Articles / 12.12.2016
Government budgets, and the social services they have heretofore funded, suffer from exacting scrutiny in today’s political environment. The recent U.S. election outcomes will almost certainly exacerbate this trend as our conservative legislative and executive branches look to further slash public spending in certain areas. The result, partly by design, will be that the private market increasingly intervenes to provide important social services. Some may view this as a potential tailwind for impact investing since the ecosystem is also focused on generating social benefits. However, under the current circumstances, I believe heightened privatization is a cause for alarm in our industry.
To start, there exists a natural tension in capitalist economies between the public good and the profit motive – perhaps no more than in the provision of vital goods and services. The seduction of impact investing lies in its ability to harmonize this tension. Nevertheless, the pursuit of profit frequently has unfair and unfortunate outcomes.1 Thus, as government funding of public services has diminished, we should not be surprised that some of their private market alternatives have had disappointing results. In the Public Interest released a thorough analysis that convincingly demonstrates how privatization of numerous public goods and services (e.g. Medicaid, education, transit, parks, libraries, water systems, criminal justice, foster care) has increased inequality. Earlier this year, the New York Times published a similarly saddening investigation into several private equity firms’ woeful provision of emergency care and firefighting services. Finally, many impact investors cannot easily forget the suicide crisis that befell the microfinance industry as it scaled up its base of institutional investors.
Let me be clear: I do not believe that public services, when provided by the government, are necessarily more just, fair, or efficient. The reason I work in this field is because I firmly believe that capitalism is an economic system that can deliver solutions, at scale, to some of the world’s intractable problems. That said, an unabashed prioritization of profit naturally leads to serious shortcomings on the social benefit scale.
So let us consider a comment from a spokesman for a private equity lobbying group, who proclaimed that his industry “advances both our economic and societal well-being.” To me, this sounds an awful lot like the GIIN’s definition of an impact investment. Indeed, a hypothetical private equity fund focused on investments in, say, emergency care companies, could easily meet the core characteristics of an impact investor. After all, they could claim an intention to have 1) a positive social impact, 2) which is measurable (e.g. number of patients served), along with 3) a financial return. Note that there need not be a rank order to these three things; even the greediest profiteer, focused on the neediest citizens, is, literally, an impact investor.
No wonder our industry continues to expand so quickly!
In all seriousness, I believe the prevalence of privatization threatens to undermine the modus operandi of impact investing. At Caprock, we have already witnessed a growing number of wolves dressed in sheep’s clothing, as fund managers across every asset class start to market themselves with an impact label. And why shouldn’t they, given that they meet the definitional prerequisites of the fastest-growing area of finance?
Thus, I believe our industry will need to ascertain how we distinguish avarice from altruism when investing for impact.
I don’t believe this can be done solely by looking at financial returns. In today’s historically low-interest rate environment, even community development financial institutions must lend to small business owners at double-digit rates if they want to stay in business. Some impact investors accept outsized risks to deploy capital within inefficient, disconnected, and underserved markets. They should be compensated accordingly when doing so, especially 1) if the solution would otherwise go unfunded and 2) we hope to catalyze significant capital outlays to these markets.
Additionally, I don’t believe the distinction between avarice and altruism can be ascertained solely with impact metrics. As my earlier blog posts attest, I am a big believer in their importance. But the emergency care example demonstrates that looking only at the number of patients served ignores 1) who was served, or perhaps more importantly, not served; 2) whether the service was good or bad; 3) whether the service was reasonably priced; 4) how much choice the patient had, etc. Thus, the nuance behind each metric matters. (This is one of the reasons why our iPAR platform enables managers to offer much-needed commentary on the impact returns they generate. Indeed, this context will become increasingly pivotal as more social services are privatized.) That said, given how time-consuming impact measurement can be, few managers are likely to illuminate the underbelly associated with their impact strategies.
Our experience advising families and foundations has proven that the pursuit of social and environmental benefit is inherently subjective. But we do not use that as an excuse to cloak with impact credibility private equity offerings from KKR, Warburg Pincus, Blackstone, Fortress, etc. Granted, neither they nor any of our clients have asked us to do that. Yet. But the most cutthroat investment firms in the world could dutifully characterize their efforts as impact-oriented, simply because they extend loans (at usurious rates) to the impoverished, employ (at minimum wage) vast numbers of people, or generate (at environmental expense) low-cost energy.
Thus, we need a narrower definition of impact — accompanied by more stringent standards and insightful metrics. Otherwise, our industry’s reputation will be tarnished by social service privatization and the impact-washing that will inexorably follow. Such an outcome would make it harder for well-intentioned asset managers and investors to continue doing their work, which has elevated impact investing to the lofty position it now enjoys in the field of finance.
1 Some would argue it is no different in impact investing, going so far as to say that any profit is necessarily exploitative. That argument is philosophically tidy and can be difficult to dismiss in certain circumstances. At the same time, tax dollars and philanthropic grants alone are not making the world a place in which many of us want to live. Consequently, the capital markets would seem to be a necessary contributor. And yet, were it not for profit, there would be scant participation from this influential actor – leaving many established, equitable solutions unfunded.