Scaling successful models

Impact’s involvement with education has so far been limited, but some success stories have emerged and these can be scaled using further injections of impact finance. One outstanding example is Bridge International Academies, a for-profit whose standardized “academy-in-a-box” model has been highly successful in delivering quality education to poor communities in Kenya.

To date, Bridge has enrolled 95,216 pupils, and counting, with high rates of attainment when compared to traditional forms of schooling. With continued growth in Kenya and plans to extend its reach to other African countries, Bridge shows that it’s possible to come up with scalable models for education delivery.

Bridge represents a new breed of company taking a new approach to education. Cross-sector collaboration has been part of its fabric from the beginning and continues to be central to its development. The company was founded on the partnership between Jay Kimmelman, the entrepreneur behind successful software company Edusoft, and Shannon May, a development specialist. It was established using capital from a wide range of investors including aid agencies like OPIC and DFID, venture capital investors like LearnCapital and Rethink Education and impact investors like Omidyar Network and CDC.

This co-investment approach shows the range of players in the arena and the potential for fruitful collaboration, a theme evident across the whole education investment sector. By using such techniques, it will be possible to generate the capital necessary to bring other promising models to scale, rolling them out across more regions and adapting them to answer local needs.

Exploring the potential of edtech

Impact investors already love cleantech and greentech, but edtech, the new buzzword for education technology, is still largely unexplored ground for the impact sector.

But what is edtech? Edtech involves using information technology—including tablets, smartphones and computers—and working through various media, including social media, to deliver instruction. Its practice involves enhanced learning through computers as well as remote learning and massive online courses, or MOOCs. “Edtechers” in schools, universities and businesses design and produce online classes, tutorials, training programs and exams and then deliver them to students using technology.

Edtech is widely considered to be the new frontier in global education and the momentum behind it is growing. The UK government, long a leader in the development of socially beneficial areas of enterprise, has established an edtech incubator. Meanwhile, mainstream markets and venture capitalists are beginning to get excited about the potential of edtech, with some pundits making bullish predictions about its future The edtech market is projected to grow to $220 billion by 2017, with the US market growing by 47 percent and the EMEA countries (Europe, Middle East and Africa) projected growth standing at around 25 percent.

For impact investors, the rise of edtech, with its potential for delivering returns at both market and below-market rates as well as non-financial benefits, represents another possible entry point into the education marketplace. Education, like clean water, is popularly considered to be a good thing per se and this makes edtech an uncontroversial investment, which in turn should make it attractive to a number of different kinds of socially motivated investors. It’s no coincidence that Bridge founder Jay Kimmelmann was an edtech entrepreneur before he became CEO of Bridge International Academies, a mission-driven education delivery business.

This crossover is important when it comes to financial arrangements, too. Two of Bridge Academies’ major investors,  LearnCapital and Rethink Education are venture capital funds that focus on edtech investing. In another example of collaborative investing, last year they joined forces with the NewSchools Venture Fund, a venture philanthropy organization, to capitalize Britebytes, a platform that helps educators manage their learning technology.
While none of the three organizations in this deal call themselves impact investors, all are pursuing investment strategies that blend business and social benefit through investing in education.

This deal gives us a glimpse of the investing landscape that surrounds edtech. It’s one that draws investors equally from mainstream finance, philanthropy and government, creating a potentially dynamic market for developing education solutions. Impact investors should take note, since the chances are good that more of these collaborative deals will be coming their way in the near future. By being prepared to work with a range of different co-investors with a range of motives and a variety of appetites for both reward and risk, impact investors can play their part in a growing marketplace.

Getting deeper into student finance

Demand for student finance is exploding in developing countries with growing middle classes and increased demand for higher education, such as Vietnam, South Africa, Brazil, Morocco, and India.

At the same time, in the developed world costs for higher education continue to rise uncontrollably in the face of government cutbacks, leading some students to take on unsustainable levels of debt while others have been priced out of the education market altogether. Default rates for student loans, already high, are rising and despite a growth in student numbers the gap between educational attainment rates for rich versus poor students is widening, notably in the US. At the same time, the value of a degree in real terms has never been higher and the demand for highly skilled workers, driven by the growth in technology businesses, is rising, a trend described in a recent book by Harvard economists Claudia Goldin and Lawrence Katz: “The Race Between Education and Technology”.

For all these reasons, student finance is now being hailed as the “new frontier in impact investing.” It makes sense: impact investing has a track record of success both in providing finance directly and backing institutions who do. Recent studies show there are already some workable models being used by non-banking financial institutions (NBFIs) in the developing world some of which are backed by impact investors: South Africa’s Eduloan and Trustco Finance in Namibia, for instance are using methods including social bonds to raise money to loan to students. Other groups are collaborating with universities or governments, negotiating terms, such as discounts and subsidies, that make the programs more sustainable and secure profits for investors. Still others provide finance directly to educational institutions. There is scope for expanding some of the more successful models globally.

In the developed world, there’s also room for growth. Despite the presence of mainstream lenders, solutions are needed in higher education finance, especially for poorer students. As the cost of higher education continues to rise above the rate of inflation, there are calls for new approaches including using privately-financed Social Impact Bonds, which would raise capital for student loans with repayment tied to performance, and Income Share Agreements (ISAs). In an ISA scheme investors pay the cost of college attendance in return for a percentage of the student’s income after graduation. Higher-earning students pay more, but those who earn less pay less to investors.

These are just some ideas for how impact capital could support access to education for all students. With luck there should be many more such innovative approaches mooted in the years to come—and many opportunities for impact investors to get behind the wave of change. As the demand for global education continues to increase and the urgency of the funding crisis becomes more acute, governments, philanthropies, international aid agencies and the public will ramp up the search for solutions. And, in a new era of openness to market-based approaches, impact investors should be ready to do their part.

By establishing a focus on education as an investable sector—and learning how to work collaboratively with a range of other investors—impact investors can help turn the tide in the global education crisis through supporting sustainable, business-based solutions.

Marta Maretich, Chief Editor, MaxImpact

As we established in Part I of this series, there’s a growing global demand for education — in other words, a huge potential market that could be catalyzed by an influx of impact capital.  Add to this the fact that education is pretty much universally recognized as an effective means to break the cycle of poverty and improve lives — it may be the most powerful single tool we have — and the low level of impact involvement in the sector begins to seem surprising.

Yet that’s the reality: of $2.5 trillion is spent on education worldwide, impact capital accounts for just $3 million. In a recent survey of impact investors, only 3 percent of assets under management were in the education sector as compared to 21 percent in microfinance and 11 percent in energy. Only water and sanitation came in lower, at just 1 percent.

