Optimizing for Impact With Private Equity and Real Assets: A Guide to Integrating Impact Into Financial Analysis of Alternative Assets

Expectations of investor behavior are changing. As societies around the world deal with the challenges of climate change, a pandemic, social upheaval, and, in some cases, unrest, institutional investors are being asked to take a much more expansive view of risk than many traditional investment models currently account for.

Investors must weigh the potential positive and negative outcomes of their investments and assess how those outcomes could affect long-term value.

According to Nuveen’s annual survey of institutional investors, more than 70% agree that environmental, social, and governance (ESG) investing is about fully integrating material ESG factors into investment decision-making. This can help them better understand the full range of possible outcomes and improve decision-making. With this holistic view, investors can pursue the stability, diversification, financial performance, and positive real-world benefits that underpin long-term value growth.

Adapting Familiar Approaches

Fortunately, accounting for positive and negative impact externalities in the investment process is much more accessible than many realize. Common responsible investing frameworks and impact measurement tools can be adapted and combined into a uniform approach to assess net impact, making evaluating and managing positive and negative outcomes more systematic.

With almost 70% of investors indicating that they plan to seek out more ESG-oriented alternative investments in the near term, we are implementing a novel impact-augmented standard mean variance portfolio optimization model. Integrating impact into financial analysis helps us identify opportunities to increase impact, notably in areas aligned with the United Nations’ Sustainable Development Goals (SDGs), without compromising on risk-adjusted financial returns. And we can identify optimal portfolios to meet other client goals too, such as net-zero carbon targets.

Nuveen’s latest research demonstrates how investors can leverage existing industry frameworks to develop a holistic approach for considering positive and negative impacts in any investment or portfolio. It also shows how investors can leverage traditional portfolio analysis tools—such as the standard mean variance portfolio optimization model—to plot the most efficient path to achieving impact objectives.

Examples are drawn from Nuveen’s global impact private equity strategy and private real assets platform, which includes farmland, timberland, and infrastructure assets.

1. Defining Impact

A useful first step is to select a framework that helps define the type of impact or outcome investors intend to create or avoid. The UN SDGs and the EU Sustainable Finance Taxonomy (EU Taxonomy) are two frameworks commonly used by investors and businesses. Both identify priority impact objectives across a breadth of environmental and social issues and define indicators or criteria to help measure progress toward their achievement.

2. Measuring Impact

Within any given framework, key performance indicators (KPIs) help to measure positive or negative impact and progress toward social or environmental objectives. In the case of carbon emissions, metric tons of carbon dioxide equivalent (CO2 e) per year is a frequently used indicator of climate impact, as is average carbon intensity (MT CO2 e/$MM invested). The EU Taxonomy and the UN SDGs both offer KPIs for tracking performance, and investors can opt to use these, as well as other indicators provided by industry organizations, such as the Global Impact Investing Network (GIIN)’s IRIS+ catalog.

3. Managing for Impact

Managing for impact is different from measuring impact. It is not the amount of impact created or avoided that is important. What matters is the way in which impact is integrated and managed in the investment process and the degree to which impact is systematically considered alongside other fundamental drivers. For ESG integration strategies, impact may be considered only if material to investment performance and to mitigate risk, while impact investing approaches consider impact systematically alongside financial performance with the goal of maximizing both.

For Nuveen’s global impact private equity strategy and private real assets portfolio (which includes farmland, timberland, agribusiness, infrastructure, and energy investment strategies), we are piloting a score-based approach (see Figure 1). This serves as a management tool to understand and compare investments based on their net effects on people and the planet, and their alignment with the UN SDGs.

Figure 1

Figure 1

4. Scoring Impact

An impact scoring or ratings approach is useful to understand impact alongside ESG factors, especially when impact is nuanced across social and environmental dimensions or UN SDGs. Impact scoring allows investors to consider potential positive and negative externalities together and compare investments across sectors, strategies, and asset classes. It is applicable to all investments, including those without a specific impact objective.

Figure 2 presents the net impact score for select real assets strategies within Nuveen’s private real assets platform, all of which integrate ESG factors into the investment process and some of which also can be considered impact investing.

Figure 2

5. Optimizing for Impact

A portfolio optimization framework can help investors understand the trade-offs between risk, return, and impact across different investment types, and can also be applied to the total portfolio. Nuveen’s approach adapts the standard mean variance portfolio model to incorporate impact metrics.

Quantifying risk-return-impact trade-offs achieves two things. First, it identifies the range of portfolio impact that is achievable without affecting risk-return efficiency. Second, it supports the design of portfolios that minimize the reduction in risk-return efficiency required to achieve a targeted level of impact. The important takeaway is that impact—in the context of the UN SDGs—needs to be evaluated and considered in the investment process with the same rigor and prudence as financial performance.

Achieving Impact Goals and Financial Returns

Institutional investors are identifying a desire to change, whether that is for different behaviors, for different processes, or for different outcomes. As they commit capital to doing things differently, they want to understand how that difference will be made and see evidence of it. They want information that will guide investment decisions, allowing positive (and negative) impacts to be priced into those decisions as they seek a return on their capital. Identifying compelling impact investments opens up a vast and growing opportunity set for institutional investors, as the real asset examples in Nuveen’s research illustrate.

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A word on risk
Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the potential use of leverage, potential short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Responsible investing incorporates environmental social and governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well.
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