Impact investing is only a good idea in specific circumstances

Link post

I’ve re­cently writ­ten a re­port on im­pact in­vest­ing in col­lab­o­ra­tion with John Halstead at Founders Pledge. We find that effec­tive im­pact in­vest­ing is very hard and, to max­i­mize so­cial im­pact, it is usu­ally much more effec­tive to donate. You can read the Ex­ec­u­tive Sum­mary be­low. You can down­load the full re­port on the Founders Pledge re­search page as well as Lets-Fund.org.

[Edit: 09/​01: We have made some minor ad­just­ments to the fram­ing of our find­ings in the Ex­ec­u­tive Sum­mary and Sec­tion 4.3 of this re­port fol­low­ing the pub­li­ca­tion of a piece on im­pact in­vest­ing by Vox that men­tioned this re­port. We be­lieve the Vox piece took a more crit­i­cal stance on im­pact in­vest­ing than was war­ranted from the ar­gu­ments here, and have made changes to our re­port to avoid mi­s­un­der­stand­ing. ]

EXECUTIVE SUMMARY

Im­pact in­vest­ing – in­vest­ing in, or di­vest­ing from, for-prof­its for the pur­pose of so­cial im­pact – is an in­creas­ingly pop­u­lar ap­proach to do­ing good. It seems to offer the promise of a dou­ble bot­tom line: di­rect so­cial im­pact and prof­its that you can keep or rein­vest in other so­cially benefi­cial busi­nesses. A dona­tion to char­ity, in con­trast, yields no mon­e­tary re­turns and can only be spent once. In this re­port, we dis­cuss whether im­pact in­vest­ing is in­deed a promis­ing ap­proach for peo­ple who want to have so­cial im­pact.

Im­pact in­vestors face two dis­tinct challenges:

  • In­vestors must find com­pa­nies with en­ter­prise im­pact – com­pa­nies that make a pos­i­tive differ­ence to the world.

  • In­vestors must have ad­di­tion­al­ity – they need to make a differ­ence to the perfor­mance of those com­pa­nies, ei­ther through pro­vid­ing ad­di­tional cap­i­tal (known as in­vest­ment im­pact) or through pro­vid­ing non-mon­e­tary sup­port, such as ad­vice or ac­cess to net­works.

For both of these challenges, it is cru­cial to con­sider the coun­ter­fac­tual. That is, we have to ask: what would have hap­pened had we not in­vested? Will a given so­lar power com­pany merely dis­place an­other near-iden­ti­cal so­lar power com­pany? Will my cap­i­tal merely dis­place an­other in­vestor? This marks a cru­cial differ­ence be­tween in­vest­ing for profit and in­vest­ing for im­pact. When in­vest­ing for profit, we do not need to con­sider these kinds of ques­tions. If the so­lar power com­pany I in­vested in is mak­ing a $100 mil­lion profit, it doesn’t mat­ter whether an iden­ti­cal so­lar power com­pany would have sprung up one week later if the com­pany did not ex­ist. And if I made a sub­stan­tial profit from my in­vest­ment in the com­pany, the fact that some­one else would have ac­quired those prof­its had I not done so is ir­rele­vant. When aiming for so­cial im­pact, how­ever, these ques­tions are fun­da­men­tal.

When we are de­cid­ing whether to im­pact in­vest, we must also con­sider the op­por­tu­nity cost of im­pact in­vest­ing. In the same way, if we want to make a profit, we wouldn’t com­pare the re­turn on our in­vest­ment to what we would have got if we had done noth­ing. In­stead, we would com­pare our ROI to what we could have done oth­er­wise with the money: if I chose an in­vest­ment with a 3% re­turn, but an­other available in­vest­ment had an 8% re­turn, then I would have made a mis­take. The same is true if our aim is to have so­cial im­pact.

