New impact-focused investment products – or those labeled as such – come into the market everyday. Investment sponsors are eager to profit from the unrelenting thirst of an investing public desperate to achieve both financial profit and to create social value.
The impact investing market itself is in its nascent stages from an investment product perspective. The investing public hasn’t clearly defined what areas of impact are “must-haves” to earn their investment dollars. Investment sponsors are spraying a variety of product types on the market in an effort to cover the assumed span of investor concerns. Climate change, social inclusion and gender equality are hot topics. Each investment manager aims to put their own spin on the impact product, with no true standard in place as to what defines “impact.” In most cases, investment products are created without any framework or KPIs for investors to determine which products actually meet the impact thresholds claimed or if such products serve any real impact purpose at all.
I will make the case that certain investment products offered by large institutional asset managers are not worthy of description as “real” impact investing products. At an investment fund level, “real” impact investing should revolve almost entirely around directly funding portfolio companies that promote the core values of impact investing – being earning profits, while also creating lasting social value.
A large number of currently available impact investment products are lazy versions of what I believe the market actually wants to see. Investment managers love these investment products largely due to the relative ease of creating them and the opportunity to earn outsized fees vs. selling traditional investment products. They charge investors higher fees by arguing that more effort is needed to find these niche impact opportunities as compared to just investing under a strict financial returns rubric. Conflicts of interest are currently running wild here.
The UBS Example – Donating Profits is Not Impact Investing
One common “impact investment” product theme that we are seeing in the market is that of asset managers donating a specified portion of their revenues from any given investment fund they structure to charity each year and selling this donation as the core impact value.
One such example is that of UBS, which recently headlined as raising the largest biotech impact fund in history. Per the fund’s portfolio manager, one of the core impact value propositions of the fund is to allocate twenty percent of the performance fee the managers earn off their investments, as well as a portion of drug royalties, to improve access to cancer treatment for children in the developing world and to fund cancer research. That proposition sounds great to an investor right, everyone wins? But is allocating profit to a nonprofit organization an effective way to demonstrate impact instead of investing in companies that are creating an impact directly? Has UBS really created anything unique here, or just added another product for increasing its assets under management?
I see a core, thematic issue with financial products that aim to demonstrate impact by investing in standard industries doing standard business (i.e. business as usual) and claiming impact simply through a donation of a portion of profits to a nonprofit organization.
The issue is not that traditional industry is necessarily bad. Nor do I want to imply any negative connotation with donating to nonprofits. Instead, I think that the financial product itself is malconstructed and misleading when labeled as impact-focused if all it does is provide that a portion of profits will be donated without respect to what business is used to generate those profits. The financial product fails to live up to what the impact investing movement is all about – get capital in the hands of for-profit businesses that can use that capital to create real social value while also providing financial returns to investors.
Take for instance the UBS example. A core value proposition to the investing public is the allocation of 20% of the asset manager’s fees to a stated charity. The product thesis of the fund is the same focus that a “traditional” biotech fund would have – invest in the best available biotechs. The fund clearly states that they will invest in companies who develop innovative treatments for cancer and other serious illnesses, period. Nearly every other biotech fund invests in emerging companies that are aiming to find solutions to an existing medical issue for the purpose of making profit, but other funds don’t classify themselves as impact-focused and charge more fees as a result.
My cynical self tells me that the fund manager is essentially overpricing their product to customers. The end result being that the customer (i.e. the investor) is essentially paying a 20% markup on their chosen investment product in order to donate the excess to a charity of the asset manager’s choosing while the asset manager is in the same financial position had the fund been labeled “non-impact”. By rebranding, these asset managers create whole new fund structures that increase their assets under management (AUM) but that do not do anything strategic or new with respect to opening new investment opportunities.
I would argue that the better, more honest, way for this product to be constructed is to sell it as a traditional biotech investment product, lower the asset manager fees by 20% and relay this discount to investors along with the asset manager’s opinion on where they would recommend investors donate their excess profits. Investors can then allocate that 20% savings to whatever nonprofit they find most rewarding, be it their own idea or that of a third party asset manager. It is the investor’s money the asset manager is donating after all. The investor should be able to choose where it goes.
The Vanguard Example – The Default Impact Fund
In the pure, public market space, Vanguard’s ESG U.S. Stock ETF (ESGV) also presents itself as an “impact-focused” fund vehicle. Now, this fund has more than $5.0 billion in total assets under management and holds more than 1,500 stocks.
You may wonder how this bundle of stocks, including blue-chip brands like JPMorgan (JPM) and Unitedhealth Group Inc. (UNH), can self-classify as “ESG” (environmental, social and governance). The answer is that this fund is merely an “exclusionary” fund. This means that the fund simply cuts out the worst ESG actors from its holdings based on its own rankings for ESG criteria and then presumes that the rest of the companies in the fund are aboveboard. What Vanguard is implicitly saying here is that it is reasonable to accept that if they eliminate any obvious impact offenders from their portfolio (likely oil, gas and tobacco companies) that they can assume every other stock that trades on the public markets is now an impact-focused company, therefore the fund itself is an impact-focused fund. If there is a less compelling impact story, I would love to hear it. This seems to be another fee grab lacking in creativity.
