This post is an excerpt from the complimentary resource Essentials of Impact Investing: A Guide for Small-Staffed Foundations, created by Exponent Philanthropy and partners Mission Investors Exchange and Arabella Advisors. Want to align your investments with your mission? Download your copy >>
By Christa Velasquez, University of Chicago
So much time and effort is focused on getting an impact investment closed and the funds disbursed. However, executing an agreement isn’t the finish line and, in fact, it may not even be the halfway point. Post-closing, there is still a lot of work to do in monitoring the performance of an investment to ensure financial health and intended impact.
Monitoring the performance of your investments ensures alignment with your foundation’s objectives, communicates expected and achieved impacts, ensures consistency among reported data, allows for performance measurement over time, and helps to identify the right questions for investors to ask. Unlike traditional investors that measure only their financial returns, impact investors track both the financial and social impact performance of their investments.
Who monitors investments varies by foundation. Some foundations have impact investing staff and other foundation stakeholders who are responsible for all aspects of investing, including monitoring. Other foundations may have finance and investment teams to monitor the portfolio. Still others utilize a team of program, finance, and investment staff. Another option that some foundations use is to engage external service providers such as an advisor, consultant, or financial intermediary who has experience monitoring and servicing investments.
Measuring Financial Impact
Assessing the financial performance of an investment is relatively straightforward and focuses on such measures as profit, cash flow, and balance sheet strength. Investors may track financial ratios including those that measure net assets, liquidity, and asset quality.
Investment terms may include covenants or financial and programmatic performance conditions in an investment agreement. These agreements require or prohibit the borrower or investee from doing certain things. Covenants typically cover financial targets or allowable uses of the investment proceeds. Part of monitoring will therefore be determining compliance with those covenants. The frequency and interval of monitoring of each covenant is clearly defined in the investment agreement (although most covenants are monitored quarterly or annually throughout the term of the investment).
Measuring Social Impact
Measuring social impact is more difficult. As with grants, foundations struggle to assess the social impact of an impact investment. Investors typically include in the investment agreement key programmatic or social indicators—a core set of metrics customized for individual transactions—that investees must regularly report on. Examples of key indicators include jobs created, affordable housing units financed, numbers of individuals accessing financial services, levels of energy conservation achieved, or number of child care slots financed. Interestingly, some foundation investors believe that they get better impact data from the impact investments than their grants because of the clear metrics and regular, ongoing reporting.
Much work has been done recently to standardize impact measures to ease reporting burdens on investees, promote transparency, and aid investors. Impact Reporting and Investment Standards (IRIS), a program of the Global Impact Investing Network, is a catalog of standardized definitions for performance measures by sector that can be used to understand an organization’s social results and make it easier to compare performance across an investment portfolio or industry.
Whereas IRIS is one metrics system, other organizations have developed their own metrics that may be applicable to foundation impact investments:
- CDFI Assessment and Ratings System (Aeris, formerly CARS)
- Small and growing business metrics from the ANDE
- Sustainable agriculture metrics from the Finance Alliance for Sustainable Trade (FAST)
- Developed and emerging market metrics from the Global Impact Investing Rating System assessment
- Land conservation metrics developed by an IRIS working group
- Microfinance metrics from the Microfinance Information Exchange and Social Performance Task Force
- Community banking metrics from National Community Investment Fund
- Metrics for investments in early-stage enterprises from Toniic
- Compilation of other metrics from the Global Impact Investing Network
How to Monitor
Investment agreements should lay out the specific financial and impact metrics and frequency of reporting. Investments should be monitored at least annually with a review of both programmatic and financial issues. The key programmatic concern is whether the investee is conducting the promised activity and reaching the target population. Financial monitoring should focus on the financial performance of the investee or the project or both, with emphasis on the investee’s likely ability to repay the investment.
The level of risk of the investments in a foundation’s portfolio should be regularly assessed. Foundations use a risk rating system to evaluate the risk of default by an investee and to identify investments with heightened risk parameters that may require more frequent monitoring or some kind of intervention. Foundations can also use an investment’s risk rating to establish the level of loss reserve to be held for the investment.