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Impact investing is a small but growing segment of the financial landscape. It is coming to the fore as individual investors seek to “do good while doing good.” Groups from wealthy entrepreneurs to the G8, the UN and the Pope are talking about the subject. Here’s what advisors need to know if they want to serve clients who strive for “impact” with their investing.
First, let’s look at how Google has bought into the impact-investing trend.
In a well-publicized, but somewhat puzzling move, Google, one of most recognized brands on the planet, recently changed its name to Alphabet. This runs counter to all business school theory that preaches the importance of building a dominant global name. Thus many MBA types were left aghast at the news that overnight Google was now recast as a subsidiary to the Alphabet holding company.
Yet when you get beyond the noise, a story begins to emerge of a pair of founders – Larry Page and Sergey Brin – who are not content to settle for incremental brick-by-brick approach to brand building. Instead, they want to invest in high risk, high impact “moon shots.” “From the start we’ve always strived to do more, and do important and meaningful things with the resources we have,” Larry Page wrote in a press release in August. These high-stakes ventures – driverless cars, cancer drugs and virtual reality to name a few – have now been placed in subsidiary businesses under the Alphabet umbrella.
There is great business logic behind the move. Each business is now accountable to the holding company and any losses do not impact the still highly profitable Google franchise. The name, Alphabet, also makes sense. A rate of return above normal – Alpha – and a gamble – bet.
The new-look Google is striving to make an impact on the world.
In many ways this decision adds to the mounting evidence that government aid and philanthropic activities are not able to have the desired impact and the recognition that perhaps private enterprise is the best vehicle to solve some of the world’s most intractable social problems. Indeed, Warren Buffett presaged this trend when he famously left his wealth to the Gates Foundation.
But, if private enterprise is the way forward, how do individuals who lack the financial muscle of these business icons make an impact on society? Is it possible to drive meaningful change with much smaller wealth?
Welcome to the world of impact investing
We may look back at the financial upheavals of the first decade of the 21st century as a significant turning point in human history. Since those dark days, there has been a growing consensus around a belief that some of the world’s problems require new approaches. Perhaps, even, a tacit acknowledgement that some problems cannot be left for others to solve. As a result, a growing number of wealthy individuals are becoming attracted to a sector of the market called impact investing.
Impact investing can trace its origins to before the financial crisis, but it has only been since these events that this area has taken on greater prominence. A simple definition of its raison d’etre is “making a return while doing good.” In other words, investors seek opportunities where they can deploy capital to make an above-market return while also benefiting society. The socially conscious investor who seeks to make a rate of return above the market but does so by avoiding investments in companies viewed as detrimental to society, for example tobacco and alcohol, differs from an impact investor who seeks to make a difference by investing in businesses striving to improve human wellbeing such as through education and healthcare.
The emergence of impact investing as an asset class is still very much in its infancy. According to the Aspen Institute only $46 billion out of $80 trillion of investable assets is allocated to impact investing – in other words, less than 1% of investable assets. In recent years much of the focus has been in less developed countries, where the need for change and the opportunity to make a difference is greater. But recently a chorus of voices has suggested that this is a way to solve some of our domestic problems, especially around education and poverty. The idea, therefore, of being able to invest money into early-stage socially impactful businesses and make a rate of return as well as a mark on society is gaining traction and becoming part of the lexicon of investing.
In this nascent sector, the easiest way to find opportunities is to invest in a pooled-asset vehicle such as a Limited Partnership. The investment manager can then combine investor capital and find suitable emerging businesses in which to allocate funds. This is the same model as venture-capital funds, but, unlike that well-established marketplace, impact investing has some challenges. Namely, it is hard to locate suitable deals (especially overseas) and locate fund managers with the expertise necessary to be successful in this sector. The Aspen Institute also points out that many would-be social entrepreneurs complain that they have trouble connecting with impact investors and these investors are not willing to take the necessary risks.
In short, there is both a human talent and information gap in the market that needs to be closed if this corner of the investing world is going to succeed.
With this gap comes opportunity, though, and we are being to see the emergence of organizations that can solve this equation. On the one hand, companies are appearing that have the management talent who can go into these emerging business and grow the enterprise and prove out the business model. On the other, as the sector grows in size, new experienced investment managers are coming to the fore to assist with capital allocation. These trends will take time to converge, but there is significant momentum building and clearly opportunities are emerging – both domestically and overseas.
