Ivestment, Responsible and Responsible Investment

This article may be controversial in some ways. While it is not science, opinions can and should differ. By generating some kind of debate or reflection, I will have accomplished my goal.

When we are in the corporate world making investment decisions, it is normal for numbers to take the place of protagonists. Generally, choosing one or another possible investment tends to seek the highest rate of return (IRR) - nothing more natural. It is also necessary to understand the risks involved and how they may eventually threaten the desired returns. Once the profitable investment is chosen at a controlled level of risk, then the source of funds and possible sources of financing are considered, and voila! - The investment is approved. This process applies from the purchase of a machine, the acquisition of another company or even to the stock investment.

When it comes to allocating resources for sole responsibility purposes, the mental model is different. The issue of IRR comes to a third level and the most relevant point is to achieve the social objectives, "whatever the cost". Thus, populations in remote areas that lack public sewage system or electricity, for example, become the ultimate goal of the investment and, if contemplated, investments will have been successful, regardless of their rate of return, which most likely will not be attractive. The debate will then be about the source of resources (capital available) versus the prioritization and choices between the various existing needs that often outweigh the size of available resources.

Then comes the complexity of Responsible Investment. Some might simplistically believe that Responsible Investment is just the intersection between making investments in the traditional way but focusing on social and environmental ends. But the reality is much more complex than this.

Serious and critical investors cannot (nor should) give up returns to make their responsible investments.

Elementary financial mathematics says that to calculate a rate of return, three elements are required: the amount invested, the time elapsed, and the value realized (terminal value) at its completion.

The first two items are easy to obtain as they are fully quantifiable. The problem would be to measure the terminal value of the investment, since as they are for social and environmental purposes, they are not necessarily easily quantifiable.

Given that this data is fundamental for the calculation of return (IRR) and considering that the Responsible Investor does not relinquish the impact measurement to approve or disapprove his capital allocation, a critical situation is evident: how to quantify the qualitative? How to turn social results into financial numbers so that they can be compared with the investments made so that the return can be measurable?

For example, what is the financial value of literacy for children, reducing ocean pollution or even saving lives? Very difficult to quantify, almost impossible to do it accurately, but absolutely necessary to measure return.

And this is where the controversial part of the text comes in. To make such computations, one has to make assumptions. The premises are harsh, controversial, doubtful, questionable, but necessary.

In my course at Harvard Kennedy School, there was a case discussion that struck me. It was a burning hospital with dozens of sick people, but a single helicopter to save them. There was no room for everyone, and it was up to me to decide who goes in or who doesn't. The exercise made me very bad. I am generally pragmatic, but that situation caused paralysis.

Although human life, any of them, has infinite value, unusual and extreme situations help to make some digressions. A sick person who needed to be transported in its bed, for example, would take the space of two who could travel seated. By rescuing one, you lose two inexorably. Thus, hypothetically, in that situation, one life was worth less than the next ... and although it is difficult to establish a financial value for it, if there is something worth more than another then, regardless of mathematics, there is already a reference of value. .

Perhaps the same rationale can be used for a disillusioned old man, a few weeks before his death, though in good condition versus a healthy 10-year-old child. Again, even though we were not attributing financial value, it is implied that there is a value scale, and having it, mathematics tries to solve the equation in one way or another.

We can think of less harsh examples: distributing a food basket to a poor family is the same if the family is from Malawi or Brussels? Do both families have the same alternatives to a "plan B"?

The establishment of financial values for each of the above scenarios leads to a second questioning. More and more companies are speaking out about having a purpose rather than just pursuing profit maximization. BlackRock President Larry Fink's spectacular letter entitled “A Sense of Purpose” has reverberated greatly among global corporations.

If our mental model as an investor is in transition, it is also time to rediscover accounting, at the risk of not being able to measure what matters.