How valuable is social impact investing?

Perhaps it is overrated? That is the theme of my latest Bloomberg column, here is one excerpt:

A second risk is that social impact investing simply redistributes wealth from investments — maybe to less socially conscientious individuals. Imagine a socially conscious investment firm that declines to participate in the initial public offering of a company that pollutes the ocean. That might create downward pressure on the price of the IPO. But there is a problem: The value of the actual investment has not declined, so at a potentially lower IPO price other investors will step in to fill the demand. In fact, those investors may have the chance to buy at a discount and earn a higher return than otherwise.

The net result is that conscientious investors have missed out on a profitable opportunity, while less socially aware investors have earned more. Over time, the less socially aware investors will become richer, and their greater wealth may translate into greater political and economic influence.

That also put less conscientious investors in control of the firm.  And:

It is also difficult to monitor the performance and social efficacy of the funds focused on doing good. In actively managed sustainable equity funds, for example, the most commonly held stocks are estimated to be Microsoft, Alphabet, Visa, Apple and Cisco. I have nothing against those companies, but you have to wonder exactly how much social improvement those investment funds are buying.

So many matters in today’s America are increasingly performative, and so:

It is increasingly difficult for businesses and investment funds to perform their proper work under the glare of perpetual debate and periodic condemnation.

Recommended.

Comments

I think Cliff Asness of AQR once pointed out the fundamental tension of social impact investing, possibly even during a conversation with Tyler. If it "works", it does so by raising the cost of capital for "socially harmful" investments due to the lower supply of capital available for those investments. A higher cost of capital, however, translates into a higher expected return for those that do invest, which is what Tyler points out.

"The net result is that 'conscientious investors' have missed out on a profitable opportunity, while less 'socially aware' investors have earned more."

Given that "conscientious" and "socially aware" belong in scare quotes, we might view this as a feature rather than a bug.

I'm a participant in the capital markets.

Raising the cost of capital isn't merely a shuffling of returns. It also determines what projects get funded by providing a hurdle rate.

If I want to open I coal mine, I can can raise funds through debt. If many (or most) investors refuse to lend to coal projects, the cost of funding will be higher. The net effect is that fewer coal mines are opened, the cost of coal goes up in response to funding constraints, and renewable projects become more cost competitive. Investment in the renewable sector bends the cost curve downwards, making coal even less competitive. The same is true of raising capital through equity , though the mechanism there will higher demanded IRRs and therefore fewer economically viable coal mines. ESG investing should raise the breakeven price of coal.

But that's not all, once this snowball goes into motion (or people expect it to go into motion) even investors who don't mind lending to coal projects won't. Why? They know their debt will become un-refinanceable; their equity buyable by an increasingly small and reluctant investor base.

This isn't speculation. There's already talk of the capital markets becoming closed to coal companies with more and more investors writing off the whole space as "univestable". Coal is becoming a stranded asset.

Also, coal investors haven't been getting rich. Returns on coal assets have been horrific with bankruptcy after bankruptcy and no light at the end of the tunnel. Part of this has to do with coal getting squeezed by both renewables and natural gas, but it's also very much an investor preference story. This is becoming true of E&P assets as well. Pull up a 5yr chart of XOP and marvel at the catastrophic destruction of value. Right now the sector feels more like a hot potato than an amoral way to earn an enhanced return.

JPMorgan just announced they will no longer fund coal or Arctic drilling projects:

https://www.sierraclub.org/sierra/jp-morgan-chase-will-halt-financing-arctic-oil-gas-drilling

Those investing socially are such a small part of total investment that they are irrelevant for rate of return. Therefore, they just make themselves feel good about themselves.

I often wonder at what measure and what cap rate the 'analysts" capitalize these stock price targets.

Pure and simple virtue signaling. Investing is meant to maximize return on invested capital.

Green boondoggle/hoax companies live by and die by climate hysterics ("...this is not about science. This is about politics. This is about controlling us..." Naomi Seibt) and government tax credits. They do not maximize return.