Small deals, few deals

A closer look at deals gives insight into what’s happened to date. According to a recent report from D. Capital and Open Society Foundations (OSF), impact investors have hardly entered the education market and when they do, deal sizes are small with direct investments typically ranging between the $.5 million and $5 million. Investment though intermediaries looks slightly more robust, with technology venture capital funds raising the stakes to $10 million, but it’s still a mere drop in the ocean.

Impact’s role in financing the education sector hasn’t only been small in size, it’s been limited in scope, largely focusing on school infrastructure programs and, to a lesser extent, people (for example teacher training schemes). Impact investors have largely ignored the potential for investment in the wider educational ecosystem and have only very limited involvement in areas such as developing new services, tools and technology. Impact investment has been sharply divided, too, between market-rate investors who target middle and upper class populations and those with an impact-first attitude who target populations at the base of the socio-economic pyramid.

What’s keeping impact investors away?

Several factors help explain this picture. First, impact is still a relatively new sector whose development has been largely uncoordinated and sometimes patchy: in other words, just because a sector is worthy of more impact capital, doesn’t mean it’s received it yet.

Impact investing is beginning to develop a track record in areas like agriculture, clean technology and finance but this is largely thanks to the determination of a few leading proponents like Acción, Root Capital and Acumen, who targeted their investments in specific areas. By contrast, few impact investors have made education their sole priority and few have developed well-defined deal sourcing strategies for education even though quite a few (21 out of the ImpactAssets 50 funds, for example) claim education as one area of focus among several others. This suggests that education is often a sideline for impact investors, with small-scale education investments tacked on to ones in more popular sectors such as finance.

Partly, this may be due to the perception that education investments have little potential to produce returns (an assumption new developments in the sector will challenge). Another reason could be that education, unlike other sectors, has traditionally been the sole preserve of governments and, to a lesser extent, international aid agencies. Until now, non-state investors have claimed a relatively small slice of the education pie with private commercial funding accounting for only $500 billion of the $2.5 trillion spending total. The state monopoly on education has created little incentive for innovation or entrepreneurial activity, with the result that there haven’t been enough education deals out there to engage the growing impact sector.

Such market issues may be contributing to the shortage of investable deals and limiting levels of investment now, but the picture looks set to change. Squeezed public budgets and a new spirit of openness on the part of the development aid community are generating more interest in market-based solutions to the education crisis. This raises the possibility of increased entrepreneurial activity in the education sector with impact investment playing a more important role in its financial profile, especially in the form of collaborative investing arrangement with governments, philanthropic bodies and other private investors. The question now is, what exactly should that role be?

Learning to do more

With opportunities at various points in the market, there’s evidence that impact capital can help education in a number of important ways. “Where government is absent,” write the authors of the D. Capital/OSF report, “impact capital can help fill a basic gap that the state cannot. Where the government provides basic services, there is also ample room to supplement public services through congruent education for at-risk children, vocational training or adult literacy services.”

Beyond this, impact investors can do their part to strengthen the sector by:

•    supporting early-stage experimentation and innovation in education
•    innovating new kinds of financial approaches that support education and the ecosystem around it
•    working in collaboration with governments and nonprofits to back socially motivated education programs with impact capital
•    investing alongside venture capitalists and venture philanthropists in scalable education businesses
•    catalyzing co-investment from other sources, such as mainstream banks, private investors and aid agencies
•    scaling approaches that show promise, adapting them and rolling them out in other contexts and other regions.

Marta Maretich, Chief Editor, MaxImpact

The role of education in improving the people’s lives and encouraging economic development is widely recognized, making it a focus for national governments, philanthropic bodies and international development agencies. Increasingly, it’s viewed as an indispensible tool for easing poverty, reducing inequality and boosting economic sustainability. Research has shown that one year of education can increase wages by five to 15 percent, while each year of secondary school raises them by up to 25 percent.

What’s more, quality education for all—including marginalized groups, women and adult learners—can generate huge economic rewards for a country, increasing its gross domestic product per capita by 23 per cent over 40 years.

More investment is needed—right now

There’s little doubt about the value of education. Yet, despite making commitments to Millennium Development Goals in education, the global community has so far failed to come up with the investment needed to hit education targets. While spending on education by low-income countries has increased by an average of 2.9 percent to 3.8 percent of GDP over the last decade rich countries have not stepped up to the same degree.

In 2010 estimates showed that an additional $16 billion per year would be needed just to provide basic education for children, youths and adults by 2015. However, actual spending has hovered around the $3 billion mark annually. The result is a funding gap that has almost doubled in the intervening years. Today, estimates place the annual financing shortfall at a staggering $26 billion.

It now seems likely that the Millennium Development Goal for education will not be reached by the 2015 deadline and there are concerns on the part organizations like Education for All about what will happen to education development post-2015 and in years to come.

In a further development, low-income countries and poor populations aren’t the only ones facing an education crisis. The education systems in rich countries like the US, the UK and Australia, for instance, are also suffering from the effects of squeezed public budgets and skyrocketing costs, especially in the higher education sector. This has left educational attainment rates dropping, especially among poor people and minority groups, over a number of years.   Many would-be students are priced out of access to higher education just when the need for an educated workforce is on the rise.

Innovative finance solutions

So what can be done to help the poorest attain access to quality education and the better-off optimize their access to higher forms of learning? The key, recent research suggests, is to bring more private capital into the sector and to experiment with new kinds of investments that target specific educational problems and meet the needs of specific groups.

In many parts of the world, education has until now been the sole preserve of governments and development aid agencies, but there is evidence that this is beginning to change as new funding approaches — like impact investing— gain popularity and prove their viability. Though governments and development aid agencies will continue to play a central funding role, the education sector is now actively looking for ways to attract private capital, often in the form of impact investment, as a means to fill that yawning $26 billion funding chasm.

Though it’s early days, there’s already evidence that impact finance can be effective in education.  George Soros’ Open Society Foundations have produced some first findings on impact investing in developing countries’ education systems. The results suggest that workable models are evolving on a small scale, often in collaboration with governments, and some are already showing respectable track records of financial return and demonstrable benefit.

These indications are hopeful, yet impact investing in education is still in its infancy. Education accounted for only 3% of the investments of participants in the GIIN’s recent sector survey, a figure that suggests that impact investors have been hesitant to engage in this sector.

The OSF report confirms this image of tentative, early-stage activity in education by impact investors:  “Most deals remain small, and investments in schools currently dominate deal-making, with more innovative technology and management models just beginning to emerge. As yet, few business models deliver strong immediate financial return while reaching the most vulnerable beneficiaries.”

More worrying perhaps is the fact that impact’s involvement in education investing remains split into two camps, according to the report. On the one hand there are impact investors focused on “reaching the lowest income populations without expectation of any financial return”; on the other are investors who expect market rate returns and place capital into deals that “target middle and upper class populations.”

