Question: Compared to a non-impact investment with identical financial risk, this specific investment can be expected to earn: A. a lower return B. identical return C. a higher return
A lower return (equilibrium theory)
Question:Compared to a non-impact investment with identical financial risk, this specific: A. Cannot have “additionality” B. Can have positive “additionality”
A. Cannot have additionality
What is WTP?
WTP: willing to pay in the sense of willing to accept a lower return in exchange for relatively “positive social impact”
Give an example why IRR is not a good measure
IRR is not the same as “effective return” because IRR assumes that distributions are reinvested at the same IRR.
- For example, if dividend of 300 is in year 1 reinvested at 68% for two years then this will be worth 848.72. Adding 100 in year 2 leads to total value of cash distributions up to year 3 = 947.72
- Geometric return(0,3)= (947.72/200)^(1/3)-1 = 68%
What are the 3 steps of creating a ‘modified IRR’?
- Plug in your own opportunity cost of capital to discount contributions to the fund made at time t to a value at t=0
- Plug in your own reinvestment return to derive forward value at t=T of each distribution at t
- Take IRR of new stream of modified contributions and distributions (the bottom row in table below)
How does the Public-Market Equivalent (PME) work?
Essentially each distributiondist(t)(such as dividend or other positive cashflow , and implicit value of assets under management (NAV)) is converted to either PRESENT VALUE (t=0) or FUTURE VALUE (t= T) using R(t), where R(t) is the return on a broad stock-market index.Then all converted distributions (incl NAV) are summed.
- Next, all PRESENT VALUES or FUTURE VALUES of contributions cont(t)to the fund are summed and used as denominator
- Basic idea: implement a stock market index as more realistic opportunity cost R(t)to evaluate PE/VC investments, somewhat corrects for risk implicitly
What is the interpretation of PME + Assumptions
Use of stock market return in Rm implied you are benchmarking fund return to a stock market equivalent, PME > 1 = outperformance relative to stock market
- Strictly it proxies for Return on wealth portfolio (incl all returns on stocks, human capital etc)
- It seems different from CAPM which says expected return on fund = Rf + Beta x Expected Market Risk premium
- PMEcorrects for realized market return (is consistent with a Dynamic CAPM from Rubinstein (1976)
What is the IRR: Evidence from Barber et al. (2021)?
On average Impact funds have about 4.6 to 9.9 percentage point lower IRR than non-impact funds, depending on which controls are used
- Similar results when MoM performance measure is used (Panel B, not shown here)
- Consistent with a tradeoff between performance and impact
- Possibly also consistent with investors willing to pay for impact
What does Jeffers. et al. (2023) find on PME for impact funds?
- PME of impact funds were on average 0.71 (1997 – 2015) KS PME measure based on “present values” of distributions and contributions
- KS PME of similar VC funds around 0.96 * In line with hypothesis that more impactful investment have lower (expected) returns (but hopefully more impact) than non-impact investment
- All funds have PMEs less than 1, i.e. VC funds underperformed stock market…
- Note that IRRs were much lower for Impact Funds…
- However, the lower PME for impact funds compared to matched VC’s is possible to a limitation of the KS PME measure
- It assumes a Beta (systematic risk) of 1 concerning the market index.
What does Cole et al. (2023) find on PME of impact funds?
Suggests PE portfolio delivered 15% more than counterfactual S&P500 investment since 1961
- But investments since 2010 performed below stock indexes
Cross-section regression of individuals investment’s PMEs on a measure of financial openness.
- Other proxies also suggest that PME declines with more market integration / openness
