Impact investing would seem to be a hot topic these days. For example, this very magazine has run at least four different articles on the subject in the past few months (see here, here, here and here). Also, my very own research center was recently given a multi-year research grant to try to make sense of the impact industry. In short, there’s a lot that’s going on, but there’s also a lot missing, such as a consensus around definitions of impact investment or even an understanding of the impact investment ecosystem. So, grab a cup of coffee and a biscuit and let me tell you what I think about impact investing, and why I believe it could be a very powerful force for positive change in the world.
The broad idea of impact investing — at least the version of impact investing that I can get behind — seeks to leverage capitalist means to achieve social and environmental ends. Put simply, it uses financial investments to drive extra-financial outcomes. In my mind, impact investing in its most elegant form resembles artfully executed judo; it works within capitalism’s institutions and organizations and leverages its own power to undo the problems that capitalism itself helped to create. After all, if you’ve got a global problem to solve, why not tap the same force that gave us globalization?
Admit it, that’s at least a little bit compelling, and it’s also not unfathomable. We know that capitalism in the right hands can drive profound impact. After all, every investment — every single one — has an impact of some form or another on somebody or something. It’s just that some of those investments will wind up also having positive social or environmental impacts (externalities). Silicon Valley, where I live, has launched companies that help bring down dictators (Facebook,Twitter); that change the way we consume energy (Tesla, Nest, Opower); that help manage scarce resources through unique insights (Climate Corp, OpenGov, Palantir); that create a more sustainably built environment (Solar City, Clean Power Finance, Project Frog); or provide access to the final frontier (SpaceX). It’s in this sphere that I think impact investing can be most powerful.
Now, there are those that view impact investing as a sort of middle ground between charity/philanthropy and the icy-veined, take-no-prisoners business of Wall Street. Viewed in this light, however, impact investing becomes “‘fence-sitting” — a way to recycle capital without giving it all away or giving up on ethical objectives. But rather than viewing this as impact investing, I’d say this is really impact indecision. There are also those that want to think that institutional investment in infrastructure counts as impact investing, and, in general, I’m fine with that; infrastructure is immensely powerful in terms of its impact on communities. But is that really what we mean when we say impact investing? Infrastructure?
In my mind, impact investing is about catalyzing companies and industries that generate positive social and environmental outcomes (without negative secondary or tertiary effects), while also positioning to profit from their rise and impact. With this in mind, I’ve pulled together some key principles that reflect my current, though not fixed, thinking:
*Catalyze: Impact investors should look for opportunities to create new companies, markets or industries. This can be done in simple ways, such as bridging a company across a funding gap or signaling to the world that an opportunity is investable (simply by investing in it as a credible party). The best impact investments are those that identify “titration” opportunities; this refers to a chemical reaction where a solution suddenly switches from being acidic to basic after a reagent is added. There exists in the world opportunities where a few impact dollars (the reagent) can change an entire environment (solution) from un-investable to investible (acidic to basic). And once it’s investable, the power of capitalism can take it forward to the marketplace.
*Optionality: If you do catalyze a new industry or help bridge a company across the “valley of death,” why wouldn’t you want to participate in the upside? As I see it, impact investors have to be adept investment bankers, putting creative transactions together that allow for different risk appetites and lots of optionality along the way.
*Deadweight Loss: Impact investors should avoid doing things that either the government or the free market would do on their own. If impact dollars are there to be catalysts, there’s really no social or environmental value in catalyzing something that would have happened anyway.
*Unintended Consequences: Impact investors should learn from the failures of government and capitalism and try not to make short-term decisions that lead to long-term problems. It’s a relatively simple concept that warrants lots of scenario planning.