By now, this is a familiar situation for impact, with well-meaning investors in many sectors still struggling to find ways to engage with the middle ground and find models that meet needs while maintaining profitability. Yet, given the pressing global demand for education, there is enormous potential for innovation, both in terms of finance models and in terms of education delivery methods. With more impact engagement—and a renewed commitment by the education sector to finding new ways to finance and deliver good quality education on all levels—there is scope for significant  positive change in which impact investing can play a significant role.

By deepening its commitment to investing in education, the impact community has the opportunity to help solve one of the world’s greatest challenges.In the next blog in this series, we’ll be looking at the places where impact capital has the potential to be most effective in the education sector. As the need for education continues to grow, so will the range of methods and approaches for private capital, including public-private collaborations, an expanded role for impact intermediaries, and new technologies with the potential to deliver education to underserved communities as never before.

By Marta Maretich

However, if your focus is emerging markets enterprises that can have an impact on people living in poverty, a recent blog by Ceniarth Capital said it best: “Those of us actively allocating capital to fragile enterprises in developing markets recognize that those people who promise comfortable market rate returns while solving global poverty are the equivalent of diet gurus promising that one can lose weight while eating limitless amounts of chocolate cake.”

In a report launched by Oxfam and Sumerian Partners today, we argue that it’s time to look at impact investing differently; to start with a focus on the needs of the businesses working to make a meaningful impact on poverty reduction, rather than on the investors who stand to benefit from their work. Enterprises working in this space are in new territory – continually adapting their business models, earning low and slow returns and operating in markets that are subject to considerable exogenous shocks (e.g., economic instability, weak infrastructure, extreme weather events and poorly developed value chains). These firms will make decisions that can seem irrational if your focus is market return. They may seek out “at risk” populations, such as single moms balancing the demands of work and family, as employees. They may share ownership and decision-making with their workers. They may pay their suppliers not the price that is commonly expected in the market, but a higher price the firm sees as “fair.” The businesses themselves, and the funds that put their money into these firms, organize around the intention to generate a measurable, beneficial social or environmental impact alongside a financial return – and that prioritization is reflected in their structures, processes and activities.

However, to meet the return expectations that have been established by the sector’s push toward the larger mainstream market, we increasingly see conventional emerging markets investments being reclassified as “impact investing.” Arguably, it’s this trend that has transformed TPG’s investment in Apollo Tower, a cellphone tower company in Myanmar, from a standard emerging market foreign direct investment into an impact investment. The impact statement claimed by supporters is that cellphone access has “helped to increase transparency in a country known for tight control of its information, helping the nation take steps toward democracy.” Hmmm. Really? A cell phone company is actually a democracy and governance project in disguise? Seems a bit of a stretch.

As we write in our report, it should not be assumed that an investment in a cell tower, or a wind farm, or any other enterprise in the global south, is inherently socially positive. Rather, it should be incumbent upon the fund to demonstrate how these enterprises are intentionally structured to optimize impact and benefit poor and marginalized groups – rather than only providing implied, incidental or indirect benefits. They should be able to show what difference the fund’s provision of capital and support and engagement has made. Any self-identifying impact investor should be able to demonstrate a clear intentionality to achieve impact.

Furthermore, the research that has set the prevailing “have your cake and eat it too”-sized return expectations has its limitations. Take, for example, the very same GIIN/Cambridge associates “benchmark” report, which included no commentary on the associated impacts achieved and instead used a self-reported intention to generate social impact as the only impact-related criteria for inclusion in the benchmark. The data included a high proportion of funds focused on the theme of financial inclusion, an industry that has depended on decades of subsidies. Finally, the “benchmark” setting was drawn from a small pool of funds, all of which were targeting market rate returns.

Why does any of this matter anyway? Big tent, right? It matters because the rush to the mainstream can pull impact investing away from its original intent and undermine the meaningful role it can and should play in poverty reduction. It matters because high-profile investments such as Apollo Towers shift the goal posts for everyone. It makes philanthropists doing the critical work of providing smart subsidy to funds and enterprises operating in the toughest places ask, as they have of Root Capital, “Am I the dumbest money in the room?” – If everyone else is making tons of money, am I a sucker if I’m giving it away? And it can divert social entrepreneurs from their mission when they are challenged with the trade-off between purpose and profit. As one social entrepreneur told me recently, “Do we really need this money? Is it going to disorganize us from our original idea? The motivating factor will be to meet the profit targets, not looking at the social part. … Maybe the pressure we will feel from the investors will move us to abandon our women’s empowerment mission. We don’t want that to happen.”

We propose six recommendations that we think can provide a more balanced understanding of what is possible in impact investing, letting the sector begin to use money more creatively:

1. We call for a shift of approach in the market; from one in which we tailor funds around the needs of investors to one focused on developing products that serve the needs of enterprises seeking to combat poverty. Specifically, we need wider adoption of alternative fund structures – such as permanent capital vehicles and evergreen funds – and new financial tools that reflect the predominantly “low and slow returns” of most enterprises prioritizing social impact.
2. The sector needs greater transparency around reporting both the impact and financial returns(gross and net) achieved by impact investors.
3. Donors and philanthropists need to deploy smart subsidy and patient capital (return of capital, rather than return on capital) to support enterprises capable of making a meaningful contribution to poverty reduction, and to support hybrid financing models alongside impact investors seeking a net return on capital. Grants, philanthropy and smart subsidy should be seen as part of the impact investing continuum, not its enemy.
4. The industry needs more independent research to understand the enterprise-level experience, and to analyze which structures, approaches and incentives best help businesses to maintain an intentionality to optimize impact.
5. We call on impact investors to agree to a voluntary code of practice that enshrines the intentionality to behave and take decisions in ways that have a primary focus on achieving impact.
6. Impact investors should adopt incentives for optimizing, measuring and reporting impact as well as achieving financial return targets.

We have no problem with financial returns, but let’s not pretend that investors seeking a pure market return can tackle the most complex global challenges in high-risk markets. They cannot. Not in education. Not in health. Not in reducing child labor and forced marriage. Not in water and sanitation. Not even in banking for small enterprises, which continue to be significantly underserved today by markets everywhere, despite SMEs being the biggest generators of jobs and incomes globally. One just needs to look at the history of Silicon Valley or the microfinance industry ­– both completely commercial today – to justify smart subsidy and venture philanthropy. Our memories are simply too short. It’s not about distorting the market – often, there is not much there to distort – it is about catalyzing it.

By Mara Bolis, Oxfam

More than 35 CEOs and civil society leaders of the Business & Sustainable Development Commission (the Commission) today reveal that sustainable business models could open economic opportunities worth at least US$12 trillion and up to 380 million jobs a year by 2030. Putting the Sustainable Development Goals, or Global Goals, at the heart of the world’s economic strategy could unleash a step-change in growth and productivity, with an investment boom in sustainable infrastructure as a critical driver. However, this will not happen without radical change in the business and investment community. Real leadership is needed for the private sector to become a trusted partner in working with government and civil society to fix the economy.

