INTRODUCTION II. THE TERMINOLOGY OF FOUNDATIONS AND OTHER PROFESSIONAL SOCIALLY MOTIVATED INVESTORS A. Unpacking Common Terminology III. IMPACT AS A REQUISITE OF SOCIAL VALUE CREATION IV. CONCESSIONARY VS. NON-CONCESSIONARY INVESTMENTS V. THE FIRST BIG QUESTION: CAN INVESTMENTS IN PUBLIC MARKETS CREATE SOCIAL VALUE? VI. THE SECOND BIG QUESTION: CAN INVESTMENTS IN PRIVATE MARKETS CREATE SOCIAL VALUE? A. Concessionary Investments in Private Markets B. Non-Concessionary Investments in Private Markets VII. THE THIRD BIG QUESTION: CAN THE POWER OF CONSUMERS, EMPLOYEES, CORPORATE ACTIVISTS, AND REGULATORS FACILITATE SOCIAL VALUE CREATION? A. ESG Criteria as Proxies for Financial Value VIII. CONCLUSION--AND ADVICE TO INVESTORS I. INTRODUCTION
Most investors throughout the world have a single goal: to earn the highest risk-adjusted financial returns. They would not accept a lower financial return from an investment that also produced social benefits.
More recently, an increasing number of socially-motivated investors have goals beyond maximizing returns. (1) They also seek to align their investments with their social values (value alignment), and some also seek to cause the companies in which they invest to create more social value as a result of their investment (social value creation). We show in this essay that while it is relatively easy to achieve value alignment, creating social value is far more difficult.
Socially-motivated investors who seek value alignment prefer to own stocks only in companies whose business and practices accord with their moral or social values. Independent of whether their investment affects the company's behavior, these investors wish to conform their investment behavior with their social values by owning the stock of companies that share them or refusing to own the stock of companies that do not.
Value-aligned investors may be concerned with a firm's outputs--its products and services. For example, they might want to own shares in an energy company that relies on renewable resources and avoid owning shares in an energy company that relies on fossil fuel. (2) Other value-aligned investors might avoid owning shares in companies that manufacture firearms or tobacco products. Or the investors may be concerned with a firm's practices--the way it produces its outputs. They might want to own shares in companies with high environmental, social and governance (ESG) standards, and eschew companies with poor ESG ratings. (3) Value-aligned investors must only examine their personal values and then learn whether a company's practices promote or conflict with those values. They then would assess the cost of value alignment by comparing the return on a portfolio affected by these value-aligned weighting considerations compared to an otherwise comparable unconstrained portfolio. (4)
Investors who wish to create social value begin with the same questions value- aligned investors do, but then must move on to the more challenging task of deploying their capital to increase an investee company's socially valuable outputs--for example, by enabling the company to provide additional health care or education to poor people in developing countries. Appropriately called "impact investments," these investments must lower the cost of capital to the investee firm compared to the cost available to the company in ordinary commercial markets, or otherwise cause it to produce more socially valuable outputs or to engage in more socially valuable practices--the criteria for creating social value.
Both investors seeking value alignment and those seeking to create social value face the initial question of what financial sacrifice, if any, they must accept to achieve their social goals. When can investors achieve these goals--value alignment or value creation--through non-concessionary investments, from which they expect a full risk-adjusted market-rate financial return? (5) When must the investments be concessionary, sacrificing some financial return to achieve social goals?
The literature published by asset managers, charitable foundations, and related trade associations manifests considerable optimism that socially-motivated investors can ensure value alignment and, indeed, create social value through non-concessionary investments. Some asset managers claim to provide their investors (at least) value alignment with no financial concession, (6) while others hold out the prospect of "excess financial return" or "alpha"--value alignment with better than risk-adjusted market returns. And some asset managers promise their investors the gold ring: social value creation without sacrificing financial return. (8) Similarly, some foundations imply that they can create social value through non-concessionary investments of their endowment assets and urge their peers to follow suit. (9)
We are skeptical about many of these claims. Precisely because the socially- motivated market sector is growing so rapidly, participants on both the sell-side and the buy-side of the market label their activities in a loose fashion that reflects either their aspirations or their marketing strategies rather than measurable results.
The need for clarity and precision in defining a socially-motivated asset management strategy is highlighted by the term impact investing. The attractions of impact investing are obvious. Socially-motivated investors seek change, and having an impact on the direction and pace of change through one's investments resonates powerfully with that aspiration. Yet this resonance has led to a grab bag of investment strategies that all claim the same mantle but with more or less precision and evidence of impact. The core of asset management is evaluation and benchmark comparison. Absent a clear framework for the strategy and, hence, a well-defined benchmark against which portfolio returns should be measured, neither evaluation nor comparison is possible. Without both, the socially-motivated investment market segment will suffer.
We do not doubt that with care and skill, it is possible to achieve value alignment with limited financial concessions over time. (10) But while we disagree with those who define impact investing to include only concessionary investments, it is in our view very difficult to create social value through one's investments while nonetheless earning full (socially-neutral) risk-adjusted and illiquidity-adjusted financial returns. In any event, we believe that the term "impact investor," as its name implies, should be reserved for investors who seek social value creation rather than simply value alignment. The social investing field can grow responsibly only if individual investors, impact investing trade associations, and asset managers are candid with themselves and others about the conditions necessary for real impact. (11)
In this Article, we first address the problem of imprecise terminology that presents a barrier to important issues actually being joined. In particular, we address a range of terms that are commonly and confusedly used in the social investing community. We then present a straight forward taxonomy of socially-motivated investments that identifies what should count as impact investing and how that framing relates to concessionary and nonconcessionary investments.
Such a taxonomy allows investors to articulate their goals and allows asset managers to articulate clearly what they offer and how their performance should be measured. Putting forward a clear taxonomy is not, as a commentator on an earlier version of this Article put it, "prescriptive." (12) There are many ways to make important contributions, but the field badly needs a benchmark against which claims of social value creation can be measured. Specifying that benchmark allows the actual debate to begin.
We next address three big questions in that debate. First, can investments in public companies achieve value alignment or create social value, whether or not with concessions on return? Second, can investments in private companies create social value, again whether or not with return concessions? Third, can socially-motivated investors working with other stakeholders cause public companies to create social value?
0ur conclusions are as follows:
* Impact investments in public markets. It is virtually impossible for investors to affect the outputs or behavior of firms whose securities trade in public markets through buying and selling securities in the secondary market. Socially-motivated investors who seek to improve ESG performance or otherwise increase the social value produced by a public company must join forces with consumers, employees, corporative activists, and regulators to affect portfolio company behavior. The recent success of climate change related proxy proposals at major oil companies illustrate the point: (13) portfolio strategy alone will not work. Finally, secondary investments in public markets are inevitably non-concessionary save through the loss of portfolio diversification.
* Concessionary investments in private markets. It is possible, however, for impact investors to affect the outputs of firms in private market transactions by accepting financial returns below those required by socially-neutral investors. Foundations' program-related investments are paradigmatic of such subsidies.
* Non-concessionary investments in private markets. It is also possible for impact investors to affect the outputs of private firms through nonconcessionary investments by taking advantage of private knowledge that they or their asset managers possess. However, non-concessionary investors' claims to have private information should be taken with a grain of salt. These investors are playing in a highly competitive game against the universe of private equity investors whose success depends on developing value-relevant private information regardless of the strategy.
THE TERMINOLOGY OF FOUNDATIONS AND OTHER PROFESSIONAL...
How Investors Can (and Can't) Create Social Value.
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