Innovation, Quality Data Are Key to Impact Investing

Advisors must look for innovative business models and do deep analysis to design impact portfolios for clients

As impact investing becomes more mainstream, some critics have argued that investors are driving the social value out as they search for financial value, according to Katherine Pease, principal at KP Advisors. Pease moderated a seminar on impact investing on Thursday at The Alliance Center in Denver.

Erika Karp, founder and CEO of Cornerstone Capital, said the most useful tool bringing together values and returns was governance. To get “the governance right, you must look at the big environmental and social imperatives,” she said.

Scalable impact investing requires innovative business models, Karp said. Not only is “systematically going down avenues of inquiry around environmental, social and governance factors” not a breach of an advisor’s fiduciary duty to investors, she said, but not doing so is. Strategists and analysts who don't "systematically look at these factors should be fired," she said. "The next iteration of finance and investing and capitalism” will consider these factors, because “all investing has impact if we know what it is and if we know how to systematically look at it and if we know how to make it intentional and if we know how to measure it," she said.

Capitalism is the best engine for driving economic prosperity, she said, but right now the engine is stalled. “The monetary authorities globally are beyond capability of doing anything at this point. There’s something messed up about negative interest rates.”

There’s a deficit of “leadership, creativity, innovation and entrepreneurship” that if corrected, can move impact investors closer to their ultimate goals. However, "we need to find the business models that work," Karp said, "and this takes time."

Technology will be a key driver in that effort.

“Say Intuit comes out with an app that is explicitly designed to engage those who are off the tax rolls – we’re really talking about the unbanked,” she said. “Intuit can have an app where they can scan a paycheck and start thinking about getting them on the tax rolls so this new tax filer can get a tax credit, a refund, that they didn’t even know was coming. We know that refund goes right back into the economy because they don’t have any discretionary dollars, so they’re going to spend it.”

Engaging consumers that way “is economically constructive for a for-profit company,” she added.

The industry has come a long way from 70 years ago when public firms didn't even have to disclose their revenues, Karp said. Investors now have more access to information about the way firms are run and can make decisions about value, and they have to decide how deep they want to go in "pure impact or how mainstream they want to go in transforming the corporate sector." She added that “anything in between is good; progress is good.”

Karp said that the structures that currently exist are undermining long-term value creation. That boards of directors are beholden to shareholders first is a myth, Karp said. Their first fiduciary duty is to the corporation, she said. “The long-term health of the corporation comes first, and if you take care of your stakeholders, your employees, your communities, your shareholders will be taken care of.”

Enhanced analytics are necessary to “sort out the dialogues between about values and value,” she said.

The Forum for Sustainable and Responsible Investment’s (US SIF) 2014 report on the size of the impact investing market found that the vast majority of the $6.7 trillion invested in that sector are in publicly held companies. Globally, there’s between $60 billion and $100 billion in “deep impact” investments, Fran Seegull, chief investment officer and managing director at ImpactAssets, said, or “private companies whose sole purpose is to create the social and environmental impact that’s at the nucleus of their business model.”

That impact covers investment themes as broad as job creation, education, sanitation, water quality, health and agriculture. There are huge opportunities for investing in those areas as population expansion, most of which is in emerging markets, creates a demand for capital, Seegull said.

For example, food production will have to increase by 70% by 2050 to keep up with demand. “There is an increasing demand and imperative to deploying impact capital,” she said.

The supply of impact capital is increasing as well as demand, but Seegull worries there is an “increasing mistrust of the capital markets and the slavish focus on quarterly returns.”

She said the size of the capital markets is about $212 trillion, domestic philanthropy accounts for about $300 billion, and U.S. government aid accounts for about $35 billion. “You can see the difference in order of magnitude between government, philanthropic giving and the enormous capital markets.”

A big driver of impact investing is wealth transfer, as boomer men begin passing their assets to women and millennials who are the primary investors in the impact sector, she noted. “At the intersection of this increasing demand for impact capital and the increasing supply of impact capital, we have a scalable market that’s increasingly mainstream.”

Seegull recommended layering philanthropic and impact capital as a way for investors to use capital wisely to achieve their ESG goals.

She referred to the California FreshWorks fund, which was created by the California Endowment to improve health and wellness in the state, as an example of layering capital. The fund combines grant capital, program-related investment, tax credits and market-rate capital from banks, Seegull said. Because market-rate capital is being combined with “deeply concessionary capital,” she said, the “cost of capital is less than what you could otherwise get at a bank.”

Advisors should be wary of "greenwashing" from companies on ESG factors, Karp said. “If someone puts a fund together based on the number of women on a board of directors, that will undermine the actual economic outcome we’re trying to get to because that in itself is not good data,” she said. Any factor in ESG investing is a “starting point for further inquiry.”

Another risk is in index products that are based on bad data. "We don't yet have standards for corporate disclosure of environmental, social and governance data,” she said. The Sustainability Accounting Standards Board, of which Karp is a founding board member, aims to create a set of such standards for companies in the United States.

--- Read Alpha Could Be Hiding in ESG Data: Report on ThinkAdvisor. 

--- Correction: An earlier version of this article misspelled Katherine Pease's name. 

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