as I will share shortly.
Which Capital Allocators should wear 3D glasses?
If your time horizon is not driven by a bonus cycle; if you are not beholden to an index as a benchmark nor an index rebalance review; if sustained financial compounding and not FOMO investing is your approach then there is a good chance that you are able to invest with impact; rather than create a separate sleeve for impact investing. For all other allocators not interested in impact (yet) hopefully this note may provide a glimpse into how overtime their 2D risk/return framework will see impact percolate into returns. Our belief is that the allocators with the 3D lens should be well positioned for when the 2D players finally see the real picture.
The 3D view of Risk/Return and Impact Please click on the link to see 5 min video presentation on the 3D framework:
Until and unless impact accounting is formalised enough to become part of the traditional risk/return metrics, capital allocators and investors will need to move beyond a 2D risk/return framework when investing with impact. As you would have seen in the video presentation, there is an all important factor P (no spoilers for those about to watch the video) that we believe drives Impact in this 3D world. In the coming months we intend to delve deeper into this factor P which is at the core of our own allocation strategy. Happy Panvesting! Munib Madni, Founding Panvestor