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Finally a decent report on Impact Investing! Thank you so much Hauke and John. Will be sending this to a fair few people.
Only wish there was a more clear division between ESG ($trillions), socially-minded angel/VC ($hundreds of billions) and those that are technically social enterprises but for all intensive purposes look like charities with business models ($hundreds millions).
I feel like most the donor conversations I have about impact investing are about the latter, even though the vast majority of the market is represented by the former.
Found Bridgespan’s 2018 report useful and interesting.
https://www.bridgespan.org/insights/library/impact-investing/what-is-impact-investing
I strong upvoted this. I think it’s great to have a reference piece on this, and particularly one which has such a good summary.
It’s super important to be thinking about the actual impact of impact investing. There’s a lot of rhetoric out there that’s not backed up, and this paper does a good job of pointing out that in public markets, investing doesn’t impact stock price. That said, there’s a few things related to public market investing that could use some more investigation.
1. I don’t think many public equity impact investors see their primary means of impact as shifting stock price. They create impact through your point 6 - signaling and improving portfolio companies. A more thorough exploration of the potential impact of signaling and the direct impact of shareholder advocacy compared to the impact of donations would make your argument more compelling.
In the report, you say that “Thus, the indirect effects of divestment campaigns are likely to be much greater than the direct effects.
This being said, we think that, given the financial opportunity costs of socially responsible investing, for people aiming to have maximal social impact, socially neutral investing to donate to effective charities will usually be more effective.”
Could you point out the justification for this claim? It certainly might be true, but I’m wondering what makes you think it is so. Also I think it’s really important to consider the wealth of literature supporting the impact of shareholder advocacy. This paper has a nice summary of some of that literature:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3289544
2. You note that the assumption of reduction in financial performance from ESG investing isn’t backed up by empirical evidence—you note in your report that there is no clear relationship shown in the literature. But it seems like you find the theoretical argument compelling enough to overcome the empirical data—which is not impossible, there could be noise that leads to inconclusive empirical data. But, I am not convinced that the theoretical argument is iron-clad enough to overcome the ambiguity in empirical data.
From your report: “Overall, our view is that screening portfolios will reduce expected financial performance. There is no theoretical explanation for the finding from some studies that screening one’s portfolio improves or does not harm financial performance.” The assumption seems to be that ESG performance is orthogonal to financial performance, I may have missed where this is justified.
A possible theoretical explanation of why screening doesn’t hurt performance: It could be possible that ESG performance is actually a driver of financial performance (or at least risk reduction)? Every active investor has a funnel. Some screen out companies with low profit margins because of a particular investment thesis. Others screen out companies with poor ESG performance because of a particular investment thesis. This idea is becoming more popular—that ESG investing is a part of good investing. See SASB for some of the case that ESG performance impacts financial performance.
https://russellinvestments.com/-/media/files/us/insights/institutions/governance/materiality-matters.pdf?la=en
https://dash.harvard.edu/bitstream/handle/1/14369106/15-073.pdf
[Speaking for myself here not necessarily Hauke.] Hello thanks for these smart comments.
1. Although there is some evidence that the indirect effects of campaigns are more substantial, the evidence isn’t all that good as divestment campaigns were often combined with boycotts and other campaigns. Secondly, take the example of Norway’s sovereign wealth fund, where tobacco divestment cost them $2bn. I would be very surprised if the indirect effects of this gesture would have been more damaging for the tobacco industry than spending the money directly on campaigns against tobacco, which looks a highly cost-effective approach. The aim of the divestment campaign would be to raise awareness among governments presumably, but if that is your aim, it seems to make sense to try to do that directly through ordinary advocacy approaches. I agree that the report could have been clearer on this.
2. The argument in that section was that genuinely strict socially responsible investing would involve financial sacrifice, and ESG-focused screening is not strict. Many socially responsible today don’t exclude all companies in harmful industries. Generally, there is a dilemma for proponents of SRI. SRI is supposed to affect the cost of capital of harmful industries. If it succeeds, then the stock price of these companies will be higher than otherwise and people who invest in them will be able to make excess returns.
I think all of this makes complete since if you look at this from the perspective of the marginal individual investor. However, when you think about the push that institutions are making towards esg, and the rise of impact investors in private equity, I think there’s significant impact to be had, and as an individual, if you choose to be part of that industry, I think that’s broadly impactful things to do.
