Three reasons to be optimistic about impact investing

A new kind of inequality – or divergence – is emerging in modern society between individuals and businesses who incorporate purpose into their work, and those who don’t. Impact investing has entered the mainstream mindset, but for many, putting it into practice has proven difficult.

Impact investing has become a hot topic over the past year: the G7 established an impact investing task force, the White House announced a related policy agenda and the Pope organized discussions on the subject at the Vatican. For the past decade, I have been studying the rise of impact investing from multiple angles. I’ve looked at how mainstream investors can maximize long-run risk-adjusted returns by managing for environmental, social and governance (ESG) metrics, how social entrepreneurs scale with private capital, how philanthropists can increase their impact with an array of tools, and how governments can fund critical societal mandates in a more cost-effective way. In some ways, the popularity of the impact investment sector has become a bellwether of this “purpose divergence”.

I recognize that there are many sceptics who think impact investing is just another fad. The truth is, we can only make that judgement in the rearview mirror. But there are several reasons why I am hopeful we are at an inflection point in capitalism. First, over the next four decades, millennials will inherit between $30 trillion and $40 trillion from baby boomers. Recent research by Deloitte shows millennials think business can do more to address society’s challenges. Of the 7,800 millennials from 28 countries polled by Deloitte, 56% said they thought business could do more about resource scarcity and 49% said businesses could do more to deal with income inequality.

Second, the LOHAS market (lifestyles of health and sustainability), now worth $300 billion, has grown 10% annually since the early 2000s. Market research shows that customers place a premium on impactful products – 76% of customers would switch to brands or retailers that have a social cause (price and quality otherwise equal) and 80% of customers in the LOHAS market would pay up to 20% more for select socially responsible products. With the popularity of impact-oriented products such as KIND bars, Method home products and Warby Parker eyeglasses has come increased investment ‒ in 2013 alone, Warby Parker raised over $100 million in series B and C rounds.

Third, preliminary research has found that managing for social impact makes financial sense in the long run. Companies with higher ratings of corporate social responsibility and ESG have lower costs of capital and exhibit market-based outperformance (89%) and account-based outperformance (85%). A study found that $1 invested in the early 1990s in a portfolio of high sustainability firms would have grown to $22.6 by the end of 2010, while a $1 investment in low-sustainability firms would have grown to $15.4. Another study found that over a three-year period ending 31 December 2013, higher impact portfolios out-performed a traditional portfolio model based on modern portfolio theory on return (10.5% annualized vs. 8.9%, higher by 1.6% per year) and risk (11.3% annual volatility vs. 13.0%, lower by 1.7% per year). While this preliminary research is cause for optimism, the data is early and limited and it will therefore be several years before we can conclude indisputably that higher impact leads to stronger financial returns.

So why is it so easy for some to weave purpose and impact into their work and so difficult for others?

First – the perception that at the beginning of the impact journey you need to be flawlessly impactful can be paralyzing. The perfect can be the enemy of the good.

Incorporating impact is not a binary decision nor is there a one-size-fits-all model; rather it is a gradual and iterative process that involves experimentation, evaluation and transparency with key stakeholders. It takes a willingness to learn, iterate and change course. The best in class see many possible ways to start, resist external labels – either as validation or as judgement ‒ and have open communication channels with their investors, clients, employees and community members.

Second – impact needs to have the commitment from top leadership and to be part of the strategy conversation (not just the marketing and supply chain conversations). Not only will this make implementation easier, but it will avoid a backlash if/when key stakeholders see an organization as inconsistent, or worse, inauthentic.

Third – business leaders feel torn between the company’s long-term values and the key stakeholders’ short-term expectations of quarterly or even daily financial metrics. Value creation has become divorced from valuation. However, over time markets will reward those companies that live their values, retain top talent and serve the best interests of their customers and society. Those that learn sooner how to proactively target, measure and incorporate impact into their business decisions will be more competitively positioned in the long run.

The divergence between the “haves” and “have nots” of purposeful impact can narrow – and businesses and society alike will benefit. What’s important for us to keep in mind is that all approaches with the intention to create positive impact have merit and can serve as gateways towards future additional engagement and to create better alignment between impact and finance.

Author: Abigail Noble is Associate Director and Head of Impact Investing Initiatives at the World Economic Forum and previously was Head of Africa and Latin America for the Schwab Foundation for Social Entrepreneurship. She is co-author of the report released today, Charting the Course: How Mainstream Investors can Design Visionary and Pragmatic Impact Investing Strategies and last year’s report, Margins to Mainstream.

Image: Coffee trees sprout at a farm in Alfenas in the southern Brazilian city of Minas Gerais July 8, 2008. REUTERS/Paulo Whitaker