If our aim is to do the most good, there are two al­ter­na­tives to im­pact in­vest­ing:

  • In­vest­ing to give – In­vest­ing for profit to donate later to effec­tive charities

  • Donat­ing now – Donat­ing the money to effec­tive char­i­ties now

Hav­ing so­cial im­pact through dona­tions is much more difficult than many peo­ple imag­ine, and it is easy to miss out on huge im­pact mul­ti­pli­ers in philan­thropy. How­ever, if done care­fully, the so­cial benefits of these al­ter­na­tive ap­proaches can be sub­stan­tial. Re­views of our recom­mended high-im­pact char­i­ties are available on our re­search page.

Key points

The key find­ings of this re­port are:

1. Find­ing an im­pact­ful com­pany is hard

The most promis­ing com­pa­nies will pro­duce pos­i­tive ex­ter­nal­ities or benefit con­sumers in poor coun­tries, and fo­cus on high-im­pact cause ar­eas, such as global poverty and health, an­i­mal welfare, or cli­mate change. How­ever, ev­i­dence sug­gests that it is difficult to iden­tify in ad­vance which so­cial pro­grammes will work: the path from ac­tion to so­cial im­pact is usu­ally not as you would ex­pect. So­cially benefi­cial busi­nesses have to solve two very difficult op­ti­mi­sa­tion prob­lems si­mul­ta­neously – turn­ing a profit and hav­ing im­pact. Con­se­quently, find­ing vi­able com­pa­nies with en­ter­prise im­pact will not be straight­for­ward. Our re­search sug­gests that many im­pact in­vestors seem not to carry out rigor­ous or an­a­lyt­i­cal im­pact eval­u­a­tions.

2. It is hard to have ad­di­tion­al­ity in large pub­lic stock markets

Many im­pact in­vestors try to af­fect the stock price of com­pa­nies in pub­lic stock mar­kets, ei­ther by boost­ing the stock price of benefi­cial com­pa­nies or by dam­ag­ing the stock price of harm­ful com­pa­nies. Th­ese efforts are com­pli­cated by so­cially neu­tral in­vestors (who only seek profit), who can po­ten­tially offset any effects on the stock price. For ex­am­ple, if im­pact in­vestors di­vest from an in­dus­try, so­cially neu­tral in­vestors can move in to buy up the un­der­priced stock. There is clear ev­i­dence of short-term mar­ket in­effi­ciency such that im­pact in­vestors can af­fect stock prices on the timescale of around 3 months. There is ex­pert dis­agree­ment about whether so­cially re­spon­si­ble in­vest­ing is likely to have an effect af­ter 6 months and be­yond: some economists hold that the effect will be com­pletely offset, some that more than half will be offset, and some that a sub­stan­tial frac­tion of the effect might per­sist be­yond 6 months.

Given the size of the mar­ket cap of firms tar­geted by so­cially re­spon­si­ble in­vest­ing, it will also be difficult for most in­vestors to have any sub­stan­tial effect on stock prices in the first place. More­over, if you in­vest in a so­cially benefi­cial com­pany offer­ing mar­ket-rate re­turns, then you will likely merely dis­place a so­cially neu­tral in­vestor. This means the coun­ter­fac­tual im­pact of your in­vest­ment is merely to provide ad­di­tional cap­i­tal to the stock mar­ket as a whole. For all of these rea­sons, the di­rect im­pact of any sin­gle so­cially re­spon­si­ble in­vestor in large pub­lic stock mar­kets is likely to be mod­est at best. All this be­ing said, gen­uine strict so­cially re­spon­si­ble in­vest­ing is un­doubt­edly more so­cially im­pact­ful than in­vest­ing solely for per­sonal profit. Even if the di­rect effects on stock prices are mod­est, the in­di­rect effects ap­pear to be more sub­stan­tial. Thus, the ar­gu­ments here do not give li­cense to ig­nor­ing di­vest­ment move­ments solely in or­der to make money.

