That investing to make a positive impact as well as a dime has evolved considerably over the past few years has turned on its head a long-standing worldview that the sole purpose of business and investing is to make money, while solving social and environmental challenges is the domain of government and charity.
While some may remain skeptical that for-profit investment can be both a morally legitimate and economically effective way to address social and environmental problems, impact investing is moving swiftly from concept to convention.
“Impact investing is the process of aligning the assets one has allocated to achieving a financial return with values and to measure and respond to the data of both performance and alignment over time,” Chris Hale, founder and CEO of microtrade finance firm kountable, told Sustainable Brands. “Impact investing is a verb.”
We recently spoke with Hale to get a deeper understanding of the current state of impact investing in 2016 and where it’s headed.
What kinds of problems can impact investing solve?
A new approach to business ...
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Impact investing can solve all kinds of problems. Many of the great companies in history have been built solving some of the world's largest problems. Our economic interconnectedness combined with the almost instantaneous scale of technology platforms makes the stakes of the global game that much higher. Impact investors simply have a willingness to embrace a larger dataset.
There are myriad examples of "externalities" that we've chosen to ignore over the last 50 to 100 years that, when included in a sound investment thesis, drive one to make impact investments. For example, Elon Musk has built his companies based on the idea that alternative energy as an infrastructure is a massively scalable solution to a massively serious "problem" if we chose to include the "externality" of the environment and fossil fuel depletion. Another way to say that is that it's just better. Neither Tesla nor SolarCity are companies built on scarcity or fear. They weren't built because we're going to run out of oil or because carbon emissions are changing our climate. Those are the "externalities" the companies are positively impacting. They were built because building the technology infrastructure to harness a currently free renewable energy source and then building the tech to consume that energy source to run houses and cars and everything else in our increasingly energy dependent lives is great business.
There are hundreds of other examples that have far less cover appeal than Musk that have great business strategies that successfully impact an "externality" that will eventually be priced in creating tremendous value. ater purity, income inequality, food security, energy, education, human mobility, government spending, pick a problem and there are many brilliant entrepreneurs competing to deliver the market winning solution.
How has digital technology made it possible to more effectively measure results and organize impact investment information? How is success measured?
In keeping with the same idea, up until very recently, it has been a data problem. It has been cumbersome, expensive or proprietary data that has made the measurement a manual process often involving site visits and airline tickets. With the combination of the costs of data storage and transmission now approaching zero, a push toward transparency and information sharing, and the proliferation of sensors and IoT, getting the data is no longer the hard part.
The challenge now is how do you analyze it and present it in a way that will allow an investor to take values-aligned action on their portfolio. The presentation layer and user interface are the next big advances in impact investing. I'll digress a bit here from the technology talk and admit that impact investing is deeply personal. It is an alternative method of portfolio construction that puts the human investor and their view of the world at the center. That requires a deep understanding of that investor, an ability, to translate that understand into an investment policy and then collect the relevant metrics to demonstrate impactful returns. As such, success criteria is also individualized but should be disciplined. Given the reality of our economy, solving energy may be more profitable than solving education but expected returns, risk models, and a quantifiable impact criteria can be established for both and measured over time and responded to - again the verb. This is not a discussion about concessionary returns, one could make the case that not outperforming the market by holding some cash is a concessionary return where one concedes return for lower risk. Impact investing, like all investing is about alignment.
How can one build an impactful portfolio without sacrificing return on investment?
Portfolio construction is primarily about allocating capital to capture a risk premium based on expected returns and expected risks. When one builds a more "traditional" portfolio one would buy bonds over cash, stocks over bonds, and invest in smaller companies or internationally over larger domestic companies, or in less liquid investments based on this principle.
The construction of an impact investment portfolio is no different with one small but important difference. There are additional criteria. An impact investor will add the following statement to that investment policy: Not all companies are created equal and not all companies invest capital and earn income in the same way. I want to be a shareholder or debt holder in companies that invest capital or earn income by solving XYZ problem. The remaining principles are the same. One must account for time horizon, tolerance of volatility, taxes, inflation, liquidity etc. Companies should be built to deliver value and solve problems for customers, impact companies solve important problems.
What kinds of impact investment products are out there, and how have these evolved and changed?
The impact universe has exploded. First you had alternative ways to invest in public markets with things like negative screens. "I'll invest in any company except those that do XYZ." Then that evolved into positive screens. I want to be a shareholder of companies that behave this way, treat their employees that way, solve these kinds of problems. Things seemed to stay that way for a while. In recent years though, with the proliferation of cheap data and the explosion of alternative marketplace models, investors can access all types of investments that previously were solely the domain of the ultra wealthy. Many of these marketplace platforms have democratized private lending, venture capital, and real estate among others and impact investing has been the beneficiary of this proliferation. An impact investor can now do direct lending to veteran owned or minority owned businesses, can invest directly in trade transactions with small business owners in emerging markets, become shareholders in peer-selected social venture funds all at a fraction of the investment size and cost structure that were major limitations only a few years ago. This phase of impact investing is about access.
What's in store for impact investing in 2016? What role will millennials play?
I think 2016 is a big year for impact investing. Clients are becoming more clear about what they want, advisors are becoming more skilled at capturing, analyzing, and presenting the data that proves that they've delivered it and platforms that deliver access are getting increasingly easier to find and to use and cheaper to be a part of. Millennials will play the central role in the future of impact investing. Certainly because they are at the center of the largest wealth transfer in history over the coming few decades but more so because anyone who knows millennials knows that they know what they want, they expect the market to come to them and then to learn very quickly how to deliver it they way they want it. I think the evolution of Impact makes it uniquely prepared for that opportunity.