A growing number of investors want to invest in impact, but many are deterred by the same problem: how can I measure impact? Portfolio construction has long gone beyond the traditional asset allocation metrics of equity and fixed income, duration and credit risk, but what do the buzzwords, like ESG, SRI and Green actually mean? New and uncertain fields are ripe for the creation of frameworks to help them realize their true potential.
Creating a framework for measuring impact is critical to build a portfolio, but it can be daunting because there are critical questions to answer just to get started. Questions like:
- What do I measure?
- Where do I find the right data to measure each metric?
- Will the data be timely through regular disclosures?
- What are the metrics and do they work across project types?
- What kinds of investments will be the most impactful?
Finding the right place to have an impact
A good place to start when deciding where to apply your resources is to structure and make sense of the problem space. The United Nations Sustainable Development Goals introduce 17 challenging problems that would require, on average, $5-7 trillion of investment annually to solve. By committing to help clients participate in impact investing, we can all have meaningful conversations about the positive effects of their investment portfolio. In situations where data is sparse, we must also commit to deeply understanding the narrative of projects while we build more robust ways to measure the impact of those projects.
The $440 billion-a-year1 municipal bond market is one place where the opportunity to invest in impact is real and tangible. Munis have funded most of the critical infrastructure that we rely on every day. Proceeds are used for projects such as schools, bridges, water systems and parks. Which is why we believe municipal bonds are the Original Impact Investment. Muni’s will also be the most efficient gateway to innovative public projects and local independence through microgrids and municipal broadband networks. Thousands of communities across the country are making changes that are exciting and crucial to our future – and they need investment to support them.
Making sense of a fragmented impact opportunity
But with this wealth of projects spread across communities, the challenge for investors is bringing coherence to a space that is historically – and some would say inherently – fragmented. For instance, the $440 billion worth of new municipal securities issued in 2016 were broken down into over 13,274 separate issuances. By comparison, the U.S. investment grade corporate bond market saw 757 issuances in 2016 totaling $1.3 trillion. With an average municipal issuance size of about $33 million and nearly one million outstanding securities, it becomes clear that the fragmented nature of the muni market makes it difficult to organize, measure and track.
Of course, at Neighborly we’re determined to shine light on the positive impact that many of these bonds are funding, even as navigating the landscape of the muni market has become increasingly difficult.
With over 10,000 yearly new issues it can be tough to distinguish the good from the bad. To make things more challenging, these 10k+ issuances often include many projects (a larger piece of market infrastructure that we are solving for through technological efficiencies).
While traditional credit analysts rarely dive deep enough to explore each project, it is important to remain aware that a private prison could be funded directly alongside a new school building. As market participants, we must spend time analyzing not only the issuers and their credit quality, but the impact of the projects driven by the issuance proceeds.
If you are an advisor who cares about delivering the positive stories that live beneath the surface, it is first important to construct a framework by which to measure impact. At Neighborly, we start with the fundamentals. Before participating in a muni issuance, we analyze the underlying projects in which the proceeds from the bond sale are being directed to. In doing so, we ensure that bond proceeds are being used toward positive projects. Sifting through the (at times) overwhelming amount of projects in a bond issuance can be challenging, but providing investors with a clear picture about where their money is being used and how it impacts their community is at the root of public finance.
From fragmentation to impact framework
We use a two-step process to measure each municipal story. First, we define the values that fit our firm and clients beliefs. For example, here at Neighborly, we began developing our framework by working with a number of select UN SDGs that we believe best represent the municipal market and our firm-wide values. Second, we map these goals to each issuance based on the impact driven by the issuance use of proceeds. Often, an issuance will contain multiple projects. The UN SDGs that we have selected cover a wide variety of positive impact and allow us to use multiple if appropriate.
If the bonds being issued do not align with the UN SDGs we have selected, they will not align with our firm’s values and will therefore not be offered to our customers. By starting with broad reference points, we are able to refine the process of defining impact over time. Here is a more detailed look at the breakdown we use.
This framework lays the foundation for the conversation about what can be considered a mission-positive project, and why. While it can be difficult to draw a hard line between the two, by starting with a solid foundation like the one above, we are able to operate as a mission-driven platform for financing demonstrably world positive public projects.
We believe a tangible example will help clients visualize what an impact portfolio looks like and why it should matter to them. As part of a follow up, we will be publishing a muni portfolio. Do you need suggestions on where to begin your impact framework? We’re happy to help. Feel free to reach out with any questions you may have. Email email@example.com and we’d be happy to have an impact conversation with you.
1 Based on the 2016 new issuance volume in the municipal market. Source: SIFMA