Economic markets are organic, living, breathing, dynamic environments. We can help make ours resilient, sustainable, and truly wealth generative for all.
I have spent much of my career working with the risks that inform institutional capital deployment, regulatory oversight, geopolitical influence, and commercial decision-making. I have tried to learn from the international and economic security issues that drove such decisions post-9-11/2001 and through the credit and financial crisis of 2008.
Perhaps some simple observations may help us finally get ahead of the curve. I believe that wealth creation and risk mitigation can be understood in a manner that is consistent with efficient markets that look to maximize total returns, and that deliver sustainable impact against some of our most pressing social and environmental challenges.
If we are really to drive human and financial capital to meet the challenges of the 21st century, we have to understand three bedrock assertions.
First, investments in effective strategies for environmental sustainability and social inclusion fundamentally support risk-reduction and enhanced welfare.
Second, decreased risk and enhanced welfare generate “wealth” in ways that are both economic and non-economic, furthering the adoption of such successful strategies.
And third, wealth itself is a rich bounty of treasures, both tangible and intangible, that investors must define for themselves, and pursue in a manner that matches perceived risks and commensurate returns.
From here, we can use traditional economic theory around investment portfolios, investment targets, asset allocation strategies and new venture opportunities, in ways that are truly wealth-accretive.
Let’s apply the logic and motivation of efficient markets in a manner that tilts the “whole system” toward the emergent and growing impact economy. Those markets, are all of us: individuals and companies, public and private entities, borrowers and lenders, buyers and sellers, and investors.
We have heard all the usual objections:
- “I would like my money to do good, but I don’t want to sacrifice economic gains.”
- “You can’t do good for the planet AND make money!”
- “Investing preserves or grows wealth, money for cause is charity.”
Unfortunately, some of the language of impact investing has reinforced rather than dismantled these siloes, encouraging investors to think in tradeoffs, hedges, and competing priorities.
At the most basic level, market participants continually seek investments that produce higher yields and ever-greater returns—and understand that such returns must at least match, if not exceed their deployed risk.
Thus, the central questions for market participants are, “What constitutes return?” or, “How do I define wealth?” From there, a more comprehensive understanding of “markets,” “risk,” “assets” and “leverage” can help simplify the tools that drive more informed risk-return decisions, and facilitate one’s fundamental investment strategy.
How do I define growth, sustainability, and impact? What constitutes “value?”
The narrow view of economic value doesn’t properly credit many kinds of wealth that we all seek: the wealth of knowledge, the wealth of time, the wealth of social networks, the wealth of identity and inclusion, the wealth of personal and family safety and security, the wealth of professional longevity, and the wealth of personal health and healthy ecosystems.
A new definition of wealth includes a growing range of tangible and intangible assets, such as food and health security; the openness of new and emerging markets and the availability of financing and credit—including to those populations that have traditionally been underserved or not served at all; the expansion of innovation, initiative and increased job opportunities; the increased value of one’s resource base—or its regenerative capacity; an extended time horizon for businesses and future generations, and a sustainable cultural or historical identity.
These kinds of wealth are as generative as economic wealth—and indeed create additional opportunities for wealth in purely financial terms as well. Such wealth provides security of basic needs (food security and health) and resiliency to environmental and social shocks. It minimizes expenses and decreases liabilities, which translates directly to increased financial and economic value. Such growth enhancement and risk mitigation should be accounted for in any estimation of value, and are the foundation to “real” as well as “perceived” wealth.
Who am I trying to serve to achieve my (or my organization’s) wealth objective? How do the markets I serve extend and grow value?
Markets for goods and services—inside and outside the community (foreign, domestic, real, and virtual)—are created for the purposes of exchanging value for both economic gain and real impact.
These markets extend well beyond the transaction venues for economic value, but include the exchange of ideas, time, expertise, and knowledge, progress, the development or preservation of community, culture and heritage, enhanced skills, productivity, a stronger resource base, and greater resilience to market-altering “forces,” be they economic, environmental, geopolitical, etc.
This understanding is considerably broader than traditional definitions of markets, where all values must be monetized, where control often rests with a few market makers, and where unequal information and access fundamentally make them less than truly free.
What are the challenges and the uncertainties I must overcome to service my identified markets and achieve my “wealth” objectives?
Economic gain depends on risk, despite the challenge such risk poses to an investment, or venture’s attainment of wealth. Investment managers understand that generating returns requires the deliberate positioning of risk. Perfectly hedged strategies yield zero returns!
Impact investments have been deemed to be risky—by stage, geography, target market, or business model—in large part due to their lack of a proven track record, but arguably also due to the assumption that they present seemingly “esoteric” or “difficult-to-quantify” risks.
We should ask, “Compared to what?” Since 2008, capital market investments, opportunities, and traditional asset classes have seen unprecedented volatility and revealed new uncertainties that have yet to be fully digested and understood. As we come off a 2013 that saw US equity indices return near 30 percent, we see blue chips, Fortune 1000, and traditional bellwether companies, growth-oriented technology “darlings” and other “hot” sectors, continually assessed by top-rated analysts as increasingly overvalued, “frothy,” or showcasing bubble-like characteristics. Yet, a number of institutional investors continue to justify capital deployment in companies that boast no near term positive cash flows simply because they are affiliated with so-called growth sectors, or in currencies tied to soaring sovereign debts on the hope that deficit-driven bail-outs have been established as the new norm.
Why is it easy to jettison the very question of uncertainty in traditional markets and asset classes, but hold so dearly to it in relation to “impact,” investment opportunities specifically devoted to positive and sustainable development?
