Will Responsible and Impact Investing Still Command the 21st Century?
By: Travis Knoll
In the aftermath of the Covid pandemic and nationwide protests demanding redress of historic racial inequities, industries looked to position themselves on what they saw as the right side of public opinion. The dawn of the Biden administration sparked a boom in thought leadership around combining social priorities and profits, from the advertising sector to banking. By 2023, the tide had turned. Even supporters of socially responsible investing called out excesses in Environment, Social, and Governance (ESG) frameworks and counseled a return to human rights basics.
William Burckart and Steven Lydenberg’s 21st Century Investing (2021) gives readers a glimpse of the headiest days of the latest wave of impact investing. The book started with a simple premise that “a growing class of investors” recognized that they have an effect on “global social, financial, and environmental systems” that in turn “impact their portfolios (3).” Systemic risks can even give rise to destabilizing social inequalities leading populations to embrace authoritarian solutions to the disparities (30-31). From housing to Board of Directors gender diversity, the future of investing laid in using traditional and novel financial instruments to address risk and stabilize the financial system. Most impact investors decided to tackle the quantifiable challenge of climate change by building renewable energy portfolios, creating green bonds, supporting government and voluntary standards, and lobbying for special buying programs backed by tax incentives.
Contrary to the claims that impact investing is a radical departure from professional financial norms, the authors argue it is merely an expansion of Modern Portfolio Theory (MPT). But while risk management largely relies on instrument diversification, the authors allege that MPT fails to acknowledge that portfolios can impact systemic markets as well as suffering the effects of systemic failures. Impact investing, then, begins from the premise that large institutional investors have a role to play in the overall stabilization of social systems, not simply maximizing returns while minimizing their own portfolio risks. The authors open with nods to Japan’s Government Pension Investment Fund and the Church of England Pensions Board, who consider themselves “universal owners” with “stewardship responsibilities (13).” But such principles can even be found in the United States’ 2010 Dodd-Frank law, which mandates large financial institutions undergo stress tests precisely because they are vital to the global financial system.
The rest of the book serves as one part case study compendium, another part how-to guide for differentiating impact investing from typical ESG index investing. The first step involved setting clear goals along social, financial, and environmental axes (36). Priority should go to issues, like food security and water access, that affect returns across asset classes (bonds, private and public equities etc.). Impact investors should first try to involve the biggest owners through coalitions such as the Global Investor Coalition. Such actors can range from pensions and financial institutions like the California Public Employees’ Retirement System and HSBC, to utilities like Xcel Energy and automakers like Volkswagen. Impact investors should work hard to win over traditionally resistant trade associations to environmental goals. Companies should base their intervention on “consensus, relevance, effectiveness” and “uncertainty (49).” That is, do the issues need addressing, is the issue relevant to the fund’s expertise, are there effective financial instruments to address the issue, and does the issue create systematic uncertainties to warrant direct addressing.
Companies can do this by deploying an asset class that fits the problem or organization addressing the issue. These solutions can be local, like the North Carolina-based Self-Help Credit Union and F.B. Heron’s below-market loans to Self-Help Enterprises. They can also be national and international solutions such as CalSTRS’s creation of the Low-Carbon Index for public equities, Caisse de dépôt et placement du Québec’s direct investment in Quebec’s infrastructure, and Bank of America’s issuance of green bonds.
There are multiple methods to create win-win investments such as Prudential Global Investment Management’s impact investment fund to address spatial inequality in Newark, the drafting of Investment Belief Statements (IBS) that prioritize both social benefit and profit, the incorporation of ESG factors into security selection, voting and policy guides, engagement of companies struggling to minimize abuses, and divestment if said engagement fails. Other tools are more quantitative, such as Hermes Investment Management’s Task Force on Climate-Related Financial Disclosures (TFCD)-aligend cross-portfolio climate risk tool.
Impact investing seeks to expand physical, human, and financial capital through a focus on environmental, social, and governance factors respectively (87). Investors can realize these gains through “opportunity generation, field building” and “investment enhancement (89).” Companies like the KL Felicitas Foundation and funds such as the Construction and Building Unions Superannuation (CBUS) can help create entire fields like impact investing and set standards like the Six Capitals. Others such as the Ireland Strategic Investment Fund (ISIF) can develop investment standards for individual projects around the principles of additionality, displacement, and dead-weight (107). Activists such as Ralph Nader and Saul Alinsky led the way on proxy voting to get socially conscious board members like Rev. Leon Sullivan (e.g. the controversial Sullivan Principles) to push General Motors to divest from South Africa (97). Systemic investors such as Dutch Pension PGGM do not simply fight against privatization of critical resources like water, but active access to said resources (99).
Burckart and Lydenberg call for a careful evaluation of impact results that moves away from an exclusive focus on metrics (118-119) and expands the traditional meaning of fiduciary responsibility from shareholder profit maximization to a focus on long-term social value, profit creation, and long-term economic stability. This can range from Norges Bank Investment Management’s engagement of their clients to encourage tax payments and the Établissement de Retraite Additionnelle de la Fonction Publique (ERAFP)’s caps on corporate executive compensation to investing in government bonds to strengthen the public sector (140-141, 145).
The case studies and surveys of different measurement techniques make this book an essential guide to those transitioning into the impact investing space. Some of the solutions point to a time when impact investors in the United States believed in the power of corporate coalition-building to reshape markets. Instead, coalitions have sometimes produced fewer results and greater legal risk than the slow and silent work of sustainable investing. Nevertheless, the trials and triumphs chronicled in this book will provide excellent lessons for the next wave of sustainable investing.
