Articles / 01.14.2016
A 5:20am rant on performance while listening to Bob Moses.
As my regular readers know, any reference that I make relative to performance is waaaay against SEC regulations. Not only does it count as “advertising” and is thus subject to increased scrutiny, but it may also be considered a “guarantee”. So I’ve stayed clear of the subject for years, as doing otherwise would induce a collective aneurism in our compliance team.
But I opened my inbox this morning to yet another email from yet another well-intentioned journalist asking about performance. Specifically, the journo wanted performance numbers. She wanted to see the proof.
I’ve written and said more times than I can count that the impact investing discipline has only recently emerged from what I call The Anecdotal Success Phase, and is moving slowly into The Thesis Validation Phase. The former was punctuated by a lot of failing forward, learning, defining, experimenting and innovation… and some underwhelming performance.
Yet, over time, as the discipline began to wrap its head around how to pursue positive financial return in addition to measurable, durable social and environmental value, the number of successful impact investments grew. Some even captured headlines (Etsy, Happy Family, Burt’s Bee’s, Warby Parker, etc.). But they were all one-off’s, explained away by unique market circumstances, driven entrepreneurs or branding exercises that drove valuations.
However, as we move from a small number of passionate, activist-oriented investors towards what I think of as “the professionalization of impact”, we are gathering rigorous, compelling performance data. And it is compelling. Really, really compelling.
I’m not sure where to start, but a recent Wharton study that got a ton of press (and which we co-underwrote) is as good a place as any. In my mind, even with some of the questions that the study raises, it is the first (only?) study executed in a rigorous, academic arena on the topic of mission preservation/persistence and financial performance. The main take-aways (I strongly encourage everyone to read, and internalize this report. Strongly.):
- As a group, mission-aligned investments outperformed conventional market-rate seeking investments
- Within the group, the more deeply aligned the mission, the better the performance
- While mission persistence is unclear, the pursuit of mission persistence/preservation remains strong and has not hampered financial return
A few other real-world examples that reflect this trend towards professionalization and enhanced performance (keep in mind that I am not able to report specifics, so apologies for the intentional opacity):
- Brevet Capital, a specialty lender that manages a conventional fund side-by-side with an impact sleeve of the fund. The latter has outperformed the former significantly since inception.
- SNW Asset Management, a fixed-income manager, manages an impact version of their core strategy, again on a side-by-side basis. The impact version has offered incrementally better performance and slightly lower defaults.
- Environmental Integrity Fund, a small impact venture fund, was the #1 performing fund in the entire Cambridge Associates venture universe for the fund’s vintage year.
- The Collaborative Fund, which sources deals exclusively from CircleUp (essentially a syndicate that provides funding to B Corps), has generated 39% IRR since launch.
- Any public equity fund that eliminated carbon from their holdings (coal, oil, natural gas, MLP’s, oilfield services, etc.) since the launch of 350.org and Divest-Invest, has seen a massive relative outperformance for the simple reason that they dodged the collapse of the price of oil. But that could easily reverse if/when oil recovers.
- Similarly, many impact funds eliminated the big money centers due to concerns about transparency, predatory lending and misaligned interests. This resulted in solid relative outperformance during the most recent financial crisis. Of course, it also resulted in underperformance as the banks recovered.
- Generation Asset Management has massively outperformed its index (over 550bps PER YEAR) over a decade+ time period. This must-read article covers all the germane points on why ESG investing (when pursued by professional investors as opposed to social activists), can be so damn compelling.
Now that I’m on a roll…
There has been so much research done on SRI/ESG funds relative to conventional funds that I can’t believe the question on relative performance is still being asked. Manager skill, timing, sector rotation, etc. etc. are all measurably more important indicators and drivers of performance than any SRI/ESG screens. And most studies clearly demonstrate that some factors (in particular the “G” (governance), and more recently the “E” (environment) have a clear link to risk mitigation and enhanced performance. The “S” (social) appears to be a slightly negative contributor to performance, depending on how the business interprets and implements its social role.
In short, SRI/ESG screening is just one more way to sort and reduce the universe of available stocks. Just like “price to earnings” or “free cash flow” or “multiple of book value” or “discount to enterprise value” or “EPS growth” or any of a bewildering array of ways to analyze the performance of a company, it is a metric by which a fund manager selects the companies that he/she believes will perform well in the coming years.
As with so many things, the truth behind impact investing – harnessing the power of the capital markets to create durable, measurable social and environmental change – is a long-term, unconventional process that will take years (decades?) to really “prove”. But, anecdotally, the evidence is stacking up that at the very least it does not require a broad performance sacrifice… and that it might actually represent a performance enhancement. But even if it doesn’t add to performance, if one can invest without sacrificing financial return while creating a positive impact on the world… why not do it?
It is also really important to stress that just because one need not sacrifice performance in pursuit of impact, that doesn’t mean that one shouldn’t. There are many, many deep impact investments that require concessionary returns, chief among them being investing for community development. But many of these potential investments are enterprises currently supported entirely by government grants or philanthropic donations. Isn’t a modest return on invested capital more interesting than a 100% loss of invested capital via a grant? And if the impact is the same (and I would argue that the impact is likely increased if the enterprise can be engineered for self-sustainability), isn’t it better to focus philanthropic dollars on enterprises that can never be commercially viable?
In other words, while I understand the relentless focus on market-rate performance, or on comparing the performance of impact investing and conventional investing, I believe that line of inquiry is misdirected. After all, “market rate” is what brought us the financial crisis, Enron, environmental destruction on an almost inconceivable scale, etc. Do we *really* want to use that history as our “market rate” benchmark?