As a venture builder, I’ve worked with quite a few impact investors. I recently recorded a conversation with an impact investor (working with Leapfrog Investments) to address some of these points, so feel free to give this a listen if this debate is of interest to you.
https://podcasts.apple.com/sg/podcast/episode-1-impact-investing-what-is-it-good-for/id1487424474?i=1000456446152&fbclid=IwAR30nAzVl6MwiJIEFfSjI3qj9Ons-ai4kTXtHKyjJ2RH_EEGNIsS63_g4XM
Will summarise some of the key arguments here:
1. In public markets, big institutions (like Blackrock and Fidelity) taking ESG screening more seriously is a huge positive. These institutions often have a seat at the board and represent a large enough capital base that they can threaten to pull out if ESG targets are not met. It is not true in this case that “socially neutral” capital will flow in and replace these investors due to the market power they have. So pushing for more esg focus in big asset managers can be a very impactful career. However, this does mean in the short term, some return goes off the table, as the company might have to stray from doing the most profitable thing in the short term, if that’s in conflict with esg standards.
2. In the private equity, venture capital space—you have to look at the effects of changing the supply of capital. If more capital , on average, is socially conscious and more geared towards renewable energy ,for example, rather than consumer internet, that’s a great thing. Because availability of capital partially determines where entrepreneurship is incentivised. For example, it took risky venture capital bets for decades in the consumer internet space to help companies figure out which business models work and which don’t. The availability of capital helped entreperneurs iterate on good business models. If this is done in broadly more productive industries and sectors that actually improve well-being, that’s something we should welcome.
3. Having said the above, the impact investing space has serious issues to deal with—standards of impact measurement are pretty low, feedback loops aren’t working properly and yes, people need to be more mindful of the opportunity cost of donating to a more effective charity. However, the assumption behind impact investing is that you at least get to recycle capital while spurring growth in an developing country and improving living standards. So comparing it to one time donations is not an apples to apples comparison. One has to prove that donating to the effective charities now is better than waiting to recycle capital, and then donating to charity, accounting for time value of money.
This article brought some very interesting points that weren’t so clear in 2018 but a lot of development has been made into ESG / SRI standards (although I feel its generally quite opaque and hard to track claims and reporting).
That being said, I believe it would be interesting to do a similar in depth analysis for private entities vs public markets. Despite the value of public stock markets, a lot of business still gets done in private markets (ex: roughly 50% of European GDP comes from SMEs). I believe the most relevant form of impact investment is in non-public entities now a days.
Hi there, I’m assuming this is written for everyday investor, but not as a critique to the whole sector?
I think some of the nuances and innovation in impact investing are overlooked in this article, though I would agree it is harder for everyday investors to tap into the sector (at least for now). However, I don’t think the solution is necessarily to just opt for donation:
(1) Simply by demanding more ethical or impact-led investment products, this will change the behaviours of fund managers and businesses. Already, there are more and more ethical products on offer, because millennials are more socially conscious. Of course, we don’t want to encourage “impact-washing” but that’s a whole different topic.
(2) There is no mention of innovative financial models used by the impact investing sector. An example is blended finance. As opposed to just giving out philanthropic donation, you can leverage that to draw out private capital. These are private capitals that would otherwise not be accessible, so I would argue this is additionality. Impact bond is another model, where you know for sure the investment is used to achieve the outcomes defined (i.e. no payment for investor if outcomes not achieved). If you were going to donate that money anyway, an impact bond gives you the chance of receiving a return + interest. If done right, impact investing can do good at scale where pure philanthropy cannot.
(3) I think a more subtle and contentious point is, by introducing market mechanism, you are forcing NGOs and social enterprises to step up their game. They need to have accountability, and are forced to be more resourceful. Effective charities stay, less effective ones die out.
Of course, impact investing is by no means a silver bullet. As of now, its financial models are more geared towards larger charities, so small/new charities would still rely primarily on donations. Philanthropy still plays an important role, but I would argue it is insufficient to solve problems at scale.
Great to have something written down on this—thanks very much guys!
I too have worried about some of the issues highlighted here and ended up not doing any impact investing for this reason. However a benefit of impact investing is that you get the money back and can invest it a new venture (or donate it) later. So to accept your conclusion that impact investing is (usually) less good than donating, you would have to believe that the problems with impact investing (e.g. crowdedness) are bigger than the benefit of getting your money back. I actually suspect that they are (so I’m in agreement with you) but I don’t think I saw this comparison done in the report. (Although admittedly I read it fairly quickly, so sorry if it’s in there and I didn’t spot it)