Responsible Investing as Part of Balance

Peter M. Lupoff

November 16, 2020

I was an investment professional for over 25 years before I came to realize that all investing had impact. Further, that returns can be the same, whether seeking financial return indifferent to the social/environmental impact of the investment, or opting for financial return in addition to seeking measurable, favorable social/environmental impact. 

Skate to where the puck is going, not where it’s been - Wayne Gretzky

Since then, I describe my ‘evolution’ from being a Traditional money manager (financial solely, indifferent to social/environmental factors) to an Impact Investor, as a ‘journey’. It’s evolution and a journey, not in that one approaches enlightenment ala Buddha, but more like Wayne Gretzky, it's where things are going. It’s not just virtue, but pragmatism. Traditional Investing is archaic, in that given the ability to achieve the same (arguably better) results, Traditional Investing ignores ‘free options’ (at minimum) on favorable social or environmental impact.

At some point, we will not distinguish between “Responsible” or “Impact” Investing and simply, describe it once again, as “investing”, as the logic of passing on/missing measurable social or environmental return makes no sense, and in the parlance of money management, would be both inefficient and violate fiduciary responsibility (for professional investors and institutions).[1]

Some Simple Nomenclature

We’ve already described Traditional Investing as indifferent to social/environmental Impact. Let’s define Socially Responsible Investing as investing in the stock market and owning the shares (bonds too) of public companies, choosing those that are considered best with regard to Environmental, Social and Governance (“ESG”) practices. As these public companies’ primary objectives ordinarily do not include impact (but selling goods, services, etc) and your ownership is passive (harder for you to influence the company), the impact you derive from these investments is described as having low intentionality. Impact Investing requires a more measurable social and/or environmental impact alongside a financial return. These investments therefore, are longer term, less liquid and usually effected through direct investment in a private company or in an Impact Fund (that invests in impact-oriented companies and/or projects). As the social/environmental impact is a more important consideration and objective, Impact Investing is described as having high intentionality.

So Socially Responsible Investing is investing in say, the equities/bonds of the top quartile ESG performing companies (avoiding poorer ESG performers) and Impact Investing is investing companies or Funds, de facto longer-term, less liquid investments, seeking demonstrable impact along with financial returns. Impact Investing can span asset classes, geographies and societal initiatives. Whether investing venture capital in an application that provides educational material for under-resourced schools, or funding a social impact bond that aims to reduce recidivism among juvenile offenders, this approach seeks profit-making commercial solutions to social and/or environmental challenges. Together, Socially Responsible Investing and Impact Investing may be considered, broadly, Responsible Investing. Institutional investors would have both types of investments. Individuals may have both based on wealth, savings, time horizon and wherewithal.

Returns, Philanthropy and Mental Accounting

I’ve been teaching investing classes at University the last few years. One of my favorite themes is “Human Biases and Investing.” There is a particular bias – mental accounting – that I believe is at the heart of investor’s historic reticence to allocate to impact investments. As humans, given a “mental accounting bias,” we are prone to intellectually create different “accounts” for money based on source or purpose. A good example is the gambler that wins some money, tucks away their original betting capital to play with just the winnings, or “house money.” Money is money, no? Well to date, and perhaps generationally, individuals and institutions have created separate buckets of capital, one earmarked to earn market-based returns and the other, to be given away to drive philanthropic goals. The twain never to meet. Why?

Al Capone, Discord and Harmony

The mental accounting bias also justifies, for we people, greater acceptance that what we do for money, does not define who we are. Further, that one can balance any harm or amorality of one’s work while earning a living, by the good works and giving we can do outside our jobs. In classes, I’d describe the notorious Chicago 1920’s gangster Al Capone, creating widows and orphans by day, attending black tie charity events in his honor at night, for his contributions to the Chicago Widows and Orphans Fund, all in the hopes that his psychic ledger was considered balanced on that day that he met his maker. There is inherent discord in this way of living. We can all find ways to bring harmony into our lives through purpose in our work, and investing (and consumption) in line with our purpose and personal beliefs. Generationally, this too, is the direction of the puck.

Address a Problem Once or in Perpetuity Until Ameliorated?

As Impact Investing (like Traditional) creates both a return on capital and a return of capital, allocations to Impact Investments are revolving, that is, as money is returned to the investor, it can be put back to work in new investments to continue the good work. That is, as opposed to philanthropy, where money is given away to address a problem, is spent, and ideally, a problem is reduced, Impact Investing allows the investor to persist in reallocating returned capital to address the problem, perhaps until eradicated. As this blurs the line between philanthropy and investment; philanthropy will come to be defined in a narrower way. There are some pressing problems where money given with no return but high impact and intentionality - philanthropy - is called for. Similarly, if a problem can be addressed with markets-based solutions that persist in addressing the problem, why, in that instance, would that not be preferred by both investor and beneficiary? 

