“Surely, if you make the most profit in any given period and then just do it again in the next period, and repeat that over time, you will get the greatest return? The “common sense” of this idea seems to have a grip on most people. Unfortunately, it is only true till it stops being true. And then the price tag on its ‘untruth’ can be huge and likely to hit in the most wicked way.”
René Magritte - The Son of Man (1964)
We are facing big issues now. We’ve had several black swan events in one year. And while impact investing is moving from what felt like a good intention to an investment category starting to get significant capital inflow, it has barely reached the spaces it must go. What is the potential of impact? What do we need it to deliver?
Impact was born out of market failures, applied to marginal situations and the disadvantaged. The scale of the problems we are encountering now suggests a different reading of what has been dismissed as market failure. The problems are not marginal. Best practices of the 20th century: efficiency through getting bigger, known as scaling; and the reduction of decision rules to the most basic elements, primarily financial; meant a lot fell through the cracks as unintended consequences. Economists term these “externalities”. The reliance on big systems has failed. And the human scale is blatantly too small to move the dial.
Data technology can now show the full impact of what is being lost to people, communities and the environment. It can show all of the consequences, both intended and neglected. This brings us back to THE POINT. What does Impact Investment need to be now, in the face of a flock of black swans? We must deliver capability and capital to people who are building enterprises that create real value; delivering solutions at the human level, the local level. They need that capability NOW, and this is the foundation of delivery of reliable returns to investors, built on human value.
What is Impact? Impact on who? How is it felt? How is it measured? Over what time period? Impact Investing speaks to one fact, your financial decisions have consequences. The answer to these questions depends very much on who is asking them, and who is trying to answer them.
As individuals, we answer this question based on what it means to us personally, impact is the things that matter in our lives. This is dominated by our personal wellbeing, our families and community, our home space and our environment. Financial measures are important, but they are primarily a proxy for wellbeing. The idea of impact is growing in significance as people realise the limitations of relying on financial measures to answer these questions.
We have seen recently a “boom” in the stock market at a time when there were major signs that people worried about the future. Anxiety has been escalating and despite rising asset prices wellbeing has been going in the opposite direction. The truth is that even when an organisation is tasked to answer this question on behalf of people it will do so by trying to help more than one person. It will try to find a shared foundation, a common logic, to deliver that answer so it can exploit efficiencies in how it helps. One description of this process is “scaling.” More on this to follow.
An organisation will base its answer now on how it has answered the question in the past. Past answers create a legacy of culture and processes. It is well understood that a dominant driver in organisations is self-justification and self-protection. A different answer will come only in the presence of very particular stress, one that challenges the organisation itself. It is not just that the efficiency in dealing with many cases overrides the logic required for any individual case, the logic of the organisation will dominate.
This is the foundational challenge of impact, and it is not a challenge that it has been readily acknowledged.
Good practice in the investment community has been defined as focusing on the single proxy variable, financial return. One of the sparkling young people that works with us, Matilda, observed that money has become divorced from value and we are the kids caught in the middle.
The character of financial returns is poorly understood. Based on “good practice” many managers have an incentive to focus on immediate return instead of long-term value creation. This approach can deliver maximum immediate fees. Simultaneously, many investors question whether managers claiming to create long- term value are just selling spin, or, are even incompetent compared to competitors providing immediate returns.
To suggest that we are building value in the long-term requires evidence we can understand and trust. Surely, if you make the most profit in any given period and then just do it again in the next period, and repeat that over time, you will get the greatest return? The “common sense” of this idea seems to have a grip on most people. Unfortunately, it is only true till it stops being true. And then the price tag on its ‘untruth’ can be huge and likely to hit in the most wicked way.
Impact was born of the extrapolation of three logics, and what they failed to deliver.
Organisational Logic.
The 20th century has been about organisations extracting the greatest efficiency by getting bigger. As discussed above, this is termed “scale advantage”. Management seeks the simplest decision rules to manage sprawling organisations. This logic has been applied to business, government, and the social sector. This means organisations choose focus points which by design let stuff fall through the cracks. Economists label what falls through these cracks as externalities. Kindly, they might be considered unintended consequences but more precisely they are neglected consequences.
