Impact investing continues to gain momentum in the U.S. and abroad, but scaling it has proven difficult. The fact that momentum has not translated into institutional capital reaching critical mass is not surprising. Why? Because at the most basic level, impact investing is challenging the building blocks of capitalism, and its profit motive, as the sole path to maximizing shareholder value. This is the language of fiduciaries and common ground is yet to be reached, but will it ever and does it matter?
A recent piece by Bob Massie in Institutional Investor focusing on ESG (environment, social, governance) criteria for institutional investors provides great insight. He offers a critical set of considerations and arguments that fall under the impact investing umbrella. One of the most powerful sentences in the article:
…”Though no one disputes capitalism’s raw force, the deeper issue is whether the free-market system, hamstrung by the narrow assumptions of economics and finance, has been asking the wrong questions, examining the wrong data, reaching the wrong conclusions and pursuing the wrong goals.”
I have been thinking about this a lot lately. To me, the sentence above is linked to one of Milton Friedman’s most powerful contributions to our collective thinking. If you know Milton Friedman, you must be going “yeah, right” – but read on.
Across asset classes there is growing interest in a panoply of strategies captured by the following terms: impact investing, ESG, social enterprise, profit with purpose, etc. Impact investing has largely attracted capital to pursue illiquid alternative investments, mainly via venture capital strategies. But the amounts deployed are dwarfed by the fact that investable assets around the world surpass $200 trillion. The big question is whether those assets can be focused on impact.
For impact investing to reach true scale, we need to cast a net less focused on definitions and motivations. This approach should attract more institutional investors. The first rule of thumb: the larger the assets under management, the more institutional the assets. And the more institutional the assets, the harder it is to change the behavior of those that control them. Large and institutional capital pools include public pension funds (e.g., CalPERS), sovereign wealth funds (e.g., ADIA) and large asset managers (e.g., Blackrock). These institutions are the ones that hold the real purse strings, hence the key for impact investing to scale. But, reaching scale will take time and persistence given the trillions of dollars involved.
As long as positive societal outcomes are being achieved, it should not matter what the motivations are to achieve them. This may unsettle purists who argue that intentionality is central to impact investing. But, if you believe that a broadly defined impact lens will be part of any and all investing decisions, does it matter what the underlying intentions are? I don’t think so, because a good fiduciary protects assets and delivers returns based on allocations to a diversified set of asset classes and investment strategies. Therefore, asset allocators that take societal impact into account – because outcomes drive value creation – trump those that center their focus on intention.
Having personally spoken about this to the largest asset managers in the world, many would agree with the last paragraph. Therefore, if there is some agreement on the “what”, the focus should now move to the specifics of the “how”. The numbers are astounding. For instance, the value of all real estate, equity and debt in the world is estimated at almost half a quadrillion dollars, that’s $500,000,000,000,000. To illustrate how this applies to a vast array of assets, I will take a relatively small but easily understood slice and talk about an example using an impact lens coupled with a financial product used by institutions.
Let’s take a “small” slice of a large market. Specifically, commercial real estate in the United States, estimated at 100 billion square feet. The Federal and state governments are committed to protecting our planet and developing the alternative energy industry. Coupled with private sector investment there is huge potential for an impact play focused on commercial real estate rooftops. The rights to buy or sell assets in the financial world are defined as ‘options’. Imagine a market for solar installation rights on commercial rooftops in the form of options. Sound strange? It may, but it should not, because the value of over the counter derivatives is about $700 trillion. This specific and purposely esoteric example represents a new market on real assets driven purely by impact. If it can be done with this theoretical example, it can be done with any asset class.
My point here is not to make heads spin, my point is that you can look at any investment with an impact lens. The word “any” is what points to the potential of unlocking institutional capital. If my conversations with institutional investors that control trillions of dollars are any indication of where investing is headed, I am encouraged. Look at the open letter Larry Fink, the Chairman and CEO of Blackrock, the largest asset manager in the world, wrote to S&P 500 CEOs and therecent changes in ERISA rules and IRS guidance that help clear the way for impact investing.
The most direct, easily understood and most executed upon value creation tactic is maximizing profit. The underlying premise that is getting a second look by many is Milton Friedman’s profit maximization being the sole purpose of a corporation. Those looking at this premise have a nagging feeling that maximizing profit (a direct proxy capital markets use to measure maximizing value) may in fact, not be maximizing value. Maximizing value should be the main purpose but not the sole purpose. Massie’s article talks about this exact idea.
Friedman crystallized a view that is for the most part taken for granted by investors, capital markets, economists and corporations. His poignantly crisp concept has single handedly, mostly due to its brutal simplicity and extreme clarity, shaped capitalism and its practice for the last half century. As asset pools continue to define their own multi-purpose and longer-term value creation constructs, my sense is that true scale in broadly defined impact investing will be achieved.
By Javier Saade, Senior Fellow at the Beeck Center for Social Impact and Innovation.