In its flagship report Better Business, Better World, the Commission recognises that while the last few decades have lifted hundreds of millions out of poverty, they have also led to unequal growth, increasing job insecurity, ever more debt and ever greater environmental risks. This mix has fueled an anti-globalisation reaction in many countries, with business and financial interests seen as central to the problem, and is undermining the long-term economic growth that the world needs. The Commission has spent the last year exploring a central question, “What will it take for business to be central to building a sustainable market economy—one that can help to deliver the Global Goals?” Better Business, Better World—the release of which is timed with the World Economist Forum in Davos and the U.S. presidential inauguration—shows how.

“This report is a call to action to business leaders. We are on the edge and business as usual will drive more political opposition and land us with an economy that simply doesn’t work for enough people. We have to switch tracks to a business model that works for a new kind of inclusive growth,” said Mark Malloch-Brown, chair of the Business & Sustainable Development Commission. “Better Business, Better World shows there is a compelling incentive for why the latter isn’t just good for the environment and society; it makes good business sense.”

At the heart of the Commission’s argument are the Sustainable Development Goals (or Global Goals)—17 objectives to eliminate poverty, improve education and health outcomes, create better jobs and tackle our key environmental challenges by 2030. The Commission believes the Global Goals provide the private sector with a new growth strategy that opens valuable market opportunities while creating a world that is both sustainable and inclusive. And the potential rewards for doing so are significant.

The report reveals 60 sustainable and inclusive market “hotspots” in just four key economic areas could create at least US$12 trillion, worth over 10% of today’s GDP. The breakdown of the four areas and their potential values are: Energy US$4.3 trillion; Cities: US$3.7 trillion; Food & Agriculture US$2.3 trillion; Health & Well-being US$1.8 trillion.

“Global Goals hot spots” identified in the report have the potential to grow 2-3 times faster than average GDP over the next 10-15 years. Beyond the US$12 trillion directly estimated, conservative analysis shows potential for an additional US$8 trillion of value creation across the wider economy if companies embed the Global Goals in their strategies. The report also shows that factoring in the cost of externalities (negative impacts from business activities such as carbon emissions or pollution) increases the overall value of opportunities by almost 40%.

“At a time when our economic model is pushing the limits of our planetary boundaries and condemning many to a future without hope, the Sustainable Development Goals offer us a way out,” said Paul Polman, CEO of Unilever, and a commissioner. “Many are now realizing the enormous opportunities that exist for enlightened businesses willing to stand up and address these urgent challenges. But every day that passes is another lost opportunity for action. We must react quickly, decisively and collectively to ensure a fairer and more prosperous world for all.”

While the opportunities are compelling, the Business Commission makes it clear that two critical conditions must be met to build these new markets. First, innovative financing from both private and public sources will be needed to unlock the US$2.4 trillion required annually to achieve the Global Goals.

“As stewards of long-term capital, the investment industry and its clients can support the achievement of the SDGs by creating simple, standardized sustainability metrics integral to the investment process,” said Hendrik du Toit, CEO, Investec Asset Management, and member of the Commission. “We also need new streamlined partnerships with governments and communities that can reduce risks for everyone and bring more private investment at lower cost into sustainable infrastructure development.” 

At the same time, the Commission believes a “new social contract” between business, government and society is essential to defining the role of business in a new, fairer economy. The recently released 2017 Edelman Trust Barometer reinforces this idea. It shows that while CEO credibility is sharply down, 75% of general population respondents agree that “a company can take specific actions that both increase profits and improve the economic and social conditions in the community where it operates.” And they can do so in ways that align with recommendations and actions outlined in Better Business, Better World: rebuilding trust by creating decent jobs, rewarding workers fairly, investing in the local community and paying a fair share of taxes.

“The promise of the Sustainable Development Goals and the Paris Climate Agreement is a zero-carbon, zero-poverty world,” said Sharan Burrow, General Secretary, International Trade Union Confederation, and commissioner. “To achieve these Global Goals, we need to rebuild trust. A new social contract for business where people, their environment and economic development are rebalanced can ensure that everybody’s sons and daughters are respected with freedom of association, minimum living wages, collective bargaining and safe work assured. Only a new business model based on old principles of human rights and social justice will support a sustainable future.”

Throughout 2017, the Commission will focus on working with companies to strengthen corporate alignment with the Global Goals, including: mentoring the next generation of sustainable development leaders; creating sectorial roadmaps and league tables that rank corporate performance against the Global Goals; and supporting measures to unlock blended finance for sustainable infrastructure investment. “We need to show these ideas work not just in a report but on the business frontline,” said Dr. Amy Jadesimi, CEO of LADOL, a Nigerian logistics and infrastructure development company, and a member of the Commission.

“The Global Goals provide a sustainable, profitable growth model for business, and have the potential to trigger a new competitive ‘race to the top,’” said Jeremy Oppenheim, Programme Director of the Commission. “The faster CEOs and boards make the Global Goals their business goals, the better off the world and their companies will be.”

— ENDS —

The Business and Sustainable Development Commission was launched at the World Economic Forum in Davos in January 2016. It brings together leaders from business, finance, civil society, labour, and international organisations, with the twin aims of mapping the economic prize that could be available to companies if the Global Goals are achieved, and describing how they can contribute to achieving them. To access the report, visit report.businesscommission.org (live on 16 January 2017). Better Business, Better World launch events will be held throughout the week of 16 January, first at the Philanthropreneurship Forum in Vienna, then at the World Economic Forum in Davos. Regional events are also scheduled.

To learn more visit www.businesscommission.org.

To read the full report visit report.businesscommission.org.

Follow us at twitter.com/BizCommission

Media Contact:

Iain Patton, Global & Regional Media

i.patton@businesscommission.org  & +44 (0)7956 430543

OUR COMMISSIONERS

The Business and Sustainable Development Commission was launched in Davos in January 2016. It brings together 36 leaders from business, finance, civil society, labour, and international organisations, with the twin aims of mapping the economic prize that could be available to business if the UN Sustainable Development Goals are achieved, and describing how business can contribute to delivering these goals. The full list of our commissioners includes:

• Amr Al-Dabbagh, Chairman & CEO, The Al-Dabbagh Group

• Laura Alfaro, Professor, Harvard Business School

• Peter Bakker, President, The World Business Council on Sustainable Development (WBCSD)

• Sharan Burrow, General Secretary, International Trade Union Confederation (ITUC)

• Ho Ching, CEO, Temasek Holdings Private Ltd.

• Bob Collymore, CEO, Safaricom Ltd.