Nothing About Us Without Us - Giving People What they Want (Demand)

Do you not sense it all coming together? Companies are increasingly embracing stakeholder capitalism, working for the benefit of shareholders and consumers, community, employees and suppliers ratably and for the longer term. One in every four dollars in global investments now is Socially Responsible Investment, investing in the best ESG performers.[2] Millennials have now surpassed Baby Boomers as the nation’s largest demographic segment. Millennials are demanding more integra-tion of their money and values by seeking personal fulfillment in their careers, applying a global consciousness to their purchases and investing in sustainable, impactful business models.  According to a US Trust 2017 study, 76% of Millennials said they consider their investment decisions to be a way to express their social, political and environmental values, and 88% said that a company’s impact in these areas is an important consideration when they make investment decisions.[3]

At more than 83 million strong and comprising nearly one-third of the US population, those born between 1980 and 2004 are redefining society in profound ways. And with more than $68 trillion passing to them through inheritance over the next 25 years.[4] Millennial investors will use their wealth to reshape not just markets, but the world.

This, the largest generational transfer of wealth and is expected to peak between 2031 and 2045, during which 10% of total wealth in the US will be changing hands every 5 years. Further, women will control approximately 70% of this wealth by 2031.[5]

Given this demographic data, there is an inexorable move in the direction of business as a force for good as it is what the consumer, employee and community want. There is a concurrent drive amongst companies to achieve measurable ESG improvements in order to satisfy a demographic that are their current or coming consumers, employees and yes, shareholders. Finally, as people seek to assert their beliefs through investment, the enormity of wealth transfer over the next 30 years (as wealth is typically invested longer-term) should drive the mainstreaming of Impact Investing.

Responsible Investing – A Mainstream Investment Philosophy

A movement is afoot that represents a significant opportunity for businesses and markets to drive social value. By allocating investible capital toward products, services and companies that generate positive social impact, the movement toward Socially Responsible Investing (public securities with ESG criteria) and Impact Investing (longer-term, more intentionally impactful) has the potential to create real value both for investors and for society.

The quest for opportunities that allow investors to do well while doing good is not a pipe dream. A growing interest in Impact Investing has spurred the development of a new field that is evolving toward integration into the mainstream of investment strategies. The funding of innovative and forward-looking business models is increasingly being facilitated by new financial structures developed to enable a triple bottom line with results for people, planet, and profit.

We appear to be at the beginning of an opportune time for Impact Investing, as more private investors seek to make meaningful differences alongside profit in their portfolios, and the public sector increasingly seeks to plug funding gaps for crucial social, environmental and development problems. As the industry matures, I believe that investors will have a plethora of innovative and effective options to make a difference in an increasingly satisfying and fulfilling manner. Further, that professional investment management will move in this direction, influencing the skills and jobs to fill in order to participate in advising and managing the magnitude of capital soon to change hands to the socially conscious investing preferences of the youthful inheritors of the largest generational transfer of wealth.

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Peter Lupoff is Chief Executive Officer of Net Impact, a 160,000+ member, 435 chapter organization with a mission to inspire, equip and activate emerging leaders to build a more just and sustainable world. www.netimpact.org

Peter previously founded Tiburon Capital Management, running Tiburon as CIO until acquired by consultant, Gray & Company. Peter later founded Lupoff Friends and Family Interests, which has committed to operating a 100% Impact Investment portfolio. Since 2016, Peter has taught Impact Investing and Investment Research classes as Special Lecturer at Yale School of Management and Fordham University (where he was Entrepreneur-in-Residence 2018-19, and remains a Fellow with their Center for Research in Contemporary Finance). He is a Member of the Impact Investing & Sustainable Finance Faculty Consortium and is a regular writer and speaker related to topics among his areas of expertise. www.lupoff.com

[1] Passing on ‘free options’ of social/environmental impact is inefficient, as no investor should choose less value for the same cost of investment. Additionally, to be indifferent to the social/environmental impact of an investment appears to breach a professional’s or Trustee’s fiduciary responsibility as a steward of the investment capital, if doing so would endanger the value of a portfolio. Arguably ignoring the ‘externalities’ of social/environmental problems in the world likely causes more stress, costs and risks on an investment portfolio. Similarly, investing indifferent to the social/environmental harm caused by a company would violate this duty. Note: while this is logical and many institutions and endowments are coming to believe this, few have codified it as an obligation - yet.

[2]  USIF - https://www.ussif.org/sribasics

[3] US Trust Insights on Wealth and Worth – The Generational Collide, 2017

[4] Cerulli Associates - https://info.cerulli.com/HNW-Transfer-of-Wealth-Cerulli.html

[5] IBID