The inexorable pursuit of scale was a one-way bet in the 20th century. It meant that “unintended consequences” would either be managed by government and communities, paid for by harvesting the profits of the industrial scale economy, or kicked down the road. “Single” purpose thinking was rewarded, big time.
“Unfettering” the Consumer".
The idea that we are defined by the objects we consume was explicitly developed in the 20th Century. It has been built on promoting Immediate Gratification (Consumption) over Deferred Gratification (Investment), unfettering consumption from responsibility. Trying to have everything NOW has been framed as desirable, and also possible. To see this at play you just need to look at a credit card advertisement or an advertisement featuring healthy young people gorging themselves on food loaded with sugar. We would not teach our children to do this as we know the consequences. Yet our culture of consumption is anchored in the Pleasure Principle, augmenting our desire for the new over the old. We are encouraged to throw away what is old, taking up what is new with little regard for the future. This is now being termed the Linear Economy. It is the opposite of the circular economy that predates the Industrial Age. We built this culture and are responsible for it.
Information dynamics.
We have moved from the challenge of limited information to too much information. Good business management is built on the ability to consider data needed to make decisions. This is about intended consequences; targeted goals, dominated by financial return. But now, not only is the data about unintended consequences more available, comprehension of its significance by people is also growing beyond the organisation. This data WILL inevitably be a foundation of judgements around the value proposition by all stakeholders. Total impact.
We commonly view the future as too uncertain to deal with. Immediate Gratification dominates many individual’s decision-making. In the absence of readily accessible information, whether it be for people or organisations, future costs are frequently treated as someone else’s problem. Responsibility is avoided or deferred. In a total impact information world this is set to change.
In the 21st century, the cost of these externalities is hitting our communities. The environment is threatened with collapse and our industrial processes no longer need to employ humans. We have sought to mask the problem, not by investment in processes to take them on, but by printing money. Real interest rates are hovering around zero. We have propped up the old to deliver significant returns to investors yet again, as a proxy for dealing with the problem.
Economic cycles are created by simple decision rules being applied and extrapolated across our communities until the cumulative weight of unconsidered costs creates too much ballast and the system tips over. And then we get the Bill, paying significant collateral damage.
In the 20th century, government had been given the responsibility to deal with the issues that couldn’t be dealt with by market forces and the untrammelled operation of business. Teddy Roosevelt led this revolution in the US at the turn of the century, being a leader in taking on monopolistic corporate power. In a world governed by big, people and communities did not have the “scale” to take on these actors. Government became the custodian of the social contract. By the end of this century, the cycle of regulation reversed for many reasons, but government still retains primary responsibility.
And it is visibly struggling. Why?
We are not questioning the intent or integrity of so many people working to step up in these big organisations, nor that these organisations haven’t delivered some extraordinary improvements in the lives of many people. But the logic of big is now simply not enough. We need something new, a different way of thinking about Impact. **The bill has arrived.
With a snowballing income and wealth gap, public health crises, and environmental damage, we have seen the collapse of the old political consensus. Corporate leaders now announce their concerns about externalities and investors about impact. People now question the extent to which government can lead.
This has pushed responsibility back to the community.
George Tooker – Landscape with Figures (1965)
Myth one. Positive impact enterprises and projects generate inferior returns and value.
The early version of impact was dominated by the idea that solving the problems of market failure could only be achieved by giving up financial return. Otherwise, the markets would have done it, wouldn’t they? This idea frames impact as industrialised charity. We sacrifice both immediate financial returns, and arguably long-term value creation for “non-economic” benefits. This trade-off has been a fundamental belief.
The use of the expression “non-economic” should be treated with suspicion. It means one thing when an activity is poorly organised and when its survival is innately questionable. It is totally another thing when it speaks to meeting real needs that create demonstrable value. The issue then becomes how to secure that value creation when it might not be immediately monetised.