• John Danilovich, Secretary General, The International Chamber of Commerce (ICC)

• Begümhan Do?an Faralyal?, Chairwoman, Do?an Holdings

• Hendrik du Toit, CEO, Investec Asset Management

• Richard Edelman, President & CEO, Edelman

• Hans Vestberg/Elaine Weidman Grunewald (acting), Ericsson

• John Fallon, CEO, Pearson plc

• Ken Frazier, Chairman & CEO, Merck & Co Inc. (2016)

• Mats Granryd, Director General, The GSM Association (GSMA)

• Helen Hai, CEO, The Made in Africa Initiative

• Svein-Tore Holsether, President & CEO, Yara International ASA

• Mo Ibrahim, Founder, Celtel & The Mo Ibrahim Foundation

• Mary Ellen Iskenderian, CEO, Women’s World Banking

• Dr. Amy Jadesimi, Managing Director & CEO, Lagos Deep Offshore Logistics Base (LADOL)

• Donald Kaberuka, former President, African Development Bank Group

• Lise Kingo, Executive Director of the United Nations Global Compact

• Jack Ma, Founder and Executive Chairman, The Alibaba Group

• Lord Mark Malloch Brown, former Deputy Secretary-General, United Nations (Chair)

• Andrew Michelmore, CEO, MMG Ltd.

• Sam Mostyn, President, Australian Council for International Development (ACFID)

• Arif Naqvi, Founder & Group CEO, The Abraaj Group

• Mads Nipper, Group President & CEO, The Grundfos Group

• Cherie Nursalim, Vice Chairman, GITI Group

• Ricken Patel, President & Executive Director, Avaaz

• Paul Polman, CEO, Unilever

• Vineet Rai, Co-Founder & Chairman, Aavishkaar Intellecap Group

• Grant Reid, CEO, Mars, Inc.

• Dinara Seijaparova, CFO, ‘Baiterek’

• Sunny Verghese, CEO, Olam International

• Gavin Wilson, CEO, IFC Asset Management Company LLC

• Mark Wilson, CEO, Aviva plc

1. Trust: Rentier economics in our countries is well-documented and as such, investors are likely to touch down in Accra and drive to the project site accompanied by concerns about self-interested officialdom. However, local stakeholders will often have a similarly low opinion of the ‘outsiders’ – informed by their experience of programmes or investments quoted in the millions, high living standards of expatriate staff and the slow pace of progress. ‘Out of the total committed, more is going to personnel pretending to work than anything else’ is a typical refrain. The result is a ‘them and us’ culture which, if not addressed properly, can harm the quality of communication, warp relations and working practices.
2. Expectations: And yet, and yet. Prevailing incentives in major impact-oriented sectors such as agriculture, healthcare and social housing can be an impediment to productivity. For example, as stated by a policy adviser at a recent Savannah Development Authority (SADA) dialogue, business pipelines are distorted by government waivers. There can also be an expectation of ‘handouts’, which, if denied, might create a constituency that will work to frustrate the proposed intervention or at the very least, not assist.
3. Disjointed Strategies: There is no shortage of individuals launching businesses in Ghana with an implicit and real commitment to creating social goods such as healthcare or jobs for communities that need them. They are motivated by profit certainly but alongside that are goals for society at large. However, at times, fear of alienating categories of investor or customer will create distortions or contradictions in business plans or marketing strategies.
4. How to Say No: Generally-speaking, there is an aversion in our community to delivering the word, ‘no’. Points one, two and three above notwithstanding, local partners are often reluctant to display their disagreement directly. With everyone bending over backward to be polite, clients may miss opportunities to get on the same page as their stakeholders. Instead, things just will not happen as expected or seemingly agreed.

In this context, it is important that clients prioritise culture and that they adopt a listening posture concerning internal and external stakeholders. Learning how others have made it work, or failed, taking time to build trust and understand the terrain – in other words ‘local intelligence’ – are equally key. Finally, in deciding how to engage, bear a Songhai maxim in mind, ‘you will spend money or you will spend time’. In setting strategy, it is safer to keep that expectation in mind than to seek short-cuts to making a profit and doing good.

By Songhai Managing Partner Nana Adu Ampofo (London) and Lord-Gustav Togobo Director of Healthcare and Social Impact (Accra)

A major reason for this expected growth is the impending transfer of wealth from parents to their children. Millennials and Generation Xers stand to inherit between $30 and $40 trillion dollars from the baby boomer generation. The magnitude of this wealth transfer is unmatched by previous generations. Beyond simply the size of the inheritance, Millennials have different priorities than the generations before them. Younger investors seek investments that yield a social return, as well as a financial one.

When asked about the primary purpose of business, 36% of Millennials selected “Improve Society” as their answer. Other answers included “Enable Progress,” which was chosen by 25% of participants, and “Create Wealth,” which was picked only 15% of the time (Deloitte Survey, 2014).

In the past, investments in emerging or non-traditional markets were viewed as exceedingly risky. A lack of transparency and available information discouraged investors from exploring opportunities abroad. The digital age has changed that. Enhanced connectivity now makes it possible for investors to act wisely when investing in emerging markets. Moreover, the credit ratings in many developing nations—such as Mexico and Brazil—have improved as governments exercise greater fiscal responsibility. This development creates more opportunity for impact investing.

Investing for gender equality is rapidly becoming one of the most popular forms of impact investing. The goal is to promote gender parity and personal empowerment through debt and equity investments. There are three basic types of gender equality investments: supporting female-owned enterprises, funding companies that offer products and services for women, or expanding employment opportunities for women.

Organizations like the Calvert Foundation and Root Capital have launched initiatives to promote gender-focused investments. To quote Jackie VanderBrug, a former managing director of Criterion Ventures and now SVP at U.S. Trust: “Women are key assets in combating poverty, building their communities, and creating new pathways to a more just and sustainable world. Investing in women’s education, economic welfare, health, and overall well-being produces powerful results that benefit families, communities, and entire societies. When women become economic agents and leaders, social change accelerates and returns multiply.”

Foreign investment in developing countries dropped 16% in 2014. This has resulted in a $2.5 trillion funding gap, which has made it nearly impossible for these countries to cope with lingering problems like food and water shortages, limited healthcare access, and failing infrastructure.

Similarly, the clean energy sector is experiencing a major shortfall. The International Energy Agency calculates that an additional $36 trillion will be needed over the next 35 years to curb the most extreme effects of climate change. Since philanthropic activity alone cannot bridge the gap, advisors must educate themselves and their clients on impact investing. Our globalized economy has made it possible to engender social change and produce a healthy return on investment. Whether we can find solutions to the most pressing global challenges will depend on the commitment and foresight of investors.

By Marguerita M. Cheng is the Chief Executive Officer at Blue Ocean Global Wealth and Blue Ocean Global Technology.

