The Financial times Morgan Stanley Capital International’s Global ESG Leaders Index reports that it tracks the MSCI Global Index because for environmental, social and governance (ESG) leaders, the components of this index are similar to its general global equity index. ‘Green washing’ is probably in the works. It is a kind of spin used to deceive people that a company’s products, goals and policies are not environmentally friendly. This is a broad position in impact investment in general.
Impact Investing emerged as part of efforts to increase the role of markets in the pursuit of economic growth. Its leading industry body, the Global Impact Investing Network, defines impact investing as “made with the intention of creating a positive, measurable social and environmental impact along with financial returns”. The idea was inspired by the Venture Capital (VC) Investment Playbook. In startups. There are three main beliefs around innovation, founders and venture capital financing in that playbook. Above all, there are disruptive innovations, especially riding behind the latest technologies, which can have a significant, transformative, impact on large development issues. The second belief is that some entrepreneurs will be able to successfully commercialize this technology. The third belief is that such entrepreneurs and their innovations have been successful behind the incentive-friendly venture financing approach. However, there are many reasons why we should be cautious in expropriating this approach pr oblems to address sustainable development.
One, the beliefs described above, based on important success stories, have a subtle bias towards the inventions and founders of certain categories. The second concern is to achieve an effect on the scale. For all the hype surrounding innovation, Impact Investing in maximizing development innovations is minimal. The third reason is the differences between innovations that can meet normal daily lives and those trying to address the developmental challenges of ‘non-regular’ lives.
Finally, the VC model may also be inappropriate. Its 5-7 year investment tenure system is not only built on management and success fees, it also has to run on the treadmill of sustainable fundraising and portfolio building, which must combine real impact investments with commercial ventures to maximize returns. This model, in line with the obsession with growth and values, has reduced the need for long-term capital for the patient in need of ESG innovations and also diluted the disciplinary role of finance in many businesses. It also has an upstream effect; The initial phase funding rounds are also in the high ticket sizes required to justify the viability of the model. These entrepreneurs seek large sums to pursue rapid growth and even at a stage where it is not clear how many pivots are needed. With funding chasing relatively mainstream risky growth companies, it is crowding out entrepreneurs who want to solve difficult problems.
As written by Jonathan Ford Financial times (‘Ethical investment is not about the morality of the markets’, 4 November 2020), “Impact investment has real meaning, that is, if funding activities do not take place. If not, where is the impact? You are wearing the ‘business as usual’ investments that are made anyway. “
Current categories of impact investing include (a) investments in businesses in low-income geographies, (b) which represent the intention to generate Z-Tech and (c) impact from Fin-Tech to Egg-Tech. This is too broad and reduces the importance of impact investment. The real purpose is to focus on social impact. Hence the definition of ‘impact’ and its assessment is critical.
We propose two first-order tests to identify impact investments:
One, the social impact test: investment directly improves the lives of the poor, rather than enhancing general economic welfare, including environmental benefits. And two, the counter-realistic test: investors who want commercial returns cannot invest.
Instead of a direct measure of impact, we propose a second best approach, including whether the innovation will deliver the promised value proposition to its customers. We need two metrics, retention and intensity. The former refers to the end user, client or buyer being with the entrepreneur service for a minimum period of time (as a recurring subscriber or as a continuous customer). Indicates the depth of subsequent use (upgrades or further purchases depending on size or type of service). No matter how relevant the value proposition is to the buyer, the severity of use will be seen in those who purchase the minimum level of retention.
Investors who really want to be investors should check out their toolkit. They need to make sure that they are supporting organizations that create the socially desired impact while generating revenue that reflects reality and the patient nature of the capital needed to achieve those results.
These are the personal opinions of the authors.
Gulzar Natarajan, Mahesh Yajnaraman & V. Anantha Nageshwaran is a civil servant respectively; India Country Director, Acumen; And a part-time member of the Ministry of Finance