Brian Trelstad: Making Impact Investing Work

Octo Members
16 November 2020

A short read.   

After decades on the margins of finance and philanthropy, impact investing is finally moving into the mainstream, with most major asset-management firms having launched impact-investment funds and strategies. But without stronger standards, greater diversity of players, and a wider focus, a promising shift could become corporate whitewash.

There is a growing consensus that capitalism needs to be reimagined. The influential Business Roundtable in the United States recently issued an appeal for corporate CEOs to think about their impact on all stakeholders, not just their financial shareholders. Equally, we have no hope of achieving the Sustainable Development Goals unless private capital is mobilized to complement public funding. Many believe that so-called impact investing can be part of the answer.

The idea is not a new one. True, most people used to think about their finances as having “two pockets” (as Ross Baird of Blueprint Local puts it). One pocket was for fiduciary investments geared toward making as much money as possible, regardless of social or environmental considerations. The other pocket was for philanthropic efforts aimed at doing as much good as possible, while disregarding financial returns.

But the ends of the “spectrum of capital” started to merge in the 1950s. At that time, some purely fiduciary investors – namely, faith-based communities, civil rights organizations, and labour unions – realized that certain investments were morally repugnant or misaligned with their values. Chief among these were holdings in companies manufacturing tobacco products, producing pornography, or doing business in apartheid South Africa.

In 1968, the Ford Foundation pioneered a new tool known as program-related investment, which used low-cost loans as a substitute for grants to affordable-housing developers. Ford realized that by designing an investment to “crowd in” private capital, it could leverage comparatively scarce philanthropic funding by a factor of three- or four-to-one and still see a return of principal. Thus, a $10 million philanthropic budget for affordable housing might translate into tens or hundreds of millions of investment dollars.

Then, in the 1990s, some intrepid investors, recognizing that simply excluding bad categories of investments from their portfolios was not enough, took program-related investing a step further. They focused on the connection between superior returns and how a company manages environment, social, and governance (ESG) issues. The early evidence from this approach suggests that treating employees well, pursuing boardroom diversity, and managing a firm’s environmental footprint can indeed have a positive impact on financial returns.

Finally, in the early 2000s, a number of investors – including Bridges Fund Management in the United Kingdom, DBL Partners and SJF Ventures in the US, and Acumen Fund and Root Capital in emerging markets – recognized that another broad change was underway. A new generation of entrepreneurs was building businesses with the explicit intent of solving pressing social and environmental problems. And it soon became apparent that investing in such companies could have real-world impact and bring outsize financial returns.

After nearly two decades of toiling in the wilderness, these organizations have continued to grow and gain credibility. What was once considered niche is now becoming mainstream. But with the rush of capital into impact investing, higher standards are needed. Specifically, three things must happen for impact investing to realize its full potential.

First, the industry needs more agreement on standards for assessing claims of impact, as well as mechanisms for independent verification. Slapping a “Sustainable Development Goals” (SDG) or “ESG” logo on your fund’s prospectus does not make you an impact investor. Credible claims of impact should follow from rigorous due diligence, clear performance measures, consultation with end beneficiaries, accurate and independently verified reporting, and relevant sector benchmarking.

In this respect, the Impact Management Project’s recent efforts to harmonize the alphabet soup of impact acronyms (such as IRIS, GIIRS, PRI, and GRI) are promising. But now we need to move from theory to practice; that is, from PowerPoint slides to user-friendly, cost-effective tools that are available to every asset manager and entrepreneur. And even with these harmonized standards and tools in place, we will need to ensure that impact claims are as legitimate as the reporting on formal financial statements.

Second, industry players must commit to recruiting a generation of talent that is proximate to the problems being addressed. A corps of predominantly white, male finance professionals based in Midtown Manhattan or Mayfair, London, will not understand the intractable global challenges that impact investments are supposed to tackle. Moreover, there is ample evidence to show that diverse teams tend to outperform homogenous ones. Asset owners, fund managers, and entrepreneurs must be representative of the communities being served.

Finally, as investors allocate funding to new impact- and sustainable-investing strategies, they also must account for the potentially negative effects of the rest of their portfolios. If a $1 billion green fund serves as cover for an additional $99 billion still invested in companies extracting fossil fuels or relying on exploitative supply chains, then impact investing will have failed. Likewise, philanthropic institutions and universities also must “look under the hood” of their endowments for investments that may run counter to their missions.

Rather than being a fig leaf, impact investing must be the thin end of the wedge, opening a space for traditional investors eventually to apply environmental- and social-impact assessments to every asset in their portfolios.

Will the next chapter be about real change at scale, or will the mainstreaming of impact investing be a hollow gesture? The stakes are high. But with operational definitions of impact, a new generation of talent, and a much wider lens, investing in our shared future might just become the future of investing generally.

Brian Trelstad

Brian Trelstad is a partner at Bridges Fund Management and co-chair of Impact Capital Managers.


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