Fact and Fiction: Impact vs. Returns

Yuval Noah Harari’s book Sapiens explores a variety of notions around what advantages made Homo sapiens so much more successful at expanding its global reach and controlling the environment than Homo neanderthalensis or any other competing species. Among the possible explanations I found most compelling was the notion that it’s not cranial capacity nor a varied diet, but rather our collective ability to create and sustain belief in fictions –including religions, nation-states, laws and limited liability companies.

This coming Saturday (November 5) I will be on a panel with DC Moore, Cyrille Arnould, Katie Ellias and Dawn Hines (moderator) talking about “Social Impact Investing, Impact vs. Return.”?We’re told 150 or more of our fellow Wharton School alumni will gather in Huntsman Hall to hear us debate the joys and frustrations of working as entrepreneurs and investors in the social impact world.?

Me being me, I intend to stir the pot a little by putting some stress on the audience’s assumptions.

Spoiler alert: I think asking whether ‘social impact’ businesses can deliver ‘risk-adjusted market returns’ is asking the wrong question. I believe Milton Friedman’s notion that the market would somehow make everything ok, and that businesses had a moral obligation ONLY to produce the highest possible financial shareholder returns, has been a curse on this country and this world. I believe business risk is overpriced by the market in Africa and underpriced in the United States and Europe. I am convinced we need to be talking not only about what “impact” means but also about what the full range of “returns” means, and whether financial return is the only type of return that should matter.??

Some of my fellow panelists were students at Wharton a decade before I graduated; others half a decade after. Social impact may be a hot topic in the curriculum for today’s students, but it was not always so. Those at Wharton 30 years ago with a “do-gooder” inclination were more likely to be steered toward charitable foundations than to for-profit businesses with an impact mission, whereas today there are ample social impact options in the curriculum, and Wharton Magazine regularly features blurbs on alumni impact around the world. The cover story of the current issue is “Profits and Purpose,” which asks “can the ESG promise of net-zero pledges, improved corporate responsibility, and sustainable strategies also be green for investors and shareholders?”

The Wharton School was founded in 1881 with gift from Joseph Wharton, whose Wikipedia entry paints an interesting picture:?

Over several decades, Wharton lobbied successfully in Washington, D.C. for tariff laws protecting U.S. manufacturing …?Wharton successfully lobbied for a bill in the Pennsylvania General Assembly supporting Limited Partnerships to allow more participation of capital in enterprises with risk … In 1881 Wharton donated $100,000 to the University of Pennsylvania to found a "School of Finance and Economy" for this purpose. He specified that the Wharton School faculty advocate economic protectionism, as he had when lobbying for American businesses in Washington. However, the school soon began to broaden its outlook to a global one and to teach other disciplines such as politics and the developing social sciences, and introduced the teaching of business management and finance as these disciplines gradually coalesced.

My company, Jobomax Global, builds houses in West Africa. We’ve done so since 2014 - the same year Harari published Sapiens. My business partner Jonathan and I came to know the region as Peace Corps volunteers in the early ‘90s, and eventually found our way back in partnership with Mamady Doumbouya, a West-Africa born Wharton alum from a much earlier era. We launched with a vision to address the gap in the housing market in West Africa that left so many homes unfinished, and so many Africans in the diaspora disappointed that they did not have a place of their own, in their home country, to return to for vacation or retirement. We started in Guinea, where Mamady had a good piece of land.

One thing we learned early on is that nobody - nobody in West Africa, nobody in North America, nobody in Europe - was financing Guineans in the diaspora to build a home in Guinea. In order to address the market we knew was there, we needed to recruit one of our investors to help set up a financing company that could provide the capital to our homebuyers. So we did.?

Ameet Dhillon has run US-Africa Housing Finance (USAHF) since 2017, regularly returning cash payments to his equity investors of around 9% each year. USAHF total returns averaged 7% more annually to investors than the S&P 500 index over every available period of time (1, 2, 3, 4 and 5 years) leading up to September 2022. Place your bets on what the comparison will look like when we get to mid-2023; I know where my bets are placed.

USAHF distributes those returns, quarter after quarter, on an asset secured by land title, in a diversified and mature portfolio with an implied loan to value ratio of around 60%. USAHF is the kind of investment that should, if priced properly for the true underlying low risk and volatility, be returning 5% - 7% to investors instead of 9%. So, while USAHF has mostly attracted investors who see themselves as investing for impact in West Africa, those investors have in fact been receiving a better-than-market financial return on an investment that is less risky and less volatile than the market. There’s an argument to be made that as self-respecting impact investors, USAHF’s equity holders should be demanding that USAHF lower its rates so that the impact could be expanded (full disclosure - while both Jobomax Global and I as an individual have financial interests in USAHF, neither I nor my company have yet demanded that USAHF lower their returns to meet our specific portfolio impact objectives).

It often takes more incentive to get investors to put money into business on the continent of Africa.?But the Africa Risk Premium – itself one of the grandest of fictions – is just part of the problem. A more widespread problem is that the impact / return conversation is typically framed in such a way that businesses with positive impact (we used to speak of this as “positive externalities” back in my economics undergrad days) are under pressure to defend their return prospects, while firms with a Friedmanian financial-return-only mindset get too few questions about their risk pricing.

More and more, we live in a world where bad actors are eventually punished for the negative externalities associated with the way they do business. You may enjoy a good run creating an opioid epidemic at Purdue Pharma and putting your name on art galleries for a while, but when life catches up with those externalities, you owe $6 billion in cash, lose the company, and suffer immense reputational damage – not to mention the collateral damage extending to others in the market (CVS, $5BN settlement; Johnson & Johnson, $5BN settlement; etc.).?

Adidas may ink a sweet deal with a global celebrity that brings in $2BN in annual revenue for their athletic shoes, but when said celebrity launches into antisemitic rants, the liability of that relationship can start to look like more than $2BN a year. Open any newspaper or business-focused website today and you’ll find more examples of these types of chickens coming home to roost.

The problem in the impact vs. returns discussion is not that unattractive returns prevent impact-focused businesses from competing in the market. The problem is that the market – which, let’s face it, is not some invisible-handed omnipotent bringer of good outcomes, but rather a fiction that simply reflects the priorities of those who can exercise the most influence on its levers – is underpricing the risk and volatility of businesses who ignore the negative externalities resulting from their operations.?

Deforested mountains, dried-up rivers and overfished trash-filled oceans are facts, but nation-states are fictions that only work because enough people believe in them. Houses and land are real, but mortgages are fictions that only work because enough people treat them as fact. Huntsman Hall is a fact – a real structure made of steel and wood and bricks, paid for with a fortune built on real styrofoam Big Mac clamshells – but the University of Pennsylvania is a fiction that only works because enough donors, parents, students, faculty and staff believe in it. Unsustainably high CO2 concentrations in the atmosphere, 80,000 opioid deaths a year in the US, lung cancer and diabetes are all facts, but the corporations whose products create these negative externalities are fictions who can only function (and attract investment) because enough people in the market are willing to believe their narrative about a world of higher-than-market financial returns with no consequences for the negative social and environmental impacts that result from the amoral pursuit of those returns.

So let’s flip the question: is it possible to have positive risk-adjusted market financial returns when a business is creating substantial negative externalities? One need look no further than historical dividend payouts from big oil, big sugar, and big tobacco (all well-represented in major market indices) over the past half-century to see that many have, in fact, profited from others’ misery. But in a world that is increasingly attentive to SDGs, ESG and social and environmental impact, our species may be defining a new reality. The market will return whatever we – its creators – prioritize.?

What kind of creator are you?