The sell side propagandists at Barron's push this BS and are about to lose one subscriber.

Lose a subscriber?!? Oh dear God what shall we do?!

Hot takes on these so-called social impact stocks:

Microsoft: Lapdog to the NSA and Windows 10 has now gone full spyware with telemetry, ads, and forcing everybody into an MS account. They would make Google blush.

Alphabet: Lapdog to the NSA and unfortunately started this trend of surveillance capitalism. Outside of search, Gmail, and Android they can't seem to stop killing any new initiative they put out. Lucky for them, ads and software are two of the highest margin businesses out there.

Visa: Along with Mastercard are the reason why the US is behind on e-payments with China and the EU in the lead. Even India's UPI is so easy to use that the recently banked there can send money to each other instantly and at no cost. Too bad, Visa is making online payments more expensive:

https://www.bloomberg.com/news/articles/2020-02-04/visa-is-planning-the-biggest-changes-to-swipe-fees-in-a-decade

Apple: They get some kudos for telling off the FBI and resisting backdoors but probably lose all that and then some with their supply chain based in totalitarian countries.

Cisco: The biggest NSA lapdog. They are literally America's Huawei leaving all kinds of backdoors in their products for spies to poke around. Same supply chain issues as Apple.

https://www.schneier.com/blog/archives/2018/08/backdoors_in_ci.html

Make no mistake. You will make lots of money betting on any of these trillion dollar horses but ask yourself what was the trade-off to get there. Cost-benefit analysis still matters.

Are you invested in Kaspersky or Hawai’i?

Nice!

What you are suggesting then, is that there would be a "value" to some hypothetically just computing system?

One that didn't have back doors and treated users as citizens with Data sovereignty?

www.pietranetwork.com

I subscribe to a 'it keeps them off the street' strategy. Much better they do something useless but satisfying than what is happening in Canada right now.

Are these so-called social impact funds competing with donations to charities? They are both in the business of providing rich people with good conscience.

Isn't it a standard result that generally speaking boycotts but not disinvestment hurts companies? Here is my list of companies to do less business with: https://www.reddit.com/r/HongKong/comments/dfkz6m/list_of_companies_that_have_bent_over_to_chinese/

What motivates wealthy investors in India is the same thing that motivates much of human behavior: signaling. Why would a wealthy person in India buy an expensive apartment in a high rise with squalor below because the name "Trump" is on the side of the building? For many, the name "Trump" is associated with cheap, flashy, garish, gaudy, loud, tawdry, and trashy, but to India's elite it's a symbol of good taste and class, of the refined. Buying an apartment in a building with the name "Trump" on the side is a form of social impact investing. https://www.nytimes.com/2020/02/23/world/asia/india-economy-trump-properties.html

“The net result is that conscientious investors have missed out on a profitable opportunity, while less socially aware investors have earned more.“ “...A second risk is that social impact investing simply redistributes wealth from investments — maybe to less socially conscientious individuals.”

This seems to be the utilitarian argument in favour of buying into poorly behaved companies.

Taking it even further, you could use social impact investing to distill the least conscientious investors into a small number of highly profitable companies egged on to do worse and worse things... right up until the point where they get regulated out of existence.

>The net result is that conscientious investors have missed out on a profitable opportunity, while less socially aware investors have earned more.

I wanted to excerpt the above because it's rare that Tyler displays a knowledge of economics.

But he's oblivious to the big picture. Socially conscious funds do nothing to improve the world or anyone's conscience. They exist to charge moron investors higher maintenance fees.

It's merely a nice bonus that they also provide higher profits to the sane investors.

I think you fundamentally misunderstand the point of social impact investing. It is decidedly to not maximize profit, but behavior.

The issue is that you get economics-- but miss people.

The syllables invest occur 13 times in Tyler's 3 paragraph excerpt. Investor is also one of the most common words found in the Wall Street Journal. Apparently, the most important constituency on earth is investors, individuals that already have more than necessary to meet day to day needs but still want even more. Non-investors are the inconsequentials that supply the investors' surplus.