3. There is more scope for ad­di­tion­al­ity in VC and an­gel investing

In in­effi­cient mar­kets with fewer in­vestors and with im­perfect in­for­ma­tion, there is more scope for your in­vest­ment to make a differ­ence to the com­pany’s cost of cap­i­tal. How­ever, find­ing and ex­ploit­ing mar­ket in­effi­ciency is difficult. Even in VC and an­gel in­vest­ing, the risk that your in­vest­ment merely dis­places some­one else’s re­mains a fun­da­men­tal con­sid­er­a­tion.

4. There is a trade-off be­tween fi­nan­cial re­turns and so­cial impact

In­vestors seek­ing mar­ket-rate re­turns risk merely dis­plac­ing so­cially neu­tral in­vestors. Con­se­quently, im­pact in­vestors may need to ac­cept lower re­turns for the sake of ad­di­tion­al­ity. Im­pact in­vestors also in­cur ad­di­tional costs in iden­ti­fy­ing, eval­u­at­ing and sup­port­ing the busi­nesses they in­vest in. If you ac­cept lower mon­e­tary re­turns, then you are giv­ing up money that could be donated to effec­tive char­i­ties.

5. Your in­vest­ment might merely dis­place an­other im­pact investor

Even if you ac­cept sub­par fi­nan­cial re­turns, you need to con­sider the risk that your in­vest­ment merely dis­places an­other im­pact in­vestor who is also will­ing to ac­cept sub­par re­turns.

6. Im­pact in­vest­ing has other benefits

Although they ap­pear to have had mod­est di­rect effects on stock prices, di­vest­ment cam­paigns might in the past have helped to stig­ma­tise tar­geted com­pa­nies and in­dus­tries, which in turn has helped to change con­sumer at­ti­tudes and en­courage re­stric­tive reg­u­la­tion. Own­ing the stock of a com­pany also gives you some con­trol over how it op­er­ates, al­low­ing you to po­ten­tially steer it to­wards so­cially valuable ends or to pre­vent mis­sion drift.

This sug­gests that, for peo­ple aiming to have max­i­mal so­cial im­pact, im­pact in­vest­ing is likely to be the best ap­proach only in spe­cific cir­cum­stances. Im­pact in­vest­ing might be a good op­tion for peo­ple who:

  • Work on an im­por­tant prob­lem that is ne­glected by other investors

  • Do VC or an­gel investing

  • Ac­cept fi­nan­cial sacrifice

  • Have an in­for­ma­tional ad­van­tage over other in­vestors that al­lows them to re­li­ably iden­tify promis­ing op­por­tu­ni­ties

A good ex­am­ple of a case fit­ting the above crite­ria would be an in­vest­ment in a com­pany pro­duc­ing a rev­olu­tion­ary meat-al­ter­na­tive product that is on the brink of fi­nan­cial vi­a­bil­ity but is, for some rea­son, ig­nored by other so­cially neu­tral or im­pact in­vestors. How­ever, when the con­di­tions above can­not be satis­fied, in­vest­ing to give or donat­ing now are likely to be a bet­ter bet, if done care­fully.

The de­ci­sion about whether to pur­sue for-profit or non-profit solu­tions to prob­lems de­pends on a few fac­tors. For-prof­its have some ad­van­tages over non-prof­its in that for-prof­its tend to be more effi­cient and cus­tomer-fo­cused. How­ever, for prod­ucts that are not yet mar­ket vi­able, such as pub­lic goods, non-prof­its will be more promis­ing. Non-prof­its also tend to be more ne­glected be­cause the in­cen­tives to sup­port them (i.e. prof­its) are lack­ing. Re­search on effec­tive char­i­ties is im­prov­ing all the time, al­low­ing donors to have truly out­stand­ing im­pact for their dol­lar.

We briefly try to gain an im­pres­sion of the im­pact in­vest­ing space by ex­am­in­ing an im­pact eval­u­a­tion by an im­pact in­vest­ing plat­form that is a field leader in im­pact eval­u­a­tion. Our in­ves­ti­ga­tion showed that dona­tions are likely up­wards of 10x more im­pact­ful than the im­pact in­vest­ing plat­form, and that there are key gaps in the eval­u­a­tion car­ried out by the im­pact in­vest­ing plat­form.