Examining the Portfolio through an Enterprise Lens
– Beyond Risk & Return
– Asset Class Highlight: Public Equities
Lessons Learned the Hard Way
Heron began its mission-related investing efforts in 1997. At the time, some mainstream critics believed that seeking impact with the whole portfolio would depress financial returns and perhaps even cause Heron to shrink over time. Despite these criticisms, Heron invested about 40% of its assets for mission, and remained at 40% for a number of years.
In 2012, Heron ramped up this work and committed to investing 100% of its assets in better alignment with its mission. Heron’s decision to pursue a mission-aligned portfolio, what we think of today as a “conscious portfolio,” was and remains undergirded by a focus on the impact of specific enterprises (as opposed to industries, asset classes, investment vehicles, or other common thematic groupings). This reflects our belief that every enterprise has a variety of impacts through its business and operations (both positive, like hiring workers and paying taxes, and negative, like polluting the environment or ignoring exploitation in their supply chain).
Upon making that commitment, we began to examine our portfolio to find out what enterprises we owned in the “unscreened” 60% of assets. The Portfolio Examination Process (or PEP) combined a general measure of each enterprise’s standing on economic, social and governance (ESG) metrics with a particular measure of how many jobs an enterprise was providing.
Unfortunately, starting with a preferred metric and applying it to the entire portfolio didn’t quite render the results we hoped for. For example, it turned out that focusing solely on the number of jobs provided (even jobs providing opportunity in low-income areas) could have made a private prison company a darling among the REITs in our portfolio. We also discovered that many enterprises appeared both in the mission-screened and “non-mission” portions of our portfolio, which called into question how we were categorizing our investments, and underscored the (positive and negative) impacts had by all enterprises.
PEP revealed the value of a discovery process that was less prescriptive and more exploratory. Our experiences with PEP, and in particular the mistakes we made, taught us to “broaden our aperture” and look at our investments with a view to overall impact first, rather than a narrow lens of one particular kind of impact — an approach we now refer to as the “net contribution” lens.
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Every investment has impact, so Heron does not limit its investment universe to just a few asset classes or types of enterprise. By using an array of financial tools, we support a diverse group of enterprises (including nonprofits, for-profits, and government entities). This helps us minimize risk, optimize liquidity, manage transaction costs, and maintain the flexibility required to provide communities with the types of capital they identify as most helpful.
Our direct investments generally take the form of grants, which we try to structure in a way that supports the health of nonprofit enterprises. By doing most of our nongrant investing indirectly through financial intermediaries, we can help capitalize a larger number of enterprises. We are also able to learn alongside our managers as the practice of impact investing matures.
Like any investor, we weigh the merits of each investment carefully. Some of these characteristics may seem relatively familiar to traditional investors, such as risk and return profiles, liquidity options, and time horizon. But as a mission-oriented investor, we also weigh other factors that traditional investors leave out, including how a company treats employees, manages waste, and impacts the communities in which it operates. And as a philanthropic investor, we sometimes choose to make investments for which we expect a below-market rate of return because we have a compelling mission-related reason for doing so (and we designate such investments as “program-related investments”).
The graphic below illustrates the spectrum of investment tools that Heron utilizes to make both market-rate and below-market investments, from low-risk guarantees in the center to “high-risk” (from a financial standpoint) investment types on either end:
Note that this graphic only looks at the risk and return expectations for a variety of investments that a conscious investor might make. In reality, every investment provides a different set of considerations, including (but not limited to) risk and return profiles, liquidity, financial diversification compared to your existing portfolio, the types of expected impact, degree of visibility to (or data about) impact, and breadth of the impact across a number of people or a geographic area.
Serving our mission through a variety of investing approaches can apply even within a single asset class. For example, in our public equities, Heron’s U.S. Community Investing Index aims to identify companies that are “best in class” contributors to communities across the United States within a particular universe of companies. Another investment, Ownership Capital, takes a different approach to portfolio construction — one portion is composed of companies that are actively counseled to become better corporate actors, while the other portion is composed of best-in-class companies.
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Looking back to the steps Heron took before, during and since our Portfolio Examination Project affirmed some aspects of our approach; other aspects we would shed or adjust.
Just as no investor ever stops optimizing for financial performance, Heron will also never stop optimizing our portfolio to better serve our mission.
Part of the impetus for that journey was our conviction that Heron and others can look at the impact of an entire portfolio, and optimize for it, while making similar or better risk-adjusted returns. Today, we see a market that is no longer mired in the belief that having a positive impact requires accepting lower returns, but rather, has ample data to encourage continued growth in the practice and development of impact investing.
As a result, we feel an increased sense of freedom, in our role as a philanthropy, to take on new and different kinds of risk in pursuing our mission with both our investment portfolio and our overall portfolio of work. We are now turning our attention to the intersection of capital markets and communities, and using our portfolio as a series of learning opportunities: Where are capital markets serving the people and communities who have been left behind? Where are there bottlenecks in flows of capital, information, innovation or tried-and-true solutions? Where can we, with a modest portfolio, a history that spans both communities and capital markets, and a determination to listen and learn, uncover and resolve those bottlenecks, and unlock investment for a thriving society?