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A recent study by the EY Global Family Business Centre of Excellence that surveyed 525 family business owners and managers across 21 countries found that nearly half (44%) of those surveyed make investment decisions targeting specific social objectives along with a financial return.

The report, entitled Family business philanthropy – creating lasting impact through values and legacy, found that family businesses globally invest, on average, 3.1% of their wealth in social impact investing, with the Middle East (investing 3.5%), Europe and Asia (both investing 3.4%) leading this trend.

Meanwhile, the majority of family business owners and managers perceive governmental support for social impact investing to be better than (28%) or similar to (62%) the support for traditional philanthropy, even though in reality, only the UK has specifically legislated to accommodate and encourage it.

Survey respondents see government incentives and regulation as key enablers of family business philanthropy. In most countries, taxation seems to be viewed as a key factor for both philanthropy and social impact investing. In countries with laws that promote tax benefits for giving, family businesses are more likely to engage in philanthropy.

Mr. Englisch opines that as companies grow in size, their commitment to philanthropy rises in tandem, emphasising that it is therefore, crucial that governments “harness this desire of family businesses to give back [to society] and make a difference”.

Delegation to external managers

When it comes to organising their philanthropic activities, up to 70% of family business owners were found to be operating via a family-specific vehicle, with 40% having a family foundation or trust, and a mere 30% operating through a family office.

In terms of the success of philanthropic activities carried out, more than half (56%) of all family business owners personally oversee the progress and effectiveness of their philanthropic projects, with very small and very large family businesses tending to exert more family control over the projects compared to mid-sized family businesses.

The recently published World Wealth Report 2016 by Capgemini reported that Asia Pacific (APAC) is now home to the biggest pool of capital after overtaking North America for the first time, holding US$17.4 trillion in wealth from high-net-worth individuals (HNWIs) and boasting a HNWI population of 5.1 million.

Within APAC, however, the degree of control varies according to country, which is likely to impact how family businesses manage their wealth and subsequently, their philanthropic activities. In Hong Kong and China – where the third generation is seen to be taking over the family’s inherited wealth and business – Enrico Mattoli, head of global family office, Greater China at UBS Wealth Management, observes an institutionalisation of family offices taking place, with management layers hired to manage family office affairs, governance measures implemented and traders or portfolio managers hired to focus on different specialisations.

Meanwhile, in other parts of Asia such as in Singapore where wealth is still largely concentrated in the hands of the first generation, Mandeep Nalwa, chief executive officer and founder of Singapore-based Taurus Family Office, says the delegation of investment responsibility does not come easy, which subsequently impacts the outsourcing of money management to funds.

“While the perceived value – in terms of the removal of the conflict of interest [element] – is well understood, oftentimes the firm belief by the family patriarch in his own ability to have checks and balances [in place] on private banks enables – mistakenly, in my opinion – high-net-worth families to dispense with hiring the services of a family office [manager], or a fund manager,” he explains.

By Asia Asset Management

SoFi

The financial market has been going though many changes thanks to the growth of the digital economy and availability of app-based mobile devices. Mobile payments are one obvious area in which the financial industry is evolving. Square is a clear leader in the U.S., Canada, Japan and Australia, while companies, such as Ezetap in India, are cornering the market in developing nations.

Another emerging sector turning traditional banking on its head is online financing. San Francisco-based SoFi (which stands for Social Finance) is set to disrupt the banking sector through its unique approach to lending and wealth management. What launched in 2011 as a financial services company to refinance student loans has expanded to mortgages, mortgage refinancing, personal loans and wealth management. The company touts its proprietary technology, customer service and products, while marketing itself as a “non-bank.” Instead of going to a local bank branch to obtain a loan, SoFi allows members to apply online or over a mobile device—making it particularly appealing to Millennials.

What Sets SoFi Apart? There are other companies that offer online financing and wealth management, but SoFi’s management team and their ability to partner with major financial institutions give them strength and credibility. Japan-based SoftBank Group was so impressed with SoFi that they provided $1 billion in funding to help the company charge lower rates on student, personal and home loans, as well as help fund plans to expand into wealth management and deposits.

23andMe

I recently went to my doctor for a yearly physical. As part of the process, I underwent several blood tests and had a heart stress test. What if, in addition to these tests, my doctor could also analyze my DNA to better understand my genetic mix and its relationship with my health? He might be able to predict and help prevent certain hereditary diseases. That is the potential behind 23andMe.

For the last ten years, the company has been developing a suite of genetics tests to provide customers information on health, ancestry and traits. The company claims more than 1 million customers and says it has built one of the world’s largest databases of individual genetic information. Though not currently cleared to use genetic information to predict the likelihood of a disease, the potential is there and investors have taken note. The potential revenue of an FDA-approved test for diseases is so significant, the company could be well on its way to an IPO.

What Sets 23andMe Apart? The company’s success is tied to the persistency of founder and CEO, Anne Wojcicki, who spent a decade in healthcare investing, primarily in biotechnology companies, before co-founding 23andMe. She understands the market and has been able to navigate some major hurdles, including gaining FDA approval for the company’s direct-to-consumer genetic testing business. Though the company had to regroup a bit, 23andMe relaunched in early 2015 with guns blazing—and hasn’t looked back since.

Udacity 

Online education is making it easier for many people to learn new things or brush up on skills to help advance their careers. While many e-learning platforms, such as Courseraand Khan Academy, offer courses across a wide variety of topics, Udacity is focused on technology. Its mission is to “bring accessible, affordable, engaging and highly effective higher education to the world.”

Udacity was created almost by accident. Co-founder, Chairman and President, Sebastian Thrun, and Peter Norvig (currently the Director of Research at Google Inc.) offered an “Introduction to Artificial Intelligence” course online to anyone, for free. Some 160,000 students from more than 190 countries enrolled. Not long afterward Udacity was born.

Today the company focuses on teaching skills that industry employers need and delivering credentials endorsed by these employers—at a fraction of the cost of most traditional schools. One of those employers is Google. The company recently announced a partnership with Udacity to offer a Google Android Basics Nanodegree designed for people with no programming experience.

What Sets Udacity Apart? The Co-founder, Chairman and President, Sebastian Thrun, recognized the opportunity to monetize courses teaching the skills employers are looking for—and he seized it. He brought in the right team to make it work, including CEO Vish Makhijani who has years of executive leadership experience working with companies including Zynga and Yahoo. The market has taken notice. Udacity has received funding from major investors, including Bertelsmann, Charles River Venturesand Andreessen Horowitz. It is currently valued at $1.1 billion and is set to become a leading provider of educations services.

Oscar 

If you are confused about your health insurance policy and bills, you aren’t alone. The insurance market in U.S. is not working well, especially when compared to most other developed nations. We pay huge premiums and still have expensive medical bills—and that’s just for the insured.

