This article is Part 2 of AJL’s Impact Investing Series, read Part 1: How We Got Started here.
At this point in our impact investing journey, the AJL Board of Directors and staff have agreed internally that our mission applies across our portfolio – not just to grantmaking – and that we need to hold ourselves accountable for the positive and negative social impacts of all of our investments as well as financial return. But how do we do that? As Executive Director, I was as new to impact investing as I was to investing in general. Our 5-member Finance and Investment Committee was made up of Directors with strong banking and investing backgrounds, but not impact investing specifically.
As a first step, we turned to our financial advisors at the time, shared our new commitment to portfolio-wide mission alignment, and asked them how we should do it. Our financial advisors represented a large national firm with $70+B assets under management (AUM) and the short answer was: we haven’t done that before, but clients are starting to ask for it so we know we need to. We’re willing to learn, however it will require more hours so we may need to charge a higher fee.
Being the guinea pig sounded expensive and likely ineffective, and it was clear we needed to find an expert on impact investing for the next step in the journey. We began meeting with consultants and advisors, trying to figure out how to tackle impact investing when our foundation and our financial advisors didn’t have the specific expertise.
It’s important to note that, in these early conversations, a challenge we ran into is that the majority of experts we were coming across were other financial advisors, which made conversations inherently conflicted, and that underscoring every discussion was the fact that management of our portfolio could end up out for bid. For asset owners at this stage of the impact investing journey, it’s important to remain cognizant of this conflict.
After initial discussions with philanthropic peers and other financial advisors, we engaged with the Impact Finance Center (IFC), a nonprofit academic center that identifies, trains and activates individuals and organizations to become impact investors. We shared with them the two biggest issues we were grappling with:
- As a private foundation with limited impact investing expertise, how do we invest for positive social impact and evaluate if it works? We need to invest for impact, but have no idea how to do that, what’s even possible within our financial system, and our current financial advisors don’t seem to know either.
- We are financial lay people - how on earth do we adequately manage and evaluate our financial advisors? How do we make sure we are good partners to our financial advisors and give them clear but flexible direction? And when we are evaluating them – how do we separate skill from luck? Beyond benchmarking, how do we know that we are getting our money’s worth for the fees we were paying? And how do we know how the fees we are being charged are in line with the industry standard?
It turns out that before we could even begin to talk about impact, we needed to back up and address gaps in governance.
STEP 1: Improving Governance
AJL needed to start from the top by improving our governance. Strong governance is a critical requirement to allow organizations to achieve above average investment outcomes on a sustainable basis, and one area of governance AJL was lacking was investment beliefs. IFC lead us through a process to learn, identify and codify our investment beliefs. Investment beliefs are a clear view on how your organization perceives the way capital markets work, and how your organization can add value and strive for excellence.
AJL’s investment beliefs include our organization’s beliefs around strategic asset allocation, dynamic asset allocation, public markets, private markets, costs and values. For AJL, investment beliefs allowed us to educate ourselves and more clearly communicate our collective understanding of how to guide AJL’s investments for the long-term with our financial advisors. Investment beliefs also gave us a framework for evaluating our financial advisors beyond just financial return.
AJL’s complete investment beliefs can be found on pages 3 - 5 of our Investment Policy Statement. To go deeper on investment beliefs, we recommend the book Investment Beliefs: A Positive Approach to Institutional Investing or Building Strong Foundations: Investment Beliefs by Willis Towers Watson, which includes a two-phase approach to investment beliefs as an example.
STEP 2: Evaluating Our Investment Advisors
After AJL’s investment beliefs were finalized and approved, we were able to evaluate our financial advisors and determine if the partnership was still aligned based on:
- AJL’s new investment beliefs
- The financial advisors’ capabilities and expertise to help AJL reach our goal of full mission-alignment across our portfolio
- The financial advisors’ financial performance and value provided over the duration of our engagement
To assess based on AJL’s new investment beliefs, we requested that the financial advisors share their investment beliefs with us so we could compare and see if we were aligned as partners. The firm did not have codified investment beliefs, so it required in-person conversations to see if they could get behind AJL’s investment beliefs for our portfolio, or if there were conflicts that would be difficult to overcome.
To assess the financial advisors’ capabilities and expertise to help us reach full mission-alignment across our portfolio, it was pretty clear upfront that impact investing was not a priority for their firm, and that they didn’t have the expertise to get us there. All this required at the time was a conversation.
To assess the financial advisors’ performance and value provided over the duration of our engagement, IFC introduced AJL to decision-based attribution evaluation. Decision-based attribution evaluation is a technique that allows for capturing all decisions that are made in the investment decision process and determining per responsible person, the added value that they have.
Using this tool, AJL can determine:
- Did our strategic asset allocation positively or negatively impact financial performance and by how much?
- Did tactical tilts positively or negatively impact financial performance and by how much?
- Did manager selection positively or negatively impact financial performance and by how much?
As part of our improved governance, AJL now requires that financial advisors provide this assessment with quarterly reports. See an example here.
STEP 3: Reviewing the Results
Here were our findings:
- Investment Beliefs: Although the financial advisors did not explicitly share the same investment beliefs, they could adjust and adopt strategies that satisfied AJL’s new investment beliefs for our portfolio.
- Impact Expertise: The financial advisors did not have the capabilities or expertise around impact investing that would be needed to lead us to full mission-alignment across our portfolio. Their firm had begun internally developing those services, but at that time, could not provide that guidance.
- Financial Performance: Even though financial returns were deemed satisfactory based on relevant benchmarking, we discovered that over our 7-year engagement with their firm, we had been modeled incorrectly, resulting in portfolio underperformance of about $1.4M. We had been overcharged by about 30% (around $230,000) in advisor fees as compared to industry standards and peer foundations.
While the findings around financial performance seem pretty negative, based on anecdotal stories with other peers, investors and financial experts, it’s possible these findings may be more rule than exception across the industry, which is one reason why AJL is sharing the details of our impact investing journey. In the interest of empowering and educating asset owners, particularly impact-oriented asset owners, we are an open book and happy to answer any questions, share resources and learn from peer foundations.
Next up on AJL’s impact investing journey is Part 3: How to Select an Impact-Oriented Advisor.
This post is the second in a series about AJL’s journey to impact investing. Other posts in the series can be viewed here:
- Part 1: How We Got Started
- Part 2: How to Evaluate Your Financial Advisor
- Part 3: Portfolio-wide Mission Alignment: Strategies and Objectives
- Part 4: Timeline and Resources
- Part 5: Diversity and Finance (coming soon)
- Part 6: What’s Next? (coming soon)
- AJL Foundation’s Portfolio
- AJL Foundation's Investment Policy Statement
- AJL Foundation's Expression of Interest for Impact-Oriented Investment Advisor (September 2018)
- AJL Foundation's Request for Proposal for Impact-Oriented Investment Advisor (December 2018)
To discuss more in depth, feel free to reach out to Kristi Petrie at email@example.com . We’d love to hear from you!