The Future of Impact Investing: Investing with Heart and Brain

Alan Schwartz AM delivered the following keynote address at the 2020 Australian Impact Investment Awards:

I am simultaneously a supporter and a critic of the Impact Investment movement. After all, my recent article in the Harvard Business Review was entitled “Impact Investing will not save capitalism”. You will be relieved to hear that I have found a way to reframe my criticism into constructive advice for Impact investors.

Impact Investing - whatever that means - may not save capitalism but impact investors can play a critical role. Hence the title of these opening words – impact investing with heart and brain. By harnessing both heart and brain Impact Investors can make a huge contribution to changing the way capitalism works - so that it takes into account not only financial returns by also impacts on the environment and society.

Let me start with my recent HBR article. The example I used in that article, and the example I will use today is environmental impact, more specifically reduction of greenhouse gas emissions - but the message is applicable to any problem or opportunity that an impact investor decides to tackle. Simply stated, the reason we have a global warming crisis is because, in most places in the world, corporations can emit greenhouse gases for free. That is, they can use the atmosphere as a free dumping ground for greenhouse gases and leave the problem of global warming to all of humanity. Economists call this an externality. Corporations “externalise” the cost of their emissions. It is easy but unfair and unproductive to blame them for doing so. If they incur extra costs by reducing their emissions and their competitors do not, they are placed at competitive disadvantage - and the dutiful or altruistic companies will be outcompeted by the ones who merely respond to the pricing signals of the market.

Asking corporations to sacrifice profits for purpose is not the answer. The answer is that all corporations should be required to reduce their emissions - either via a carbon tax or via a cap and trade system. Progress on this front is frustratingly and worryingly slow As Impact investors we find this state of affairs unacceptable - we want to see two things happening. We want to find ways of investing profitably in net zero emission businesses and we want to see government action - on a global scale - to put a cap or a price on greenhouse gas emissions for all corporations so that those who choose to invest in emission reductions - like us - are not placed at a competitive disadvantage.

By harnessing both heart and brain, Impact investors can make a huge contribution to tackling climate change The HBR article explains how Firstly there is no doubt that there are plenty of opportunities to invest in low carbon businesses without any trade off between returns and environmental outcomes - simple examples include light globes and high value, well managed solar installations. In these cases we can make a normal profit simply by being astute investors.

One could argue that this cant be impact investment because it is just ordinary financial investing. I don’t agree because the intentions are different and the investment process is different. Impact investors start with the heart: That is, “I am actively and exclusively looking for investments that reduce emissions”. And when they find investments that are both profitable and environmentally sound, they have successfully used their investment brains. As good as this sounds, the point I make in my article is that it is nowhere near enough to solve global warming. There are simply not enough profitable opportunities to make a serious dent in the problem.

The Energy Research Centre of the Netherlands estimates that we need to reduce our emissions by 160m tonnes by 2050 to limit global warming to 1.5 C degrees. But profitable investments of the sort described above - that is, those can be undertaken profitably even when there is no price or cap on emissions - will only reduce emissions by 30m Tonnes. To reach the target of 160m we would need - based on todays technologies - a price of $175 per tonne.

This brings me to the second category of useful impact investment for emissions reduction. This is the grey zone where the risk is higher than it should be for the potential return. For example, without the clear prospect of a price or cap on carbon there will be alot of wind and solar projects that are marginal - the risk/return mix is not one a financial investor would willingly accept. This is where there is a trade off between return and impact, and this is an important area for impact investors to lead by example - pushing the boundaries of innovation, technology and marketing to find pathways to beat the odds and achieve reasonable returns, with the full knowledge that the playing field is skewed against you and you may not get the sort of return you may have earned for a less environmentally worthy project. I encourage you to do this with both heart and brain - do it with heart because its the right thing to do and do it with brain - trying to beat the odds but knowing that without a level playing field you may trade profit for purpose.

I think we all do impact investments that qualify for category one above and some of us consciously pursue opportunities in category two above My objective today is to encourage you to pursue a third category of impact investment in which you use all your resources - not only financial but also your connections, your standing amongst your peers, your political influence... whatever... to contribute to the essentially political challenge of changing the rules of the game so that all corporations are required to reduce their emissions or pay for their emissions - which will in turn expand the scope of profitable investments for us as impact investors.

Some of us are still arguing about what impact investment means but I say it does not matter - what matters is impact investors who invest with both heart and brain. Those who look for relatively safe bets in renewable energy businesses and those who take greater risks in newer technologies and markets without commensurate upside. I know I am speaking to the converted. But too many of us - including me until recently - think that politics is a dirty, nasty business and we want no part in it.

This is my message today. If we want to be able to make real impact in the world, we need the regulatory framework that makes it possible for us to invest in things that we all care about - the social cohesion and well being of our communities and of our fragile earth. Politics is a necessary part of the work of an impact investor. By this I don’t mean going into politics - it means using your wealth, your connections and your reputation to promote regulatory change that enables us to do what we need to do profitably.

I have used the example of greenhouse gases and global warming, but these three categories of impact investment apply across everything we care about and everything we tackle - whether it is literacy, or social isolation or obesity or species and habitat destruction. It is hard to communicate these ideas in a few minutes and I know you have not come here today to listen to a long introduction - so if any of you finds these ideas interesting and want a more in depth discussion or links to further reading please feel free to make direct contact with me via the organisers.