*Profits: Different pools of capital will have different return objectives. And I definitely see the value of philanthropic capital that has relatively low or even no return objectives. (In fact, some would say this capital is the most valuable to society.) But my personal opinion is that impact investors should not, a priori, take a hit to their financial returns or underwriting. Why? Because if they are trying to use capitalism to maximize impacts beyond the capitalist system, then high financial returns for impact investments are crucial. To me, that implies rapid growth of a socially or environmentally positive company, therefore, returns.
*Rigor: Impact is not an excuse for a lack of rigor in investments. In fact, if you’re going to try to use financial markets to drive extra-financial benefits, you need to be more rigorous and savvy than the average investor. Or, at the very least, you better understand your strengths and weaknesses very well.
So how can you do all of this? As I see it, the best way to combine all of the above themes is to get involved with small- and medium-sized enterprises (SMEs) and then work hard to have a real influence on their future trajectory. You help the good ones succeed commercially. You push the ones that are ambivalent about impact to integrate impact thinking into their day-to-day operations. And as for the ones that are potentially going to play a negative role in society, you roll up your sleeves and push them (hard) to pivot — and in return for pivoting, you help them succeed.
And you only do these things in sectors where you are highly credible and carry influence. Could impact investors have an influence on large companies? Sure. For example, private equity shops have big impacts on medium and large corporations – it may not be the kind of impact you’d like to see, but their impact is undeniable. For the rest of us, focusing on small- and medium-size opportunities may be the best path. Doing this demands a new set of investment logics and tools. For example, you need to catalogue the areas where you feel you can add value and indeed influence SMEs. And then you need to identify companies or opportunities where you can personally (or organizationally) influence outcomes. And then you need to get to work.
So, that’s my vision for where impact investing can truly have an impact. This raises a question: Why aren’t more people within the impact investing universe talking about this sector in these kinds of terms? It’s a tough question and the answer won’t make me make me many friends in the mainstream finance world (not that I have many at this point anyway).
As I see it, most impact investors don’t really understand what they are trying to accomplish. They don’t understand the business of finance and investment. In fact they are often frustrated by the finance industry and the role it has played in creating short termism and negative externalities. And, yet, they still often revert back to the traditional finance industry for help in this domain. Check out this actual blurb from a recent article describing the amazing opportunity that impact investing represents: “There are a number of big players on the scene to help understand where your impact investing can be most successful. Among these are investment firms such as JPMorgan Chase, Goldman Sachs, and Morgan Stanley, which have dedicated staff to advise on impact investing.” Ugh. Really? Oh I bet they do have dedicated staff. And plenty of fees.
Most of the financial intermediaries I see in today’s impact investment ecosystem aren’t really in the business of driving impact; they are in the business of selling product. It just so happens that slapping an impact label on their product seems to create higher demand and thus allows for higher margins. (See “organic” in the food business as a similar case.) But don’t kid yourself; the powers-that-be at the big Wall Street banks didn’t get to be where they are by pushing for more social and environmental appreciation. These banks are moving into impact investing because it’s very profitable for them to do so. And what frustrates me about this is that the impact dollars going to these banks are diverted away from real impact opportunities, as I’ve described above.
Anyway, this has gotten to be a very long post, so let me stop here with some final thoughts:
*Beware of bankers slangin’ products that claim to deliver impact. Those products probably don’t create the kind of impact that you want (especially when you consider the secondary and tertiary impacts of the access point).
*Every investment — every single one — has an impact of some form or another on somebody or something. All investing is impact investing; it’s just a matter of understanding what that impact is, where the attribution lies and how certain types of impacts can be prioritized over others. (Are you part of the Rebel Alliance? Or are you working for the Empire?)
*Impact investing isn’t hard. But it is time consuming. There’s no such thing as a passive impact investor — don’t let the banks fool you. Sending your money to Wall Street in the hopes of creating enduring social and environmental change in the world is... foolhardy.
*Add value to companies that are good (helping them reach commercial scale) and help companies that are bad pivot before it’s too late. Don’t let those companies that are ambivalent stay that way.
Do all of those things and you’ll be an impact black belt in no time...
