Last month, leaders at some of the world’s largest companies took the notable step of redefining the purpose of a corporation, adopting a “modern standard” for corporate responsibility that promotes “an economy that serves all Americans.”
The 181 CEOs who signed the statement from Business Roundtable, an association of chief executive officers headed by JPMorgan Chase’s Jamie Dimon, pledged to run their companies “for the benefit of all stakeholders — customers, employees, suppliers, communities, and shareholders.”
The statement marks a notable move away from the adherence to shareholder primacy — the belief that corporations exist principally to serve shareholders — which the group had embraced since at least 1997. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term,” Dimon said in prepared remarks.
That pivot should catch the eye of a growing number of organizations committed to impact investing, the practice of investing in companies, organizations, and funds with the intention of generating not just financial returns, but measurable social and environmental impact as well.
Underlying that philosophy is the belief that private capital is critical to tackling the world’s most pressing environmental, social, and governance (ESG) problems, an ethos echoed in the Business Roundtable statement of purpose, which said, “We believe the free-market system is the best means of generating good jobs, a strong and sustainable economy, innovation, a healthy environment, and economic opportunity for all.”
That dovetails with views shared at an impact investing panel held earlier this year, part of the 2019 MIT Sloan Investment Conference.
“It’s one of the fastest-growing areas of the investment business,” said panel moderator Liqian Ma, head of impact investing research at global investment firm Cambridge Associates. “The goal is to invest in products and services that serve a need, address real challenges, and also can and deserve to be profitable.”
“Impact investing is values-driven finance — you allocate capital to align with the world you want to see,” said Amrita Sankar, MBA ’20, co-president of the MIT Impact Investing Initiative. “My generation has grown up watching the world's most intractable problems become only more exacerbated — poverty, climate change, social injustice, and more. We see impact investing as an opportunity to use markets to correct for these kinds of issues by providing positive social and environmental returns.”
For all its appeal, the concept can be hard to nail down — the phrase “impact investing” itself is ambiguous, said Gita Rao, a member of the MIT Sloan finance faculty who teaches a class on social impact investing.
“In a sense, the term ‘impact investing’ is an oxymoron, because all investing is inherently impactful: you are investing with a specific objective,” said Rao, who is the faculty advisor for the Impact Investing Initiative and has managed socially responsible portfolios for two decades. “That's why my course is titled 'Social Impact Investing,' because we're focusing on the impact that investing has beyond financial return. In addition to financial return, you're hoping to generate an environmental or other impact.”
The evolution of impact
The idea of investing with intention beyond financial return isn’t new, Rao said. “Faith-based organizations have been investing in accordance with their values for a very long time,” she pointed out.
Rao managed a global equity portfolio for a large endowment in the 2000s under what were known colloquially as “Catholic constraints”— no guns, no tobacco, no pornography, as might be expected. But the exclusion criteria additionally affected investment decisions in areas one might not expect, Rao said.
For example, the portfolio could not invest in Total, a large French energy company, because one of the byproducts of oil refining is rubber, which is used in contraceptive products. Similar guardrails guide Islamic investing, which has seen significant growth in the Middle East as well as Asia, said Rao.
Intentional investing is alternatively known as corporate social responsibility, socially responsible investing, and sustainable investing, among other terms. The most common of these — ESG — refers to the environmental impact, social impact, and corporate governance of a company. Investment professionals use ESG ratings to evaluate how specific companies are performing along these dimensions, and how well those companies align with their own values.
There is a distinction between impact investing and ESG-based investing. Investing for impact is often described as investing with a “double bottom line” — that is, financial return and a clear, well-articulated set of impact goals often, but not always, aligned with the United Nation Development Programme’s 17 sustainable development goals.
ESG-based investing evaluates companies on a set of criteria defined by the investor, and the business model of the company need not explicitly incorporate social impact.
