Investing to Create a Sustainable Future — Second Vatican Impact Investing Conference
Presentation from the Second Vatican Conference on Impact Investing, June 2016.
Investing to Create a Sustainable Future
An exploration of the various types of capital — from philanthropic to fully commercial — being deployed around the world by impact-oriented investors to scale enterprises capable of using the power of business to deliver positive environmental and social impact.
- Audrey Choi, CEO of the Institute for Sustainable Investing at Morgan Stanley
- Matthew Patsky, CEO of Trillium Asset Management
This conversation revolved around the different types of impact investment capital. The presenters emphasized the range of return expectations — from philanthropic to concessionary to market rate — and the importance of appropriately aligning investor expectations with social entrepreneur needs.
After brief introductions, [Time: 4.45] Choi opened by taking a poll of the audience and found that they were pretty evenly split between investors and social entrepreneurs (or program focused representatives).
She then continued the session with what she described as her own “Trinity”:
- The importance of Clarity or “to know thyself”
- Investors need to understand the “color of the money” that they are seeking to employ. Is it purely philanthropic (i.e. a grant or donation), a hybrid (such as a program-related investment) or part of an endowment where a financial return is necessary?
- Social enterprises need to truly understand the purpose of their businesses. If they should never make money from their work (such as disaster relief), they should not partner with investors that require financial returns.
- Blended model social enterprises should understand if their priority is to make money or to have a social or environmental impact, and pursue investment types aligned with their priority.
- Choi used Greystone Bakery example of a blended model. The bakery sells brownies to employee homeless people. The founder wanted anyone to have the opportunity of employment to the enterprise re-engineered its hiring and management process to accommodate the needs of homeless people, previously incarcerated people, or anyone who had difficulty landing a job through traditional employment avenues. Profit maximization is not the main purpose of the business.
2. The need for Fidelity or “to thine own self be true”
- Social enterprises that don’t have robust revenue models should not look for — or accept — investments that require a high rate of return, such as from a hedge fund.
3. The reality of Unity
- Investors need to remember that all money can have positive impacts, whether it’s what you don’t invest in, how you use your investment as a shareholder to advocate for change, or how you proactively choose impact investments.
[Time: 11.50] Patsky then discussed what he wanted the audience to leave the session understanding.
- Impact investing isn’t new. It’s been around under different names and descriptions for hundreds of year. The Quakers and the Methodists were practicing forms of impact investing in the US in the mid-1800’s. Trillium Asset Management was founded in the 1980’s with the mandate of socially responsible investing.
- Impact Investing does not require — but it can have — a sacrifice in returns. Depending on the investor’s profile, a portion of the portfolio might be targeted for lower returns/higher impact investments.
- Publicly traded equities and fixed income have place in the impact investing ecosystem.
- Fiduciary duty requires investors to consider the mission of the companies they invest in.
Patsky referenced a quote he attributed Charly Kleisner, founder of the KL Felicitas Foundation, that all investments have impact; the goal is to maximize the positive impacts and minimize the negative ones. The same is true that all philanthropy has intentional and unintentional consequences.
- For example, Toms Shoes’ Buy One Give One model does not have particularly positive consequences for a shoe maker in developing world. It is training people to get shoes rather than training them how to make shoes.
- US Food Aid has destroyed food production in other parts of the world, like Ghana. This was not intended but is the big picture.
[Time 17.45] Patsky looks at an investor’s risk profile and income needs when determining the appropriate asset allocation.
- Tries to devote as much impact investment in private markets possible. Usually this is around 10%, but it can be very little.
- Patsky directs those investors with smaller amounts for impact investing to Calvert Foundation notes. Calvert Foundation has put $1.5 billion to work for impact.
[Time 18.55] Root Capital
- Many Trillium clients support Root Capital
- It has $140 million in its loan portfolio
Patsky told a quick cautionary tale about how organizations like Root Capital have to be a good match for investors. Root Capital accepted funding from a hedge fund that wanted to be involved in philanthropic and loan capital. However, when the hedge fund wanted for-profit metrics that didn’t make sense for Root Capital, it asked for its money back that next week. Fortunately, — wanted money back next week OPIC (Overseas Private Investment Corporation) a Trillium client, was able to step in and partner with Root Capital in a way that allowed them to grow.
