Is social investment an asset class?
Positioning impact investing as an asset class has helped explain the concept to mainstream investors in a language they understand. But the approach has its limits.
James Perry channels Abaraham Lincoln to challenge the impact investing community to step up and embrace a new way of thinking.
Abraham Lincoln didn’t start out to free the slaves in the US. He could see that the uncomfortable settlement between the slave states and the slave-free states was falling apart and his motivation was to prevent the Union from disintegrating. “If I could save the Union without freeing any slave I would do it, and if I could save it by freeing all the slaves I would do it”. But when it became clear that the two could not be reconciled without undermining the Union, Lincoln acted decisively: “I do order and declare that all persons held as slaves … are, and henceforward, shall be free!” His story is that of a man who sought consensual, evolutionary change at every point, yet who had the courage to see things for what they were, and then to act – even when those actions changed the fundamental basis of society.
The seminal research into the impact investment industry was published by JP Morgan in 2010. It suggested to a world, which had come to believe that the only purpose of investment capital was to enrich shareholders, that it could have a broader purpose. It illuminated an emerging world where the profound power of investment capital could be used to solve social problems. By doing so, it heralded a new era where the binary worlds of ‘maximising profit’ and ‘social spending’ might be merged, so that the interests of society could be aligned with the interests of savers. Whilst some argued that this was nothing new, that business had operated like this for most of history, it was taken by the financial services industry as a new insight. This was mostly because it extrapolated that impact investments could attract up to $1trn of investment capital in the next 10 years.
Its interest relied on the suggestion that impact investing was an emerging ‘asset class’.
The rationale for positioning impact investing in this way was sound. The investment industry makes ‘allocations’ into different ‘asset classes’. Equities, fixed income,
property, private equity, emerging markets and so on are all ‘asset classes’, into which a fund manager will make an allocation of their total funds under management. It is quite proper for them to do this as they seek to balance the risk and potential returns for their clients’ money. By creating a new asset class, the research opened the door to significant capital flows.
The reasons for making such an argument were sound in the context of a world that did not understand the notion of impact investments, and which needed arguments to be made in a language that it could understand. It was the best way, perhaps the only way, to create a pool of capital that had an appetite to invest in, and so stimulate, the emerging businesses which sought to create some sort of social value alongside shareholder value. So it would be wrong to criticise such logic. “If I could save the Union without freeing any slave I would do it, and if I could save it by freeing all the slaves I would do it”.
But things move on, and it is a positive sign of the success of this approach that means that it may now be time to revisit the rationale for positioning impact investing as an asset class.
A reappraisal is required because there are a number of constraints that an asset class lens imposes on impact investing. It infers that positive social outcomes are only ever going to be the concern of a small allocation of capital deployed in society. It suggests that the rest can get on with ‘business as usual’ and leave this small allocation to sort out the problems. It is, ultimately, a repeat of the sacred/secular divide that led us into these problems – the idea that business (other than perhaps a small impact allocation) can just get on with making money regardless of the consequences to society, whilst governments and charities – now joined by impact investments - pick up the pieces.
We live in a world where we have only two theories of capital operation – socialism, and free-market capitalism. Both theories have been tried, and have been seen to fail.
Impact investing seeks to align the interests of society alongside the interests of savers. At its heart it puts a value on the social consequences of the operation of capital. This is as true for capital operated at global scale my mega-corporations as it is for a mutually owned village pub. It is also true for the 45% of the UK economy that is accounted for by government intervention. This capital is allocated by the state, based on a five year plan. If it positions itself as an asset class, impact investing is irrelevant to global business and state intervention. Its impact can only ever be marginal.
All of this leads one inexorably to the conclusion that if it is to achieve the systemic change that it seeks, impact investment cannot be an asset class. It must embrace the difficult truth that it is in fact a theory of capital – all capital. The state is starting to issue claims to impact investors in return for solving certain social problems. The genie is out of the bottle.
Perhaps most interesting of all is that this is not a new theory of capital. Adam Smith wrote the Theory of Moral Sentiments as well as The Wealth of Nations. It wasn’t until Milton Freidman’s teachings that “the social responsibility of business is to maximise profits” became an orthodoxy in business schools in the 1980s that business and finance abandoned any notion of broader responsibilities to society.
The implications of a new theory of capital are too great to process. It is a frightening idea. It is a risky thing to say. It can sound grandiose and ridiculous. But it is true. If it is to have any real significance, then Impact Investing needs to step up. It’s time to end the phoney war and embrace the challenge. As honest Abe said, “I do order and declare that all persons held as slaves … are, and henceforward, shall be free!”