The Coming Capital Convergence
As attendees entered last week’s SoCap conference in an old Army warehouse on the San Francisco waterfront, they filed past a large graphic projected on a screen depicting the full spectrum of socially motivated financial capital, from socially responsible investment to charitable giving.
At the center was impact investing — the financing of for-profit ventures and initiatives that explicitly address major social challenges — that is the focus of SoCap, now in its 4th year.
The prominence of a still-tiny category — total impact investments represent an estimated $50 billion, an afterthought in Wall Street terms — testified to the faith of many SoCap participants that powerful forces are driving the growth of impact investing and pushing it from the margins of the investment world to the core.
The creator of the infographic, Brian Walsh, director of Liquidnet for Good, had dubbed the presentation “The Coming Capital Convergence,” adding to the messianic feel. If it’s not quite the Rapture, believers nonetheless say the day is coming when mainstream capital markets align to finance ventures that deliver shared prosperity, environmental sustainability and other social goals.
The investors at SoCap were not just waiting for such deliverance; they are creating the measurement tools and financial products to make it happen. New social-impact reporting metrics are driving new indexes and enabling new financial products to increase liquidity, transparency and scale, so impact investing can follow the same path to Wall Street acceptance taken by venture capital in the 1980s and hedge funds in the 1990s.
“We’re here to catalyze capital,” said Ron Cordes, co-chairman of $21 billion Genworth Financial Wealth Management and a founder and board member of ImpactAssets, which has created an index of 50 top impact asset fund managers and is seeking approval for a family of impact investing products that financial advisors can offer their high net worth clients. “There’s a tremendous opportunity from a game-changing perspective, and investors are interested.”
Tom Steyer, the billionaire founder of Farallon Capital Management, one of the world’s largest hedge funds, agreed that public policy and environmental realities will increasingly require businesses to account for the full costs of their economic activity, he said, making sustainability the only path to long-term profitability.
Steyer keeps his own impact investing (he and his wife, Kat Taylor, are the primary backers of One PacificCoast Bank, a community development bank in Oakland, Calif.) separate from the $21.5 billion under management at Farallon. But he expects institutional investors at foundation and university endowments will eventually insist on what he calls “sustainability investing.”
“I do believe this is going to be the dominant form of investing, at some point,” he said. “It’s probably going to take a lot longer than I expect. But the thing that will make it happen faster is if it turns out to be, I hate to say this, really profitable.”
Other fund managers were even more bullish about the potential of impact investing to not only account for the downside costs, but also to capture the upside potential of social impacts. “I believe investors can actually make more money, investing in companies that have a social purpose, rather than less,” said Mike Dorsey, managing partner with Westly Group, the venture capital firm of Steve Westly, formerly California’s state controller. Dorsey cited public policy imperatives that can drive attractive investments in areas such as financial services for low-income communities, low-cost health care services and, of course, cleantech.
As evidence, Dorsey compares his earlier fund, the $75 million Bay Area Equity Fund, which explicitly measured indicators such as job-creation, health care coverage and even ergonomic practices, at its portfolio companies. The two funds he has raised with Westly ($127 million in the first, and an expected $175 to $200 million in the next) do not measure such social impacts and are focused only on financial returns. Nonetheless, Dorsey has invested in the same kinds of companies, and in several cases, in follow-on financing for the very same companies, such as Revolution Foods, a maker of healthier school lunches and other food products. Impact investments can also be compelling financial investments, he says.
David Chen, founder of Equilibrium Capital Group in Portland, Ore., said impact investors have the opportunity to unlock “alpha” returns far in excess of the broader market through financial and other innovations that address social challenges. “It’s not just do-gooding; it’s investing behind fundamental themes,” he says.
Equilibrium invests in fund managers that have an investment thesis that identifies such hidden opportunities. For example, Chen is backing the Gerding Edlen Green Cities fund, raised by the large green real estate developer. which is focused on high-rise and multi-family development and redevelopment. Some Gerding Edlen projects recycle their wastewater — a competitive advantage in water- and sewage-constrained cities such as Mexico City and Sao Paolo.
Ron Cordes said social entrepreneurs working in some of the world’s poorest countries can point investors to new opportunities. “These countries are growing more quickly than developed countries, they have an exploding middle class and billions of new consumers, there’s a lack of capital, and great entrepreneurs are being created by their educational institutions,” he said. “From a societal point of view, all of the pieces are in place, but it’s going to take a while for early investors to have returns that can then be referenced by later investors, who will see returns that are higher than expected, and risks that are lower.”
Making that kind of knowledge about successful impact investment fund managers widely available can incite the kind of demand that will propel the broader market shift, said Cordes. When financial advisors have such vehicles, high net worth clients (generally those with $5 million or more in investable assets) will begin to understand the value of moving beyond philanthropy, and putting some of their capital to work in impact investments that offer a rate of return — enabling them to reinvest again and again. Institutional investors, who are bound by more complex fiduciary requirements, will follow in time, he said.
ImpactAssets has already rolled out the Global Impact 50 index, a database of top managers in social and environmental impact investing. Now it is seeking approval, both from financial management firms such as Merrill Lynch and Morgan Stanley and from government regulators, for multi-fund investment products that would enable investors to place their money with high-performing managers addressing their choice of eight issues, including global poverty, U.S. education and climate change.
Cordes predicted that in 20 years, social and environmental impact will be integrated into nearly all financial activity. Other investment categories have started similarly, with small firms pioneering new approaches and products. “The next step is the large firms will recognize the market opportunity, and either buy or build impact capacity in their firms,” he said. “Then these large firms will look at the rest of the portfolio and say, ‘What’s the impact on the environment, or on workers rights, of our emerging markets equity portfolio?’”
“At first, firms will think of it as an additional expense, but the most enlightened will see a market opportunity. I think the market opportunities are there to show we can deliver both returns and impact.”
Graphic courtesy of Brian Walsh and Liquidnet