The failure to meet this challenge means we do not address the lost value of unmet needs in exchange for immediate return delivered to some people. The information revolution is delivering the data that will make this lost value abundantly clear. The issue then is not the need, but how we are organising ourselves. This realisation is now being addressed globally.
“Good design” enterprises are sustainable, cover their costs and deliver financial returns by demonstrating total value creation. The idea of the trade-off is born out of an old way of thinking about people’s unmet needs as an innate problem, not a design mistake; bad economics and not non-economic.
High sustainable activities receive a higher valuation.
Myth two. Applying scale efficiency is how we should take on market failure.
If the problems are in part a function of the logic of big, should we question an answer that is built on that same logic to compensate for market failure?
We are not suggesting that scale has not delivered a significant jump in human capability and that large social programs haven’t done significant good in some areas. They have a very important place, but their limitations must be recognised. What falls between the cracks of these programs is significant. They can promote cultures of disempowerment and blame-shifting. We believe the biggest impact we can have is empowering people to have the resources and capability to live their best lives and take on the challenges they face.
In a world of urgent and pressing challenges, from the environment to health and wellbeing, moving at human scale rather than industrial scale gives the ability to move faster with motivated people focusing on what is urgent, now. A major reason why we face these problems today are the externalities produced by scale and centralisation. The impact we need is not going to be driven by grand programs, it’s going to be driven by architectures that help people make changes, to take responsibility, and most importantly believe that they can. Much of the world feels utterly powerless in the face of crisis.
Think about a big solution like building a large dam which has significant upfront costs, environmental impacts, and takes a lot of time in planning and construction to deliver. In contrast, a smaller scale cluster of water solutions like investing in water tanks and stormwater harvesting, supported by education, could improve communities water storage capability in a relatively far shorter time.
This fundamental dynamic will change the shape of impact.
Note: In describing the evolution of impact investment, we want to emphasise that each generation played and continues to play a key role.
Generation One. Industrialised Philanthropy.
The trade-off of Lost Return for Positive Impact was the starting point of this thinking.
There was a mission to use some portion of large company surpluses and the wealthy to meet problems that government was losing the capacity to deal with. Government was a willing partner looking for support. These programs started from unstructured interventions, moving to the adoption of good practice, scale processes and measurable outcomes - and impact funds were an adjunct to this system.
Generation Two. Investments that deliver positive impact without loss of return.
Ethical investors focusing on factors termed ESG {Environment, Society, Governance] pioneered this terrain at the start of the new millennium. The trade-off was rejected as a foundation principle. Investors could make positive impact choice investments and receive economic returns. Five Oceans Asset Management, the firm that I founded with Ross Youngman in 1986 was such a firm. It was built on this principle and delivered market- leading returns.
Generation Three. Grassroots enablement.
Delivering the desired impact requires getting capability and resources to the human level. This means moving beyond narrow scale logic. While there are still significant benefits from scale processes that we should be employing, they need to support human engagement with human problems.
With respect to the economics of an enterprise or project, we need to distinguish between covering basic costs (wages or short-term capital which is a basic sustainability condition for any enterprise) to the delivery of longer-term benefits which matter to people in their communities. Generation Three, Impact Funds, and their support platforms and toolsets, link human capital to human enterprise in the places we live.
This moves impact investing beyond the trade-off problem to the delivery of maximum value, by allowing people to deal with all the challenges in their lives, not just those that big industrial service providers can touch. Impact measures in this world are delivered and applied to human scale choices and organisations. This allows for the fullest potential impact. Maximum Impact. Maximum Value. Local or global investors get the highest quality sustainable returns delivering value that matters to people using those services.
“Surely, if you make the most profit in any given period and then just do it again in the next period, and repeat that over time, you will get the greatest return? The “common sense” of this idea seems to have a grip on most people. Unfortunately, it is only true till it stops being true. And then the price tag on its ‘untruth’ can be huge and likely to hit in the most wicked way.”
René Magritte - The Son of Man (1964)