Investors like Calpers and your pension fund? Investors who fund the capital improvements that increase worker wages?

I guess we are supposed to save for retirement by hoarding commodities.

The person who makes more gets taxed on it while the person who invests in a social aware manner has the corporation do the work without the intervening taxation.

Taxes were not considered.

"The value of the actual investment has not declined, so at a potentially lower IPO price other investors will step in to fill the demand."

I'm not sure about this part. Talk of value is is ambiguous. The price of the investment is partly determined by the behaviour of other investors. If large and important investors are abandoning certain stocks, or refusing to buy into them, that is going to affect market sentiment and people's expectations about future prices.

Agreed-- that sentence is shocking.

It appears as though Tyler is not distinguishing between NPV and cashflows in order to simplify the blog post, but this oversimplification is causing confusion. ESG will not change the cashflows, but ESG will change the NPV. I would very much enjoy listening to Cliff and Tyler disccuss the topic: https://www.aqr.com/Insights/Perspectives/Virtue-is-its-Own-Reward-Or-One-Mans-Ceiling-is-Another-Mans-Floor

But it's so much easier to #VirtueSignal and do nothing. And in the end, isn't making sure everyone else knows what a good person you are what's really important?

Is there a "socially conscious" tipping-point where enough investors eschew an investment that the return is suppressed due to lack of demand?

Value is whatever people agree upon.

The real problem is that "ESG experts" are often wrong about what is good for man's environment, society, and Corp governance. It has become a way for ivy leaguers who actually suck at investment decision making to take the helmet of the commanding heights of the industry, injecting their woke values on it.

"The value of the actual investment has not declined, so at a potentially lower IPO price other investors will step in to fill the demand."

No, if you lose a potential buyer then the price and the 'value' did decrease. This is basic. Value is either the price or it is not.

Now maybe the fundamentals of the business didn't change but the purchase pressure did, and if the opposite was true with the Social Firm stepping in, it would make the price increase.

If price is not value-- as explicitly stated by our system-- then our system needs to change to reflect that reality. But in a market if you lose a buyer your price will go down.

However-- Price is not value (IMO)-- in fact this is the huge issue dealing with the health care sector. The sector creates way more value, than it receives in it's pricing. Ie US Hospitals billed ~3.2T and received 890B. (2015 cms)

Social Impact investing has not been fully tapped into, because of lack of models for sustainable value driven business models.

Ie-- the value medicine delivers is astronomically more than the price it receives as a payment. Value-- IMO is real, it is not price, it is the use of the asset by it's society. So the value of medicine is real, as we really use the services, we just don't pay doctors and hospitals what they bill.

This is real economic behavior generating some position between the bills received of 890 billion and the bills charged around 3.2 Trillion, leaving somewhere around 2.3 trillion of real economic activity that is currently considered losses. That's incredible!

That is real value-- and we currently account for it very badly.

DLT + Social Impact Strategies can create a new type of firm that is not "for-profit", nor not, "Not-for-profit"-- but a new type of firm that is "for value."

Ie when you return a laborer back to work quicker because of good medicine you increase overall productivity, whether or not he/she can pay the bill directly, increases. Waiting for the arbitrary condition of profit motivation, (needing the patient to pay) slows down overall productivity.

Ie a For-Value motivation would help PRICE the issue.

https://vimeo.com/314148356

Often overlooked is the huge cost in making workers with health issues immobile by tying their insurance to their employment. Immobile workers cannot leave the job they hate for the job they love. This perpetuates bad matching and has huge hidden costs for worker and employer.

So, it appears that the economically optimal solution, based on the post, is to invest in a polluter, and use the income to clean it up.

How about not investing in the polluter, or taxiing it for the pollution, and investing in something that does not pollute as much?

Everybody can invest their own money as they seem fit. They can do so directly or through investment funds with a declared social investment focus.

Social impact investing, however, is frequently the agenda of managers who are not investing their own money and who do not give their investors a choice. Public pension funds are the prime example.

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