All investments deliver impact. However, in order for a family office to really drive impact, they need to clearly define it and then propose how they plan on achieving it. This forms the foundation of an impact thesis – a working document that guides the operations and strategy of an impact fund.
Now whilst this may sound simple, the process of co-creating this shared definition of impact (and success) and then using a series of experiments to achieve it, is not. So what methods can you use to de-risk this process by generating alignment amongst wealth owners and managers, and in turn deliver the desired future impact of capital deployed?
This process is a hybrid of methods. Firstly building on a framework used in effective philanthropy called the theory of change, which defines long-term goals and then maps them backward to identify necessary preconditions. To achieve this requires collective agreement on how to define success, both amongst the investors and investment managers. This means it has to be a co-creational process, which is perhaps the toughest part, and benefits from a third party facilitating or driving the process to keep things on track.
Then next, in order to proactively define this future goal or goals, an array of future scenarios need to be explored and devised. To do this some of the methods from foresight strategy can be added to the model. Once these scenarios are agreed upon. The core theory then needs to be distilled down to a strategic “north star”, which borrows from the world of branding. Then finally to put this theory into action which will require input from investment theory.
The theory of change meets foresight strategy
A method of problem-solving that starts at the end results and then reverse engineers, or “backcasts”, the process based on the organization’s capability. It was originally attributed to earlier work on Peter Drucker’s articulation of “Management by Objectives”.Theory of Change extends beyond goals (commonly named Outcomes in Theory of Change terminology) and Objectives to include Impact – the anticipated result of achieving stated goals.
While the theory of change is a proven effective framework, it can at times prove to be less proactive in defining that desired future impact and potentially ignore some of the signals and risks that could throw that desired impact off course from being achieved.
Enter the process of foresight strategy. This process is a bit more explorative starting with a series of future scenarios both ideal and undesirable. It builds up these scenarios based on signals, trends, patterns from the past as well as potential macro predictions of the future.
Ideally, multiple stakeholders contribute to the preferred vision, through a series of exercises that are intended to provoke exploration and discussion. Now, much in the same way as the theory of change the path to this preferred future is then backcast. In order to do this, there are three key steps to achieve an actionable strategy, which then feeds into the impact investment thesis namely: explore implications, set the guiding principles, and define the strategy.
From implications to principles
Once the preferred vision of the future impact is clear and agreed upon through prior exploration around risk factors and macro effects, then implications of these future scenarios need to be distilled down. In plain terms, what does it mean to achieve this impact? What are the pre-conditions that would allow this to be effective? Once a few key implications for the family office’s potential fund are clarified and agreed upon, then principles need to design that will allow for this impact to come to life.
Principles are fundamental truths or propositions that serve as the foundation of a system. Now most successful investors will understand the importance of principles, which work as mental shortcuts to guide an investor to act rationally and help embed long-term thinking when there are high levels of uncertainty. In fact Ray Dalio, hedge fund titan is famous for applying the process of principles created to both his work and life.
Now when transitioning from implications to principles, the key is simplicity. Try to simplify the language as much as possible and see these principles as keys to broader concepts which are the counterbalances to the implications you had previously explored. Whilst these principles are powerful tools for decision-making for the family, remember that, like the family and the team that serves them, they may very well evolve with time, as are often based on assumptions that need to be tested to prove they are not entrenched in bias.
Principles as the foundations of a strategy
Once you have clearly defined what the principles of a fund should be, based on the implication caused by a desired future scenario and impact., you need to put this into action. To get there you need a north star. This is your strategy. A strategy or impact statement needs to be as clear and specific as possible, however with the fewest words possible.
Crafting this statement is tough, however here we can lean on the methods used in branding and communication. Start by defining the basics of your value proposition why, what, how is this fund going to achieve the desired impact that the family has agreed as to their desired future scenarios for it.
Moving from strategy to action through micro-experiments.
The reason an investment thesis is called a thesis is that it’s a theory. Now to test that this theory is in fact correct, a series of experiments need to be actioned in order to see if the method of achieving the desired long-term impact is correct. Naturally, this is the hard part. Now in the case of a fund, these experiments are investments. Here it’s important to understand the financial mechanisms that offer the highest potential for achieving the desired long-term returns.
Yet alongside this financial incentive is, of course, an impact incentive whereby you need to be able to understand whether the returns and impact of each experiment collectively drive you towards your desired future. And if not, why not? This process of experimentation is methodical and iterative, and understandably difficult. However, by this point, you are set for success through having explored multiple future scenarios understanding what principles are required to guide your thinking, and having a clear and agreed-upon a north star.
The result? A higher chance of achieving the intended impact that the wealth owners had co-created by the investment team.