A piece in this weekend’s Financial Times shows that there are still some pretty basic misunderstandings around impact investment, which must be cleared up if the market is to grow as we want it to.
Jonathan Ford, the FT’s City editor, writes in “The difficulty with the EU’s sustainable investment rules”, that impact investing is a way of allocating “concessionary” capital, which accepts sub-market returns in exchange for social impact. He also argues that if what is called impact investment does deliver a market return, it cannot be differentiated from traditional investment, which would have been attracted to the investible opportunity anyway.
Impact investment is not about allocating concessionary capital. It is investment that delivers a measurable social or environmental benefit, as well as a financial return. In some cases, if the investor so chooses, the targeted return may be below market rates. In others, there may be no element of concession at all.
True, some of the most impactful investments require investors to accept concessionary returns, but that does not mean that all impact investing must, nor that it should. Impact investing allows investors to achieve different ambitions. This may be to achieve a desired level of risk-adjusted return (with investors also likely to benefit from the relatively low correlation of impact investments with the rest of a portfolio), and a degree of desired contribution towards one or more social or environment goals (such as the UN’s Sustainable Development Goals).
Ford’s mistake is to assume that doing good must always and only be a (financially) charitable activity. It can be and often should be, but it doesn’t have to be. The pool of money available to address the challenging social and environmental issues that we face will be greater if we don’t falsely isolate impact from the rest of the market.
He also states that “social value” investing ought to encourage things that would not happen otherwise. It does. Capitalism encourages quite a lot of things that would not happen otherwise. Finance enables things that would not happen otherwise. So does impact investment, in the following ways.
Firstly, some investors have a preference for impact. They may not be prepared to forego return, but they would prefer their portfolios also to deliver social or environmental benefit. Impact investing allows this preference to be met.
Secondly, entrepreneurs might be motivated not just by running a good business that generates revenue streams that will support financing, but by the impact the business has on society. It might be discomfiting for some to find that people can make money out of doing good, but happily that is the way the world is moving and it is welcome.
Ford goes on to argue that the EU’s efforts to design a “taxonomy” for sustainable investments would not be necessary if they produced superior returns.
This misses the point. The taxonomy’s development is about protecting investors and giving people more confidence in what they’re buying. It will help to make sure that sustainable investments are accurately labelled to prevent “green washing” or “social washing”, that is, claiming that an investment is sustainable when it isn’t. Its development reflects consumers’ growing preference for sustainable investments, combined with their continuing uncertainty about what is green and what is sustainable.
Impact investing is at a relatively early stage of its development. The fact that an article by the FT’s City editor misunderstands what it is, and how it should be regulated, is a sign that we in the financial services industry, and the Impact Investing Institute, must do a better job of explaining it as the market grows.