Imagine what the world would look like if impact investing had the same mainstream acceptance as value investing? There would be fewer people imprisoned, healthier children, a cleaner environment, improved infrastructure and more efficient governments. In this utopia, investors would also be earning above market returns allowing them to sleep more peacefully at night.
Originally devised by Ben Graham and later popularized by Warren Buffett, value investing is described as the investment approach in which investors seek to profit when price does not reflect the intrinsic value. In contrast, impact investing is the investment approach that seeks to achieve measurable results beyond purely financial returns. In other words, the intrinsic value may include non-financial metrics. However different these two investment approaches may initially appear, value and impact investing have much in common. This is because value investing creates impact, and in turn, impact investing creates value.
According to a report released by the World Economic Forum, the impact investment market is currently estimated to be between $25 and $40 billion. This is a miniscule figure in comparison to the broader investment market. After all, at the recent Berkshire Hathaway Annual Meeting, the Oracle of Omaha said "(I)f we see a really good $50 billion deal, we'll figure out a way to do it." It will be a monumental day when the total impact investment capital pool is greater than the bite size of the next Berkshire Hathaway acquisition.
Whilst on the topic of Warren Buffett, much publicity has been made of his "$1 Billion Bracket Challenge." In this challenge, Buffett offered a $1 billion reward to the individual who correctly predicted the full suite of college basketball results. Imagine if Buffett, the world's greatest investor, used those same billion dollars to challenge the government of his home State of Nebraska, to structure a social impact bond designed to raise the education standards of minority elementary school students struggling with math, reading and science. Nebraska's Department of Education reports that 54% of Black or African American students demonstrate proficiency in reading as compared to the average of 77% for all students. Forty-seven percent of Hispanic students are proficient in science as compared to the average of 70% for all students.
Closing this gap is a win-win because research suggests that increasing early childhood education standards benefits society as a whole. In this instance, the private sector funds the initial financial capital aimed specifically at improving the proficiency of minority children in reading and science. The money could be used to fund extra classes, extra teachers or smaller class sizes, and the metrics are initially agreed upon for improved proficiency rates. If the standards are not achieved, the private sector capital is at risk. However, if the standards are achieved private investors receive an agreed interest rate, or coupon, for the capital at risk in the social impact bond paid by the savings accrued to the taxpayer in the State of Nebraska.
Smarter children yield higher incomes later in life, giving way to increasing entrepreneurship and risk-taking to build small businesses. This subsequently generates profits, leading to greater employment opportunities, and more people in the workforce delivers greater tax revenues. Raising education standards saves the State vital resources on remedial education costs later, reduces poverty, saves on welfare costs, hopefully decreasing crime and seeing fewer in prison. Children win, Nebraska wins, and private investors win. Such an investment unlocks deep intrinsic value, demonstrating that impact investing could really be the new value investing.
If impact investing is going to earn mainstream acceptance, it requires a champion with the same appeal of a Warren Buffett. In a report co-authored by Rockefeller Foundation and JP Morgan, the total impact investment market is optimistically forecasted to target an upper limit of $1 trillion by 2020. Although this projection may sound lofty, it's not unrealistic when you consider that Apple's current market capitalization is approximately $550 billion. Impact investing may truly be accepted when its total market size exceeds that of just a single company.
The meaning of impact needs to be re-defined if the impact investment market is ever to reach $1 trillion. This revision should effectively recognize firms like Apple, who are doing more than solely maximizing economic returns. After all, Apple has been at the forefront of the technological revolution having a profound impact on the world. Beyond generating enormous profits, Apple's impact has directly and indirectly led to the creation of millions of new jobs, improved access to educational resources via the internet, and empowered small businesses in the developing world to access global markets. All of this has been achieved using a single piece of technology literally in the palm of your hand demonstrating that every investment has an impact, positive or negative.
The 6 E Paradigm is a proprietary framework intended to compliment the financial analysis of an investment by measuring its holistic impact. For instance, when an investor is satisfied with the economics of a particular investment, the 6 E Paradigm positively screens the investment's full impact on employment, education, empowerment, ethics and environment, prior to allocating capital. Using this revolutionary framework increases both transparency and objectivity therefore elevating investor confidence encouraging new sources of capital, and greater volumes, to flow into the market. Impact investing is a trillion dollar market opportunity, but unlike the Garden of Eden, fruits are ripe for the picking.
Today, US pension funds control over $16 trillion making it the largest pool of capital on earth. According to Deloitte, only 6% have actually made an impact investment compared to 64% that "expect" to make an investment in the future. As the most influential source of capital, pension funds have a critical role to play in positively influencing the allocation of capital through impact investing. The same is true of Generation X and Millennials, who are poised to inherit an estimated $41 trillion from the Baby Boomers over the next 40 years. In the Deloitte study of Millennial investment trends, respondents ranked "to improve society" as the number one priority of business. This result marginally trumped "generate profit" as their core focus. Monitor Institute estimates the entire impact investment market to reach a mere 1% of all managed assets by 2020.
If only one cent in each dollar is likely to be allocated for positive impact, the other ninety-nine cents provide a significant opportunity for progressive asset managers to enter the impact investment market. Impact investment is a trillion dollar frontier market waiting for the pioneers to capture the highest margins in the increasingly competitive landscape for asset management growth and market share. The world will be a better place when financial innovators develop investment products allowing retail investors the opportunity to have positive impact and generate profit.
In this world, impact investors can and will, generate enormous economic value for their portfolio and society at large, because there is nothing more powerful than financial capital when applied as a force for good.
Follow Jeremy Balkin on Twitter: www.twitter.com/jbapex