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What impact investing is really about

Geschreven door Koen The op 28 december 2020

Lendahand CEO Koen The takes us back to the essence of impact investing in concluding odd 2020 and warming up for 2021. 

Impact investing is all the rage nowadays. Who wouldn't want to make a good return on their money while helping people in need and saving the planet? What kind of self-serving, tunnel-visioned, person are you!

Of course life is not that simple. While there are research and evangelists out there claiming that impact investing can deliver market returns, I argue that that is not the case. But also that that is besides the point. But let's first define what impact investing is. And to do that, it's best to go back in time.

 

Once upon a time it was about greed and fear

Milton Friedman is famous for quoting: "There is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

May I remind you that Friedman won the Nobel Prize in economics? (Well, technically it's not a Nobel Prize since Alfred Nobel didn't see economics as something that could contribute to the greatest benefit of mankind.) Friedman is basically saying that as long as you don't break the law, you should only care about increasing profits. I guess investors on their turn should only be concerned about greed and fear, and may the best man win.

Thus investors became the most important stakeholders of a company. Employees, clients, suppliers, regulators... they all had to take the backseat as it was all about maximizing shareholder value.

But luckily things started to take a turn. Investors started to realize that there is good money to be made in some industries, but at the cost of a negative contribution to society. Obvious ones are the weapon industry and sectors that benefit from addictions such as tobacco and gambling. One day, companies in these sectors may find themselves on the wrong side of history as investors started to do negative screening of companies for their investment portfolio. And so, responsible investing was born: certain investors would not invest in certain sectors any longer.

 

A better approach is sustainable investing

Hurray for responsible investing! But surely there must be more to true impact investing than just ignoring a few sectors? Indeed there is. Taking it one step further, more and more investors started to look at the sectors they were invested in and would only invest in those that were 'best-in-class' when it came down to 'sustainable' criteria. A well-known framework is ESGs: Environmental, Social, and Governance.

Companies are measured on their ESG metrics and only the ones with the highest scores are deemed investable. These are the companies that have a long-term vision and a sustainable business model. They may not be the winners of tomorrow, but definitely of next year.

And that is what sustainable investing is about: per sector, you look at the financially most attractive companies, as long as they are best-in-class from a sustainability point of view. These are companies that are not trying to push the (moral) boundaries to generate profits. On the contrary, they want to do what is right to ensure their business is not hurting people or the planet while making a profit. It's smart to invest in such companies. They tend to outperform companies that go for a string of short term gains. You avoid investing in companies that have no vision, that miss out on mega trends, and are very sensitive to market sentiments.

There is an obvious caveat though: it's not always easy to identify responsible investments. All companies know that people are scrutinizing their corporate citizenship. An easy way out is to do greenwashing. The Cambridge Dictionary defines this as "to make people believe that your company is doing more to protect the environment than it really is”. More generally, some companies are "ESG-ing" their reputation. A signing on the wall is if CSR or the likes live in the marketing department and the CEO is not fully committed.

 

But what we really should look for is Impact investing

Investing in companies that score high on ESGs is definitely impactful. But is it enough? As an ex-Facebook employee put it,: "The best minds of my generation are thinking about how to make people click ads. That sucks."

There is so much possible with the technology available that the solutions to very big, global problems are within reach. But we need people to work on that (instead of making people click). And not just a few people, but many. We need many nudges. Some big, some small, but all pushing us into the right direction. And luckily we see more and more companies that first consider how to create a positive impact on people and the planet, and then how to generate profits. Don't get me wrong, for these companies the path to profitability (and staying there) is important. However, these companies are all about intended positive impact, rather than impact as a by-product in its quest to make money.

Investors are increasingly putting money into such companies. This is called impact investing. It's very different from responsible investing. Companies that make an intended positive impact - let's call them social enterprises - work with different decision trees than companies that don't have a pure social mission. A company's journey is made up of countless small and big decisions. Social enterprises understand that and start with the end in mind. Their social mission provides the framework to make tough decisions along the way.

Now here comes the hard part. From a risk-return perspective this is not good news for investors. Social enterprises operate under more constraints than others and at best end up at a local optimum from a financial return perspective. In other words, impact investing leads to underperformance versus the market. There I just said it.

But really, who cares? Who decided that investing is about maximizing financial returns (given the risks)? If an 'investment' is about securing the future, why only look at it from a financial perspective? Impact investors measure success differently. Their portfolio is a success if it leads to wealth accumulation for themselves and a better life for others.

 

Let's go through some examples

Now let's have a look at a few companies and see how we should categorize an investment in that company.

Danone. Their B Corp Certification is in line with their long-term commitment to combine economic success and social progress. They have a good track record of trying to make their products in a more sustainable way. Therefore, an investment in Danone would be sustainable investing.

Fair Phone. This is a company that sells phones. No big deal, except that they do that while trying to make the value chain fair. Their phones are made out of 40% recycled plastic and most of the other materials are sourced in a sustainable way. And what the heck, you can even open it up and replace the battery so you don't have to buy a new phone because of a degrading battery. An investment in Fair Phone would be impact investing.

 

The endgame

From responsible investing to sustainable investing to impact investing. One might be forgiven to think that impact investing is the end game. It's really just the start. Capitalism as we know it is outdated and impact investing is the next step in moving to a new equilibrium. One where we don't feel the need to grow (profits) at all cost.

As our supervisory board thoughtfully shared with us: “Once the dust of the pandemic has settled, emerging markets will be even more vulnerable, making Lendahand’s primary objective to end poverty more relevant than ever before.”

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