The Counter-Argument: Any Social Good Can Be Sold As Impact
Many readers may not agree with my assessment above. They may argue that these products have a net positive in that they are still forcing capital movements into the hands of nonprofit organizations focused purely on the social good and punishing the worst ESG offenders. They may argue that without these investment products in place, these nonprofits would never receive this funding and that these bad actors would suffer less public pressure to reform. Therefore, the argument would go, that some good was created and labelling these as impact-focused funds is fair. I disagree:
- The product examples above are, in reality, just “traditional” investment products that were rebranded “impact” as the popularity of impact investing grows: Investors are ultimately investing in traditional funds by investing in either of the two options above. They are not choosing social good over profit. Asset managers won’t offer the product if it is not profitable to their own businesses, full stop. The post 20% reduction in fees for UBS’s product should be assumed to be a market rate for their services. The donation is essentially coming right out of the pocket of the investor. Vanguard’s exclusionary “ESG” fund is as impactful as it is visionary. Not holding a few stocks of companies that clearly destroy the earth and investing in everything else doesn’t mean that you are actively involved in providing measurable, positive social value to the world around you. You’ve only not invested in the worst offenders. This doesn’t necessarily net you a positive position.
- Wealthy individuals have not stopped donating to charities and won’t stop if companies don’t donate for them: The argument assumes that investors would not donate to nonprofit organizations if there is not a corresponding profit from which they could extract the donation amount. One needs only to look to Andrew Carnegie’s “Gospel of Wealth” in 1889, which promoted the idea of owing a duty to society, and encouraged donating to causes to understand that donations to nonprofits have existed since at least the 1800s. In 2020, within the U.S. alone, there was over $42 billion of charitable giving according to the Blackbaud Institute. Nonprofits are a key value contributor to the social economy of the world, expect these to be around for the long haul. Wealthy individuals will not unilaterally stop donating because they suddenly realize that nonprofits won’t earn them financial returns.
- Apparently, professional money managers need to be involved for wealthy individuals to donate effectively and to ensure nonprofits don’t go out of business. I don’t think so: The above assumes that investors and/or donors are incapable of making intelligent decisions as it comes to the use of their own capital and can not adequately balance the value of social good and the allocation of their own personal resources to such a good. Rather than have an asset manager allocate donation value to a counterparty of their choosing, I would argue that investment funds should merely give the earnings back to investors and investors should choose the donation of their choice.
Further, I would assess that although the amount of money that is donated to nonprofits varies slightly per year, it is expected to rise during 2021, the pool of money available to the nonprofit sector is somewhat fixed. There are not massive historical swings to suggest that if professional money managers don’t step in to help the situation the nonprofit sector will perish. Products like the UBS example above merely will affect cash flows to specific charities, likely removing that capital from the potential pool of total charitable capital available to be allocated to other worthy nonprofits.
What does this mean for investors who want to participate in the impact-focused investment marketplace?
Although much of the theme of this article is to inform the reader about bad selling practices and confusion among market participants, this does not mean the entire impact investing market is faulty. The impact investing world is just getting started. For investors who are looking to make meaningful placements in impact-focused companies and funds, I offer the following advice:
- Most public companies, and funds consisting solely of public companies, will be incapable of proving the material creation of social value: In my opinion, within the impact investing realm it will be private companies that create the most impact value. For investors looking to participate effectively and honestly in this market, investors should be looking at funds that invest in early-stage, small private companies. These funds will likely be newer entrants into the market and marketed as venture capital or early stage private equity funds. We see huge potential for investors in emerging markets and alternative investments. If funds are not of interest and investors prefer a direct investment approach, they should look to invest in individual portfolio companies themselves, the likes of which we focus on at Legacy Group. Look to the private placement world, even look to some of the new crowdfunding platforms that exist in the market. We are seeing more and more opportunities open up in the impact space with the allure of significantly higher returns than what we are seeing in public markets with the added value of promoting social good.
- Value created through impact investments should be redeployed into non-profits: It has always been my opinion that companies, including impact-focused companies, are primarily focused on earning profits above all else. Impact-focused companies will engage in behavior that benefits the social good as long as there is obtainable and recognizable value that is gained from that transaction or it is at worst value neutral (i.e. the effect on profit must always be considered). Nonprofits have the luxury of spending their capital on initiatives that derive only social good and can maximize that value creation as a result of the lack of a contradictory profit requirement. For certain creations of social value, which do not create the potential for profit within a company, the only realistic way to build that value is via nonprofits. We recommend playing both sides – invest in true impact companies that can create value and, once created, redeploy your capital to non-profits after distributions are made and shareholder profits are realized to further advance impact interests.
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