Enter Oscar Health Insurance. The company was created in 2012 partially because co-founder Josh Kushner was frustrated over trying to make sense of a health insurance bill. He and fellow co-founders, Mario Schosser and Kevin Nazemi, wanted to use technology to improve how customers find health care. According to its website, Oscar is “reinventing how to manage care, process medical claims, control healthcare costs and provide transparency. With all the complexity hidden behind an easy experience for our members.”

What Sets Oscar Apart? Oscar is changing a broken industry by offering a common sense solution to health insurance. It uses sophisticated technology to make it easy for customers to find information and be able to make decisions. Though currently only offering plans in parts of New York, New Jersey, California and Texas, the company is growing rapidly. It currently has more than 145,000 customers and is valued at $2.7 billion. Investors include Khosla Ventures, General Catalyst Partners and Goldman Sachs.

WeWork

Great ideas don’t have to be all about technology, but they should be about the market and customer needs. If you can identify and solve a market challenge, you can win.Adam Neumann and Miguel McKelvey did just that when they founded WeWork back in 2010. Both were independently employed and were working out of a partially vacant office building. They convinced the landlord to let them rent out the empty parts as shared workspace—and WeWork was born.

Today the New York City-based company fills the need among entrepreneurs for a work space that won’t cost an arm and a leg. It currently serves close to 50,000 people in cities across the U.S. and around the globe. Part of the appeal of WeWork is that it doesn’t just provide an empty desk. Membership includes access to a number of perks, from free coffee and craft beer on tap to Wi-Fi, printing and even meeting rooms with ping pong tables. Just the type of hip appeal that many of today’s entrepreneurs and independently employed persons are looking for.

What Sets WeWork Apart? The company recognized that technology is not always the path to success – marketing is. It’s not just enough to offer office space for rent—it has to appeal to the mindset of the self-employed generation. Though this startup is not tech-based and has a pure and simple business plan, it’s attracted the attention of Benchmark, Goldman Sachs, Fidelity and T. Rowe Price, who have funneled $1.4 billion into the company—putting it at a valuation of $10.2 billion.

These five companies have all approached business a little differently and, in so doing, have made their way into the “billion dollar club.” One size does not fit all when it comes to building a company, but studying the approach of these success cases is a good way to find inspiration for your own business plan. Strong partnerships, a good leadership team, persistency, common sense solutions and a solid marketing plan can make the difference between an average company and one that takes the market by storm.

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Institutional investors face a moment of truth about their commitment to environmental, social, and governance (ESG) factors. Many have long realized that these issues—including climate change, workplace diversity, and long-standing corporate concerns such as executive compensation—can drive risks and returns. In fact, many large institutional investors have publicly committed themselves to integrate ESG factors into their investing. The UN-backed Principles for Responsible Investment (PRI) have been signed by more than 1,500 investors and managers, representing nearly $60 trillion in assets under management.

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Yet look a little deeper, and it’s clear that many investors have struggled to convert their commitment into practice. For example, less than 1 percent of the total capital of the 15 largest US public pension funds is allocated to ESG-specific strategies, such as ESG-screened passive indexes, active management using ESG insights, or private-market management with a fully integrated ESG strategy. Moreover, many institutional investors continue to treat ESG as a sideshow rather than an integral part of their investing. While ESG and corporate-governance teams are commonplace, they are often held at arm’s length from core investment activities. Even the most successful funds have integrated ESG unevenly. While sustainable-equities strategies (such as low-carbon indexes) are no longer oddities, most funds haven’t expanded ESG integration to other asset classes. Members of the PRI agree that more is required. Its board is considering a change that would allow it to remove signatories that haven’t made sufficient practical progress.

This is not to say that the industry has been standing still. In fact, three big problems have recently been cracked, setting the stage for continued growth. First, investors have struggled for some time to determine which ESG concerns are relevant to particular investments. In response, some leading institutions have embraced the idea of “materiality,” derived from the concept of material information in accounting. Much as knowledge that could influence investors’ decisions is deemed material, so too are ESG factors that will have a measurable effect on an investment’s financial performance. According to a recent study using the materiality framework of the Sustainability Accounting Standards Board (SASB), companies that address material ESG issues and ignore immaterial ones outperform those that address both material and immaterial issues by 4 percent and outperform companies that address neither by nearly 9 percent (exhibit). Generation Investment Management, a sustainable-investing specialist founded by David Blood and Al Gore, put ESG materiality at the heart of its global equity strategy and has reportedly exceeded its benchmark by an annualized 500 basis points for over a decade.

Second, many institutions have found it hard to measure external managers’ regard for ESG issues; they need a kind of “greenwashing” detector to see through the obfuscation that plagues some managers’ activities. A number of institutions are now successfully deploying new mechanisms to increase accountability. The New York Common Retirement Fund, for example, recently developed a comprehensive scoring system based on the best available benchmarks. Managers that don’t disclose information receive poor marks, hammering home the idea that transparency is paramount when someone else’s capital is on the line.

Third, some board members and trustees of institutional investors have worried about whether, as part of meeting their fiduciary duties, they are considering ESG factors. Recently, the US Department of Labor revised its ERISA1guidance to say explicitly that consideration of ESG concerns is a part of the pension plans’ fiduciary duty. The department also specified that when a fiduciary considers two investments that are similar from a financial perspective, it should select the one that’s better from the standpoint of ESG. Such cases come up frequently. In France, the Ministry of Finance recently announced new rules that require investors to measure their portfolios’ exposure to carbon, among other ESG considerations. With the regulatory drumbeat picking up tempo, investors will probably soon adopt sound practices to determine materiality and evaluate managers.

Accelerating progress

Materiality, scorecards, and clearer definitions of fiduciary duty are only a launchpad. A commitment to ESG integration will remain merely symbolic unless institutions change their investment and capital-allocation processes in the ways required for this kind of investing to lift off. Investors should consider six steps to broaden and enhance their ESG impact.

Require uniform corporate ESG-reporting standards based on the principle of materiality

Considerations of materiality ought to be a two-way street: publicly traded companies as well as investment managers should disclose material ESG information. Some institutional investors have already been working with groups such as the Carbon Disclosure Project to push companies to report their ESG metrics (for instance, their carbon footprint or water usage), but more must be done.

Requiring companies to share all material information in a standardized, comparable way is necessary if institutional investors and their external managers are to assess the meaningful ESG-related risks and opportunities companies face. Institutional investors can work with the groups that have sprung up to advance the cause. The Sustainability Accounting Standards Board, for example, has rigorously defined materiality factors at sector and industry levels and is pushing for disclosure of material ESG factors in IPO and 10-K filings. Institutional investors should also collaborate with the Financial Stability Board’s task force on climate-related financial disclosures (led by Bank of England governor Mark Carney and Michael Bloomberg) and support the efforts of the International Integrated Reporting Council to encourage more comprehensive corporate reporting, including reporting on material ESG factors. They may also wish to comment on the US Securities and Exchange Commission’s recent consultation about whether investors would like to see more formal disclosure requirements for companies’ sustainability measures.

