PUBLISHER: Journal of Impact and ESG Investing
DATE: Spring 2021

Typically, impact investments come with some expected cost—the loss of return or increased volatility. Given that investors typically have multiple goals which compete for the same pool of wealth, it must be true that the pursuit of an impact mandate lowers the probability of achieving other goals. However, impact mandates are themselves goals so we can use goals-based utility theory to help manage the tradeoff.

This model also yields some interesting results. People are not equally willing to give up return at all times. Market losses, volatility expectations, and other factors affect willingness to give up returns for impact mandates. In addition, the mathematics shows that an investor who prioritizes the mandate above other goals (i.e. the impact mandate is a foundational goal) is willing to accept any level of return drag. I argue that this is the point at which an investor ceases to become an investor and instead becomes a philanthropist.

Because the goals-based utility model is a normative one (i.e. it is a model of what you should do), this may or may not reflect actual behavior in the real world. Instead, it is a framework for managing the necessary tradeoffs for investors who have specific objectives to achieve, but who also want to pursue an impact investing mandate. This carries use for investment committees of foundations and trustees, as well as individual investors.

For investors who wish to engage in impact investing and who have specific goals to achieve, there exists the potential for a trade-off. When impact investments yield lower returns than nonimpact portfolios, how much return should an investor be willing to give up to incorporate it? Using recent advances in goals-based utility theory, this article explores an answer to that question and offers practical and concrete advice for advisors to individual investors and fiduciaries of trusts. Using the goals-based framework, the author shows how an investor’s willingness to sacrifice return for an impact investing mandate changes in response to market and portfolio conditions.

Goals-based investing, impact investing, portfolio management, utility theory