Impact investments are by definition wealth accretive (see above), stimulative and generative of new markets (e.g. the global poor). They are beneficial of sectors that reduce societally- and environmentally-destructive costs—those that exacerbate externalities, undermine market efficiencies, and burden the social safety net. Importantly, many impact investments remain uncorrelated with traditional debt and equity markets, providing healthy risk diversification to most investment porfolios.
Risks have traditionally been understood simply as volatility, deviations from planned or expected outcomes. Whether beneficial or detrimental, such a view of risk falls short of the comprehensive challenges faced by portfolio and asset managers, business owners, entrepreneurs and investors when assessing opportunities that generate “productive” value—not just gains to be exploited by price distortions or market inefficiencies. Investment decisions should be driven by the need to effectively and efficiently price and overcome uncertainties related to everyday operations and future investments.
A more comprehensive definition of risk takes into consideration the uncertainties and challenges in the context in which we are living and working, investing and transacting. These would not only include risks to economic value, but importantly, those that directly or indirectly impact such value as well, e.g. the business risks of under-representation of women in key roles when women globally are increasingly in charge of households, and even corporate buying decisions. These examples are many!
When driven by a more expansive definition of wealth, understanding risk is understanding uncertainty. By contrast, a pure focus on volatility allows for continued speculation on what we may not know or understand—because the management of volatility is the navigation around expected or perceived outcomes, and NOT the management of uncertainty or challenges to sustainability or wealth creation itself.
Taken comprehensively, such risks include:
- Competitive risks: who are a venture’s competitors, or an investor’s competing opportunity costs to investment?
- Tenor risks: what are the risks related to investment timing, volatile or seasonal cash flows, duration of exposure, and/or real and expected returns?
- Geo-political risks: what are the sovereign, regional risks, or other risks associated with an investment, a venture’s location, or exposure?
- Environmental risks: what are the endogenous and exogenous impacts (such as climate or weather) to a venture and/or investment opportunity?
- Depth of financial resources: what are a venture’s access to credit or financial resources, and how does its level of management expertise affect the entity’s longevity?
- Loss of, or threat to, cultural or societal identity: what are the challenges of an entity’s operation or investment allocation to a particular culture, societal, or historical character?
What resources do I own, control, or have access to that mitigate the risks I face in servicing the marketplace to achieve my wealth objective?
Thought of in this way, even “assets” take on a new meaning. They are not only those specifically monetarily defined, nor only things that are directly owned, but any resource owned, controlled or accessible that mitigates identified risk and enhances resiliency, or provides “value” or wealth as defined by the organization or investor.
This includes both tangible and intangible interests, and items that produce present and perceived future value.
Importantly, assets include the talent and human capacity of management/staff, the understanding of cultural and historical nuance, personal and organizational relationships, and the ultimate capability and commitment of personnel that can manage a venture in a manner that achieves “wealth.”
How do I utilize my assets to mitigate the risks I face, service my market, and ultimately achieve my “wealth” objective?
Leverage is the “how” of any venture of investment strategy—the creation of a greater whole of value. All the tools of modern finance come into play in the creation of a bigger pie, making 2×2=5. This can apply to the business/personal resources required to gain “wealth” or mitigate risk, personal or community knowledge to deliver a service or product, the benefit of personal relationships to advance a venture’s objective, win business and advance operations; the knowledge of history and culture to provide enhanced security or safety—for health, environment, family, community; or the power and influence in a community, business, and government to promote understanding and diversity—all of which can lead to strengthened business potential.
Importantly, for philanthropists or economically driven financial purists, leverage is the method to achieve greater impact—however defined!
To recap, we can redefine traditional metrics as follows:
To be sure, measurement and assessment issues remain. The rigor and methodology employed by traditional money managers to align investment objectives with commensurate return seem to be easily abandoned when evaluating positive social impacts. Fortunately, a host of assessment systems are emerging to comprehensively and transparently capture social and environmental impact, including ratings monitors, analytics tools, and accounting systems. Some even attempt to align such objectives with economic value drivers, though there are already complaints that ESG (environment/social/governance) ratings and analytics are at risk of being too complex or even undecipherable to traditional or institutional economic agents, whose support and inclusion would undoubtedly grow the impact marketplace.
Any ratings and assessment methodology—especially those that rely on self-reporting and embed economic incentives—must have the integrity and transparency required to protect against conflict of interest and collusion, especially in our post-2008-crisis environment.
Ultimately, our collective goal should be to illustrate how “impact” as an approach weaves easily into the context of any broader investment strategy, which warrants an underlying assessment methodology that is simple, and easily understood across the spectrum of investors, including institutional, high net worth individuals, foundations, and endowments.
When we measure in these new ways, we will see that true impact investments can indeed be risk-reductive and wealth-generative. Such a track record of returns provides momentum for more such investments by investors seeking the full range of wealth, in a virtuous circle that can yield a bountiful and sustainable economy for all.
Taking stock of investment portfolios and investment targets within this re-defined paradigm does not force a departure from traditional economic theory. Rather, it helps capture a more comprehensive understanding of value and wealth across diversified asset classes and investment opportunities. Investors increasingly seek portfolios that are well intentioned and aligned with values and philosophies that deliver economic returns commensurate with risk.
We may be surprised at the similarities with which impact and mainstream investment strategies approach capital deployment and corresponding risk-return valuation. By speaking the same language across these differing investment approaches, we break down the barriers that have continued to separate impact from more traditional fiduciary activities.
We are not only investors, of course. As individuals, too, we must assess how best to leverage our assets, mitigate our risks, and engage in markets to sustain and produce wealth. We must better understand how we can be efficient and effective investors—certainly of our money, but also of our time, our energy, our civic participation, and our ideas.
Yes, you can achieve wealth—total and comprehensive wealth. The business of social venture creation is the business of sustainability. And the business of sustainability is the business of wealth generation—for our families, our finances, and our future.