ESG investing typically has a strong shareholder advocacy component, with what Cambridge Associates’ Ma called “a cohort of thoughtful investors” actively work to influence companies’ direction. “It’s not just a matter of excluding the not-so-responsible companies, but of engaging them,” said Ma. “Some clients may still have mining, oil, and gas in their portfolio, for example, but they will be asking those companies where they can make improvements.”
Climate at the head of the pack
Climate change is increasingly top of mind for impact investors, some of whom, like Ma, have a personal interest in climate-conscious investing.
Growing up in China, Ma experienced firsthand the effects on air quality when households burned coal for heating and cooking. “I needed coal to survive as a child, and every time I go back [to China] I see the environmental effects of burning that coal. I encourage people to think about it,” said Ma, who categorized resource efficiency as one of the fastest growing areas of actionable investing.
Rao agreed. “Climate change in all its ramifications not only affects people profoundly, but it affects [markets] on a geopolitical level. From an investor's perspective, climate change poses a material risk, which is often not incorporated into the pricing of securities. It affects the business strategy that companies have to adopt going forward,” she said.
Measuring impact and intent
For all their virtue, impact investments are still subject to the rules of the marketplace, which poses some distinct challenges. First and foremost, it’s not easy to find companies that meet stringent impact requirements while still providing market rates of return. “Achieving these twin goals is not easy or straightforward. It requires additional resources to measure impact and may involve greater risk,” said Rao.
Assessment can be a challenge. At minimum, potential investors want to evaluate the environmental, social, and corporate governance of a company with the same rigor that’s applied to financial performance — but it’s not always a clear-cut evaluation. In fact, new research from MIT Sloan found that ESG ratings diverge substantially among the agencies that provide those services. As a result, researchers warned, corporate stock and bond prices are unlikely to properly reflect ESG performance, causing investors to struggle to accurately identify out-performers and laggards.
Beyond ESG, which primarily focuses on a company’s operational practices, many investment management firms have developed their own frameworks to assess impact.
MIT Investment Conference panelist Quyen Tran, a sustainable investment strategist and member of the Global Impact team at Wellington Management Co., said the team looks for three attributes in companies it’s considering adding to its Global Impact portfolio, which is drawn from a universe of approximately 500 publicly traded impact companies:
Materiality (meaning a prospective firm’s core products or services — rather than its operations — must solve a problem that falls under one of three global impact themes: life essentials; human empowerment; and environment).
- Additionality (meaning the company provides a product or service that a competitor or government entity isn’t providing, thereby advancing rather than simply maintaining social or environmental goals).
- Measurability (which provides a way for investors to ensure the company continues to meet or exceed the investors’ impact goals).
Then there’s the question of scalability. A startup that provides learning technology to underserved high schoolers in Africa might be delivering direct impact, but does it have the potential to grow, Rao asks — both in the sense of broadening and deepening its influence, but also its ability to deliver returns.
In contrast, a multinational corporation like Unilever might present with some problematic areas, but by dint of its size and reach, has the potential through its impact activities to move the needle more significantly, Rao said. “There’s a tradeoff here. With the Unilevers of the world, the impact may be diffuse, but the scale is enormous. It’s not an either-or decision. ”
Playing the long (long) game
Finally, there’s the question of investment horizon. Impact projects by their nature tend to need long development cycles to come to fruition. Investors may have much shorter time horizons and lower risk tolerance. “The market punishes or reward stocks based on whether they can meet or beat earnings,” Rao said. “Impact projects involve upfront costs with the benefits often accruing over the long term. Investors need to be patient.”
Ma, who once authored a report titled “Risks and Opportunities from the Changing Climate: Playbook for the Truly Long Term Investor,” believes that longest view is in harmony with Cambridge Associates’ fiduciary responsibility to its clients.
“If you’re really being thoughtful and authentic, long-term is how you should think of the world,” he said. “Our clients are stewards of capital that they want to preserve for decades, for a few hundred years. We would not be doing our jobs if we weren’t identifying risks and opportunities with those timeframes in mind.”