How are we doing?
Skeptics of the asset class suggest that little of the impact-investing market actually matches its description. In other words, it is difficult to quantify the actual impact. Indeed, some argue that time is better spent investing in companies that make money so any profits can be given to charity or to start a business that will benefit customers, employees and society*. But this message misses the bigger picture trend afoot – namely a desire to do something in the world to make a difference by using the tools of the free market.
To counter the skeptics and to give greater substance to this area, the Global Impact Investing Network in partnership with Cambridge Associates, has just launched the Impact Investing Benchmark so that investors finally have a tool to assess just how successful firms that invest in this arena are doing. The results to-date show that it is possible to achieve market rates of return, but, not surprisingly, investment selection is the key driver of success.
As some of the data goes back to 1998, the benchmark also documents growth and begins to bring legitimacy of the sector. But more importantly, perhaps, the data helps future investors make better decisions. In turn this forces greater accountability among investment managers. All of which should, over time, close the human-talent and information gaps.
There is room for improvement. For example, the current data set is limited and in need of expansion so that accusations of cherry picking can be overcome and more types of investment strategies should be included. However, this is a valuable addition and signifies the coming of age of impact investing.
Coming to the fore
The emerging prominence of the sector was evident when the G8 (the group of the world’s eight leading economic powers) embraced impact investing with the formation of the Social Impact Investment Taskforce. The aim of this initiative was to influence and shape the development of the social-impact investment market. In other words, there was recognition within the governments of the world’s eight leading industrialized nations that the forces of impact investing could be used for the greater good if a proper foundation were build. Spearheaded by the U.K., the final report published in September 2014 outlined how impact investing was the “invisible hand of the markets” and outlined how it harnessed entrepreneurship, innovation and capital to power social progress.
Pope Francis added his substantial voice to the movement by stating, “It is urgent that governments throughout the world commit themselves to developing an international framework capable of promoting a market of high impact investments and thus to combating an economy which excludes and discards.”
Finally, the United Nations has entered the arena by integrating impact investing into the U.N. Sustainability Development Goals (SDG’s). These SDG’s contain 17 goals with 169 targets covering a broad range of sustainable development issues. These include ending poverty and hunger, improving health and education, making cities more sustainable, combating climate change and protecting the oceans and forests. The SDGs are due for final approval at the end of September 2015 and mark the UN’s focus over the upcoming years.
Some of the world’s most powerful voices are pushing for the tools of private enterprise to be used to make a societal difference. Impact investing is being seen as a necessary cog in the allocation of investment capital.
Catch the wave?
Impact investing is capturing the imagination. It is recognition that private enterprise is emerging as the best way to solve some of the Earth’s most pressing issues by more effectively managing and deploying capital. At the macro level, the momentum is building with some of the world’s largest economies and institutions on board. At the micro level, the foundation is slowly being put in place so that much greater transparency exists for all investors. Investors in this sector want to understand the good they are doing as well as their rate of return.
The founders of Google have the financial wherewithal to fund their own “moon shots;” their new corporate structure will enable them to take high risks without worrying about the vagaries of Wall Street. For the rest of the investing public, impact investing remains an Alphabet soup, but it will not be long before clarity emerges and individuals will be able place their own Alpha-bets on making a difference in the world and reaping a financial return while doing it.
John Appleby is a managing director with CAPTRUST Financial Advisors, a North Carolina investment advisory firm.
References
*For a more detailed argument see: Is Impact Investing Just Bad Economics by Phil Demuth. Forbes 4/24/2014
The Bottom Line: Investing for Impact on Economic Mobility in the US. By Randall Kempner and Alex Pan – The Aspen Institute.
When Can Impact Investing Create Real Impact? By Paul Brest and Kelly Born – Stanford Social Innovation Review Fall 2013.
The Coming of Age for Impact Investing. By Amit Bouri – Stanford Social Innovation Review August 3, 2015.
For a copy of the G8 report of impact investing see www.socialimpactinvestment.org
For a summary of the United Nations Sustainable Development Goals see The Guardian Newspaper www.theguardian.co.uk September 3, 2015
Other Resources
www.theGIIN.com
www.andeglobal.org
Read more articles by John Appleby
