Moskowitz Prize Winners on Why There’s Room for Innovation in Impact Investing
Research

Moskowitz Prize Winners on Why There’s Room for Innovation in Impact Investing
Q&A with Professor Brad Barber and Associate Professor Ayako Yasuda

Private capital has the scale to fundamentally address global social and environmental challenges, but traditional financial instruments and intermediaries are designed to maximize returns rather than make a positive social impact. Yet, as of November 2016, nearly 1,400 organizations representing $62 trillion in assets under management have signed the United Nations Principles of Responsible Investment (UNPRI).

However, investors have allocated very little private capital with the expressed intent of generating social impact.

Enter UC Davis Professor Brad Barber and Associate Professor Ayako Yasuda, and Associate Professor Adair Morse of UC Berkeley. They studied more than 160 impact funds launched between 1989-2014—both venture and growth private equity—and 25,000 capital commitments by more than 3,500 investors to more than 5,000 funds.

They found that the demand for impact investing alternatives is outstripping the available supply of such choices for investors: “(W)e find a 13.5 percent higher investment rate for impact funds compared to the benchmark investment rate of traditional venture funds. Our results imply that the supply of impact funds is incomplete, failing to meet demand,” the study concludes.

For their work, Barber, Yasuda and Morse were recognized with UC Berkeley’s 2016 Moskowitz Prize for Socially Responsible Investing, the only global award recognizing outstanding quantitative research in sustainable and responsible investing. (It was the second time Barber has won the prestigious award).

We asked Yasuda about the research, plans for follow up studies, and why there is room for innovation in impact investing.

Q. – What motivated/facilitated your research into these type of funds?

There is a ton of research on SRI (socially responsible investments), most of which is in public equity, and is either negative screening of socially undesirable companies (think tobacco), or positively screening undervalued assets or exploiting a temporary advantage for purely profit-driven reasons (e.g., buy green while it’s cheap).

Impact investing is different. It explicitly aims to generate positive impact for the society/environment, not just avoid sins, while also generating financial returns for the investors. It is also done for the sake of generating externality, not “do well by doing good.”

The whole concept is radically different from traditional models of investing that are focused exclusively on risk-adjusted financial returns. It is very intriguing, and potentially paradigm shifting, to think that private capital (not government funds or charity money) can be effectively deployed to solve the world’s pressing problems such as economic inequality or climate change. And we need a lot of capital to solve those problems!

We wanted to better understand private investors’ appetite for this type of investments, and to identify institutional bottlenecks, if any, that could be removed to further increase demand. 

Q. – Why do some institutional investors such as endowments, private pensions and corporate/government portfolios eschew impact funds? Are there regulations that deter them from seeking those opportunities?

Many investors, including U.S. endowments and private pensions, face strong forms of fiduciary duty and legal restrictions against investments for non-financial motives (e.g., ERISA and UPMIFA). We find evidence that these legal restrictions sharply depress investment rates in impact funds among those investors. We suspect that these laws make investors stay away from impact investments for fear that they be sued and found in breach of their fiduciary duty. Were these restrictions to be removed, we estimate that there would be 25% more impact investments. 

The Global Sustainable Investment Alliance reported in 2014 that there is $13.6 trillion committed globally for socially responsible investments. Extrapolating our results on impact funds to the overall market for sustainably and responsibly managed assets, it is possible that reducing legal impediments faced by many investor types (such as private pensions) could increase private capital tilted towards generating positive impact by as much as $3.4 trillion (25% of $13.6 trillion).

Q. – Your results suggest that implementing U.S. Community Reinvestment Act -like regulation elsewhere, and relaxing the strict Employee Retirement Income Security Act (ERISA) interpretation of fiduciary duty in the U.S., could potentially dramatically increase demand for impact investments. What is your view on how likely these type of regulatory changes may happen given the Trump administration and Congress and EU governance?

That is a good question, but I haven’t heard any speculations on what the new U.S. Administration will do either pro or against relaxation of the ERISA rule vis-à-vis impact investments. While the new Administration is unlikely to be very supportive of government spending on these social or environment issues, it remains to be seen what their stance will be on galvanizing private capital.

Q. – You found that the pinch is most acute in Europe where the demand for impact investing (versus traditional investments) is three times higher than in the U.S. and the rest of North America. Why is that? Are European funds not as interested in offering impact alternatives or are there other forces at work in European financial markets that do not exist in U.S.?

We interpret that result as Europeans having greater enthusiasm for impact investments as compared to non-Europeans. This could be partly because fewer European investors are bound by ERISA-like legal restrictions; it could also be because Europeans have cultural values that are more conducive to channeling private capital to impact investments.

For example, we use the Hofstede measures of cultural values to compare Europeans to Americans, and find that they are measurably more pro-collective (vs. individualistic), longer-term oriented, and more restrained. These are values consistent with putting high values on investments that generate positive social or environmental impact. 

Q. – Where do you see the next steps in the research? Do you have plans for follow up studies on this topic?

Yes, in our next study we are analyzing the performance differences between impact funds and traditional venture capital funds. Preliminary evidence suggests that impact funds earn lower financial returns than traditional venture capital funds, and investors expect and accept such trade-offs between financial and impact returns on average. 

Q. – The Moskowitz Prize is the only global annual award recognizing outstanding quantitative research in the field of sustainable, responsible, impact investing. What does this recognition mean to you and the importance and impact of your work in this field?

This project took us many years to collect the data and build the empirical model, since we had to start everything from the scratch to study and understand these new types of funds. We can say it has been a labor of love. So receiving the Moskowitz Prize was such a wonderful affirmation to us all that our work has relevance in this important and growing field, and that motivates us to continue work on our follow-on projects! 

Download the Impact Investing study