Paul Brest, Ronald Gilson, and Mark Wolfson’s thoughtful consideration of social value added and impact investing will undoubtedly stimulate a lively debate. The authors deserve credit for promoting the sort of analytical rigor and precision typically applied to conventional investing. Their analyses of concessionary returns, the impact shortcomings of public equity investing, and impact/”but for”/additionality/social value added are especially valuable.
The authors focus appropriately on the issue of whether impact returns are concessionary or not. They state: “But though we disagree with those who define impact investing to include only concessionary investments, it is in fact quite difficult, albeit not impossible, to create value―to have social impact―while targeting risk-adjusted financial market returns.” This is, of course, an assertion that can be tested both theoretically and empirically, and it bears deep exploration.
There are strong theoretical reasons to agree with the authors, most notably that it is extremely difficult to compete against incumbents when you internalize externalities and they do not. It is easy to envision a “first mover disadvantage.” It is also obvious that, all things being equal, the less the investor in a social enterprise makes, the more benefit can accrue to those the enterprise aims to serve.
But based on my experience as CEO of New Island Capital, the financial returns from investments that have transformational social and environmental effects, that truly catalyze and create social value added, are ambiguous. These investments do tend to be private, small, early stage, and risky. Certainly some of them are long on impact and short on expected return. But the field is simply too young and the track records too short to draw definitive conclusions. There is still an enormous amount of innovation occurring, and even New Island was pleasantly surprised by its experience in private credit and real assets.
New Island Capital was one of the first investors in this field to operate at institutional scale. Our mandate was to invest entirely for profit across multiple asset classes and impact themes, and to accomplish social or environmental good with 100 percent of our capital. We invested across multiple geographies and investment stages, directly and through funds.
Modern portfolio theory provides a framework for constructing optimal portfolios across spectra of risk, return, and liquidity. And just as investments sit on spectra of risk, return, and liquidity; so too do they sit on a spectrum of impact.
Accordingly, at New Island we viewed our mandate as an optimization: how to design a balanced and diversified portfolio, with each investment rigorously assessed for risk, return, liquidity, and impact. In this way, we could both report to our investors and compare one hypothetical impact portfolio with another.
One could also envision how, for example, a solid portfolio of private credit transactions, or an alpha-generating strategy such as Generation Investment Management’s, could provide current return and liquidity and support more aggressive participation in higher impact private equity investments. Of course, there are also many reasons why a portfolio would not consist solely of investments that meet the authors’ strict definition of impact: for example, retention of dry powder for future prospects, requirements for liquidity to fund capital calls or mandatory pay out obligations, the need for vintage year diversification, and limited capacity to staff early stage high impact investments.
New Island’s mandate was unusual but it will become far more common as the field matures and scales. When it does, impact will be assessed at the level of the portfolio as well as the individual investment. At that point, the emphasis will shift from investment level impact to the achievement by the portfolio of an optimal balance among risk, return, liquidity, and impact.
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