Family offices are increasingly seeking to use their assets to achieve financial returns and build a legacy that aligns with their deeply held values. Traditional approaches to philanthropy have been used for generations by families in the form of charitable contributions or dedication of personal time and expertise to support various philanthropic causes. Today's family offices are looking for other avenues to effect change, and impact investing is a key tool to do so.
In examining impact investing’s evolution, trends and drivers, and regulatory landscape, this Insight will detail how family offices can approach and optimize their impact investing activities.
Over the last 30 years, the pace and scope of impact investing has significantly expanded across the nonprofit, tax-exempt sector as well as within the for-profit sector. Market investors outside of the charitable and family office space increasingly use impact investing as part of a standard portfolio allocation. Impact investing currently exists along a continuum of choices relating to the relative value of impact, on the one hand, and the pure profit motive on the other. Given their makeup and constituencies, family offices are considering this movement away from a binary approach of either donative impact or pure market investing and are seeking ways to create a blended approach to combining impact and financial return goals.
This is also evident in a shift in attitude towards fiduciary oversight in the impact investment context for private foundation capital within a family office structure, where investment fiduciaries are more willing to incorporate the mission aspects and relationship of an investment with the charitable purposes of the foundation into a more traditional fiduciary investment review.
One of the prevailing impact fund trends is the need for more in-depth reporting, which can be a challenge because fund managers are faced with responding to a variety of unique investor goals and reporting requests. Family offices should consider and be clear about their impact reporting needs and negotiate reporting obligations up front with the fund sponsor.
Private credit and lending vehicles have become more common with family office and other impact investors. These vehicles can be used to provide more affordable credit to underserved communities or for specific social welfare projects.
Family offices are also increasingly entering into joint ventures and other co-investing arrangements with either affiliated and non-affiliated foundations and nonprofits as well as traditional money managers in order to team up in sourcing and pursuing impact investment opportunities.
Other trends include utilizing more complex program-related investments and other philanthropic vehicles, including grants, recoverable grants, and debt, that put capital in a first loss position to leverage increased market investment to achieve greater impact (blended finance).
The extent to which the US federal securities laws apply to an impact strategy depend on the product (i.e., the wrapper for the impact strategy) and the operator of the strategy (i.e., the investment manager or decisionmaker). With respect to the latter, one major question is whether the decisionmaker is an “investment adviser,” as defined under the federal securities laws.
As family offices expand their operations and participate in projects with other organizations, including affiliated non-profit entities, they should remain mindful of the parameters of the family office exemption from investment adviser status. The US Securities and Exchange Commission (SEC) is also very focused on impact investing specifically with respect to defrauding investors and making sure that investors and others who are investing in impact products are not victimized by greenwashing.
Although there is a regulatory push to increase transparency and reporting about beneficial ownership, as evidenced by rules recently proposed by the SEC and the Financial Crimes Enforcement Network (FinCEN), family offices continue their strident efforts to maintain their anonymity.
Although there is no official definition of diversity, equity, and inclusion (DEI) investing, it is generally understood to mean incorporating DEI practices into investment and ownership decisions. DEI investing often focuses on investing in companies that target certain inclusion checkpoints or milestones by a particular date and for specific populations.
The SEC has not defined environmental, social, and governance (ESG), but does have a pending rule proposal out for investment advisers that use ESG strategies.
Family offices should consider several components when investing in an impact fund, including how those investments should be structured, how the terms might differ from their existing investments, and how to responsibly exit impact investments.
A family office need not change its entire investment structure in order to pursue impact investments. First time investors in an impact fund should note that timing can also be different than traditional fund investments. Some impact funds have 20-year terms and more evergreen structures to achieve their mission, requiring longer investment periods and patience. This could be beneficial for family offices, which often have a long-time horizon and are not necessarily restricted to a fixed 10-year-fund construct, such as private equity-style funds making impact investments.
Fees and carried interest often look very similar in impact funds as they do in for-profit only funds, but they can have different elements and triggers such as satisfying certain impact goals or thresholds in order to reach higher levels of compensation. Of course, how to measure impact for purposes of calculating impact-based compensation can be difficult and should be considered carefully.
Regarding exit strategy for an impact fund investment, there are no hard-and-fast rules, and family offices should consider governance and who will be at the table making exit decisions in a way that is consistent with the family office’s impact goals.