Josh Stunkel
Every month, The Big Question video series brings together a panel of experts for an in-depth discussion. In this edited excerpt from September’s episode, Robert H. Gertner, Joel F. Gemunder Professor of Strategy and Finance and deputy dean for the part-time MBA programs at Chicago Booth, and Steve Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance at Chicago Booth, were joined by Tasha Seitz, chief investment officer for Impact Engine, and Liz Michaels, chief of staff and director of socially responsible investing and environmental, social, and governance issues at Aperio Group, in a conversation about impact investing. The discussion was hosted by Hal Weitzman, Booth’s executive director for intellectual capital.
Seitz: The World Economic Forum defines it as “deliberately generating both financial and social return in a way that is measurable.” It’s about financial and social return, intentionality, and measurement.
Gertner: It’s hard to observe intentionality, so the measurement becomes important. The definition doesn’t specify whether or not you’re actually trading off financial returns for impact, so this includes both investments that are willing to put up with lower financial returns, and those that seek market returns.
Seitz: Lots of people are trying to crack this problem and create the equivalent of the Financial Accounting Standards Board for impact, but it’s very challenging, because there are a lot of different kinds of impact. We have the social entrepreneurs that we invest in come up with one or two measures that capture the impact they’re trying to create, and use those as key performance indicators.
Michaels: When you’re dealing with a family or a foundation where this is their passion, the measurement is, “What does it mean to me?” That’s one of the challenges, because people’s values are different, and that’s very different from financial returns, which are more homogeneous.
Kaplan: By definition, when you invest for nonfinancial reasons, you’re giving up returns and diversification. Liz is trying to make that give-up as little as possible. But don’t fool yourself: there is some give-up any time you restrict yourself. Isn’t that a form of philanthropy?
Gertner: It’s essential to distinguish between nonconcessionary impact investing, which targets market-based financial returns, and explicit concessionary impact investing, where you’re not going to get market returns. The concessionary side is interesting. Does a foundation that cares about its philanthropic impact manage its portfolio to maximize return, and then make grants entirely separately? Or should it think that it will give up some return on its portfolio for those investments to have some impact, and therefore it has less to give away in the future? That’s a deep, empirical question, and we don’t know the answer to that yet.
Seitz: Every dollar has an impact and a return at some level. [The return] might be zero if you’re giving it away to create this positive social impact in the world, or it may be you’re trying to maximize your financial returns, but there’s a spectrum in between, and so different investors will choose to be at different points along the spectrum.
Seitz: The notion that you can have these dollars working independently is false from an impact perspective—they might be working at cross-purposes. If you’re focusing on climate change as an issue, and you’re putting money into coal-fired plants, you have dollars that are working against each other.
Kaplan: If you’re not investing in coal or tobacco, you’re giving up returns and/or diversification. It’s concessionary, and I’m not convinced you can do this in a nonconcessionary way. It’s very hard to say when a social enterprise doesn’t cut it, because you can always say, “It’s creating nonfinancial value here or there,” and if you’re making up the metrics, you can always fudge them. That’s my skepticism about impact investing: as it goes bad, people say, “Oh, but we’re creating nonfinancial value, so let’s keep doing it.” You end up losing money. And it may not be easy to measure whether you really have created nonfinancial value.
Michaels: There’s a difference between values alignment—removing things from the portfolio, and then doing what you can to limit the constraint—and saying, “These are better investments,” that you are a better company in managing your supply chain, because it has a direct impact on your business and your bottom line. Look at Tesla. They are clearly an impact company, but they were profit-first. That’s where you see impact going—not needing to be concessionary.
Kaplan: The investments that create the greatest impact and the greatest value are the ones like Apple or Facebook, which create a huge amount of utility and happiness around the world. As a result, they also make a lot of money.
Gertner: A lot of impact investing will evolve to the concessionary sort, where investors are saying, “I want to make this trade-off and I’m willing to do so.” Then the question becomes, how is a dollar of capital different from a dollar of philanthropy? Sometimes there are reasons why a dollar of capital can be a more effective way to have social impact. If you get it back, you can redeploy it. In venture and growth stages, capital is scarce. Sometimes the concessionary impact investor can leverage those concessions to bring in other, purely financial-return investors by bearing more of the risk, potentially having greater impact than if [the dollar] were purely a charitable donation.
Kaplan: There’s also better governance.
Gertner: The impact investor is thinking of how the financial return, even if it’s concessionary, adds value by helping create a structure that allows others to come in.
Michaels: For values alignment, it’s about minimizing incremental risk and having a more holistic view. For others, companies that are doing a better job around their environmental footprint, social policies, and internal governance are alpha drivers.
Kaplan: The research I have seen on that is mixed. You have to be careful about causality. The companies that do well can afford to spend money on environmental and social policies, so the causality is unclear. In other words, if you make money, you can spend money on those policies; if you don’t make money, you can’t.
Michaels: All investment is making choices. All managers constrain their universe for one reason or another—only investing in value companies, or high-quality companies. Those are all decisions, some subjective, some bound by quantitative numbers. This is a new set of metrics that should be considered because they impact long-term performance.
Seitz: It’s moving in that direction, and millennials are driving that. Millennials think about baking their values into their employment decisions, investment decisions, and purchase decisions. More and more, it’s going to become a topic of conversation, and increasingly mainstream.
Kaplan: That wouldn’t necessarily be impact investing. That’s the market saying, “People want these companies or these products, so people will buy them, so they ought to be profitable.” So what does impact investing add? Why is it necessary?
Michaels: The core of this conversation is this concept of additionality. Does the investment itself have an impact, or do the market mechanisms start to incorporate impact into the way they work? I would love to see the market fully incorporate impact so that, as an investor, I’m making my investment decisions based on finding the optimal mix. There will always be room for both of those kinds of investors, but more and more, the traditional market mechanisms are starting to incorporate impact and values.
Michaels: There’s this conversation around philanthropic risk capital—being able to jump-start a pipeline of companies, or creating financial structures that allow financial capital to come in—and demonstrating that there are returns there. It can happen in a number of ways.
Gertner: Very traditional financial market incentives will work to change how companies behave. Values will show up because customers will make demands on the companies they buy from, and employees will make demands on the companies they work for. The pure profit motive will shift the way companies act, and that will be reflected in the financial markets.
Kaplan: Financial markets already do that. Companies that create a social value and are profitable get funded. The slippery slope that concerns me is the concessionary part, saying, “We’re going to get a financial return, but we may give up a little bit for social benefits.” It’s very easy to define the social benefits in a way that says, “We’re providing those and taking a lower financial return.” That’s where I’m a little skeptical.
Gertner: That is the challenge, and that’s why so much of the focus is on impact measurement, so that some discipline can evolve in this marketplace.
Michaels: One bellwether I look at is what owners are doing with their shares. BlackRock’s announcement of how they’re voting their proxies and being more public about their shareholder engagement around environmental and social governance issues is a huge move. When we talk to clients about reflecting their values, ownership is only one piece of it. What you do with what you own as a public stock-owner, which bequeaths upon you certain rights, including voting and ability to dialogue, is really important.
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