Build a shared ESG-rating system for external managers

Institutional investors usually have a rigorous due-diligence process for evaluating their external managers, yet too many treat their assessment of the managers’ approach to ESG as merely an exercise in box ticking. Farsighted institutions are already building systems to rate external managers more thoroughly, but a shared system would multiply the benefits considerably. Rather than duplicating one another’s work, funds could both cut the effort needed to make informed decisions and hold managers to a high standard for their ESG performance across the board.

A shared rating system should consider the sources of a manager’s ESG insights and the ways it seeks to engage with the companies in which it invests. The system will need to reflect the nuances of different asset classes and investment styles; ESG factors will be less material for many hedge-fund strategies than for managers investing in real assets or global equities, for example. Over time, a shared rating system should help prime the market for ESG-informed investment strategies. Many of them have historically struggled to gain allocations because of their short investment histories or skepticism about whether the alpha they generate will endure. That’s why institutional investors should invest in building a shared, open standard that their investment professionals will understand rather than simply outsourcing this task to investment consultants.

Work together to engage with corporations

Most investors recognize that as patient capital, engagement is for them both a social responsibility and a source of long-term returns. Yet most have small corporate-engagement teams that can work with only a few companies each year. Leaders such as the Canada Pension Plan Investment Board, the Ontario Teachers’ Pension Plan, and Calpers have built relationship-investing strategies—they back engagement with dedicated capital and sometimes board seats. Large external asset managers such as BlackRock and Vanguard have strengthened their engagement teams and are working with their investors on this front.2But even these efforts have limits to what they can achieve.

Too many investors fritter away their best chance at engagement by relying blindly on third-party proxy-voting guidance. Investors have a real opportunity to move beyond ad-hoc collaboration; instead, they could agree on a specific and narrow set of principles, back these with capital, and commit their votes. From this platform, they could demand that laggards disclose material ESG factors. For example, they might join Fidelity in calling for the pay of all CEOs to be based on incentive plans that are at least five years long—or go further and call for such plans to be based on a mix of operational, free-cash-flow, and material ESG metrics.

Investors should also request better disclosure and ask companies to lay out long-term strategies showing how ESG factors may affect their ability to generate value. Businesses that depend on a “social license to operate” to maintain their pricing power or that need to invest heavily in training to expand a peer-to-peer sales force should reveal these ESG-related dependencies. Investors might slap proxy motions on companies slow to respond.

Stress-test portfolios for ESG risk factors

Since 2008, many institutional investors have strengthened their risk management—for example, by adding tools and skills needed to run scenario analyses on how their portfolios might behave in times of stress. Yet most focus narrowly on “tail” value-at-risk scenarios driven by broad macroeconomic volatility. They ought to complement this approach with considerations of unpredictable shocks, such as regional water shortages, avian-flu pandemics, and increases in (or the introduction of) externality pricing.

Other institutions are embracing risk-factor investing: they evaluate their exposure to root sources of risk, such as currencies and interest rates, and then set limits for them. In both stress-test and risk-factor investing, material ESG considerations are not always taken into account, but they should be. A risk-informed decision-making process allows institutional investors to fulfill their fiduciary duty as stewards of university and foundation assets or of the retirement savings of public-sector employees.

Public concern over climate change is a particularly acute risk factor and source of value at risk. Many institutional investors are considering whether to reduce the carbon exposure in their portfolios or even to divest out of fossil fuels entirely. We realize that some fiduciaries view this as a moral decision. Nonetheless, it is important for institutional investors to have a nuanced understanding of the actual ESG risks they are exposed to, so that they can choose whether and how to respond. Some institutional investors have decided against divestment in the short term but plan to test their portfolios continually for climate risk. They are setting clear limits that, when triggered, will require them to reduce their exposure, to encourage companies to return cash rather than invest in exploration, or ultimately to divest fully.

Use a long-term ESG outlook to unlock new investment opportunities

All investors ought to consider material ESG factors. But the long time horizons and broad market exposure of institutional investors mean that they are particularly vulnerable to the good or bad ESG decisions of the companies in which they invest. Some institutions have developed innovative investment strategies to deal with this issue. For example, several have created indexes that either screen out worst-in-class ESG companies or weight toward best-in-class companies. Since 2012, the Swedish pension plan AP4 has been running a low-carbon fund that excludes the 150 worst polluters in the S&P 500, thereby producing an index whose carbon footprint is about 50 percent lower than that of the broader index.

While differing liability profiles may make custom indexes the optimal solution for institutions, they should consider the scale benefits of collaborating with others. A good example is the $2 billion committed by six big institutions to the Long-Term Value Creation Global Index, designed for them by S&P. Investors should also think beyond passive equities and consider how they can use ESG factors to reduce risk or identify alpha across a range of asset classes. An obvious possibility is direct investments in companies and real assets where institutional investors have enough influence or control to upgrade the ESG management.

Finally, only a handful of ESG managers have ten-year track records. Institutional investors shouldn’t wait passively for such track records to turn up—they ought to use their emerging-manager programs to seed and support innovative ESG-informed strategies. Several managers are pushing the boundaries of ESG-informed investing (see sidebar, “Innovative approaches to integrating ESG”).

Confront the skepticism and misunderstanding that surround ESG head-on

Successful investment organizations have strong cultures, but strengthening a culture takes time. At many institutions, ESG investing is caught in a cultural trap. For decades, conventional wisdom has held that ESG and its forebears, such as socially responsible investing, are merely a sideline, something to be worked on separately from the true business of investing. Changing this mind-set requires concrete action.

Chief investment officers must direct a cultural change within their investment teams. For a start, they can model the right behavior by leading the integration of ESG into the investment committee’s risk/return discussions. Institutional investors should also consider whether training and certifications may advertise the value they place on ESG fluency. Just as the CFA Institute’s Claritas certificate gives investment professionals a measure of credibility after only 100 hours of study, an industry-wide ESG certification could become a signal of qualification to institutional investors as they hire and invest. Bloomberg, the CFA Institute, the SASB, and many universities already offer ESG courses, and some consolidation around a clear industry qualification would benefit everyone.

Turning a symbolic commitment to ESG into daily practice will not be easy. But faced with rising stakeholder demand for meaningful action, there is little choice. Institutions that get out in front of the growing wave will be the first to reap the benefits of sound ESG investing: better returns, lower risk, and—should these ideas be widely adopted—a more sustainable world.