Patsky said that early money came into returning rice growing to Ghana from Acumen, which was followed by venture capital. VC money caused Trillium to shy away from investing (which was a good move). He explained the importance of understanding when you as a mission driven investor want to germinate and catalyze innovation
[Time: 23.30] What is sustainable investing and why would Morgan Stanley do it?
- Sustainable investing is still obeying all the hard-nosed rules while also considering environment and social implications
- Morgan Stanley got involved because it saw how risk could be avoided and returns could be earned
- Choi spoke about the evolution of sustainable investing in her experience at Morgan Stanley. When she began in her role around eight years ago, many of her colleagues responded with “that seems lovely — let us know how it works out”. But then clients (especially religious institutions) began asking for responsible options. And now there’s a real business case for considering sustainability in investment decisions.
Evidence shows you can preserve or increase return with same or less risk. In a poll of 1000 investors:
- 71% said interested that they were interested in sustainable investing, and this percentage was higher for women and millennials.
- 72% said that companies that do the right thing will do better, but 54% said as investors they would not make the same rate of returns in “good” companies.
- In a comparison of 10,000 mutual funds, 64% of those with sustainable strategies had the same or slightly higher returns as their peers with the same or slightly less risk.
[Time: 28.55] Patsky again referenced Root Capital and gave more information about its founder and history.
- Willy Foote founded Root Capital around 11 or 12 years ago as Ecologic Finance, a subsidiary of the Ecologic Development Fund.
- He had witnessed the problem of the “missing middle” (businesses that are too big for microfinance and too small for traditional banks) as a member of the international finance team at Lehman Brothers.
- He developed program to provide capital to rural small and growing businesses in Latin America then to Africa.
- Root Capital provides training farmers to improve yields, helps them join cooperatives and then directly connects the farmers to markets.
- This economic development improves the entire community with better schools and access to running water.
[Time: 32.15] The panelists opened up the floor for questions. The audience seemed particularly interested in climate change and how impact investing can address the pace of climate change. Choi agreed with the urgency and severity of the issue, calling climate change a “massive, pervasive mega-trend” that will affect every industry. She referenced the disproportionate effect of climate change on the poorest populations. It is an investment opportunity and moral imperative.
- We need to invest in preserving clean water and other natural resources for moral reasons. However, conservative economists say there is a $10 trillion opportunity in doing so.
- We also need to be aware of unintended negative consequences. Choi gave the example of how affordable housing needs to be environmentally sustainable to be a smart, resilient investment.
Patsky agreed saying that Trillium encourages all clients to divest from fossil fuels.
When asked about developing products to keep up with the pace of climate change, Patsky said there was lots of activity on a smaller scale at firms like Trillium. It’s more complex for larger firms to pool. Investments need to be above $500 million or it doesn’t fit the fund. Choi expressed optimism at the increasing rate of change, citing that 2015 was the first year that investments in renewable energy in developing countries were larger than investments in traditional energy — meaning that these countries may be able to leapfrog directly clean energy. But she added that civil society needs to keep the pressure on governments to maintain the Paris agreement and other climate agreements.
When the topic of commercializing public goods (such as energy and water) and the potential of doing so making poor people even poorer, Patsky adamantly argued for the need to recognize basic rights and not allowing for-profit entities to privatize them. This is an unintended consequence of developing a world-wide interest in water.
As advisors, Patsky tells clients that they can accept a below market rate of return for part of their portfolio. They determine this percentage by backing out cash and return needs. Choi agreed on the need to be clear about the part of the portfolio investors want to use to catalyze social activities. These are likely to be in DAF’s or other accounts reserved for philanthropy.
Morgan Stanley is looking into ESG equity models. They asked equity research analysts, “for your industry what are the most material social and environmental factors that can affect value.” Choi gave examples of how analysts changed their calls after thinking about these more long-term issues. She thinks that as the sector gets more people to understand costs, the forward-looking investor will figure out how to monetize ESG information.