Published in Partnership with Forbes.com.
- The power which sits with investors and the business community is immense.
- Financial institutions can help mobilize new and existing capital channels to help solve global challenges.
- Socially Responsible Investing and Impact Investing are two methods of investing that can be developed and scaled up to become a more powerful tool in addressing the world’s problems.
I believe banks can play a bigger role in addressing the social challenges of our time.
Those closest to capital flows are financial institutions, and mobilizing new and existing capital channels in the smartest way possible can help change the world for good. Traditionally, banks were intermediaries between buyers, sellers, investors and investments, but they can help by encouraging investors to put more of their capital into sustainable investments. Banks can also develop the market to allow impact investing and socially responsible investing (SRI) become mainstream and scalable.
Financial institutions can play help aggregate demand and run down the cost curve of the industry. They can establish industry standards to create confidence in the broader investment community. For example, instead of multiple single deals, invest in managers who can handle multiple investments. Intermediaries who can package and deliver products to large-scale wealth holders with the objective of running down the cost curve are one solution. Another might be directing a fragmented impact measurement standards industry towards convergence – this builds up trust and ultimately helps to decrease transaction costs.
Impact investing belongs to the field of social investing, where social considerations are important in driving decisions. It is not the prerogative of philanthropic foundations or financial and government institutions, but pertains to private investors, giving it enormous potential.
Many foundations such as the Mistra Foundation in Sweden, Cariplo Foundation in Italy, the William and Flora Hewlett Foundation in the U.S. and entrepreneurs like Jeff Skoll and Pierre Omidyar manage part of their and/or their foundations’ assets in a way that furthers social good and generates financial returns. Many private investors have followed suit.
Since the entry of these new private innovators, the impact investing market size was estimated to be worth up to $1 trillion by 2020. This figure appears ambitious, since this represents 1 percent of presently managed assets globally. The industry currently only manages $50 billion. However, if we take into account that the pent-up demand from low-income communities for affordable goods and services is huge—representing an annual aggregate purchasing power of $5.1 trillion—the industry’s extrapolation appears realistic in the medium to long-term.
Businesses are revenue generating, and their social impact can be ongoing and sustainable. In addition, impact markets are growth markets where investors can profit significantly in the medium to long-term. So why is there a USD multi-billion funding shortfall for local profit making businesses that create value for local stakeholders?
Although growing, this market is still in its infancy and there are still many challenges to be overcome to really make impact investing scalable and viable. The market still lacks impact investing expertise and investment managers with a strong track record of impact. There is a relatively small universe of private equity fund of funds with an established track record in impact investing.
Impact investing is also difficult to classify and doesn’t fit easily into conventional portfolio construction and investment policies. Due to the nature of investing in small medium enterprises (SMEs) in developing countries there are high perceived risks which deter many investors.
The lack of existing standards and infrastructure combined with the challenges of operating in emerging markets means that due diligence is costly and time intensive.
Another solution to increasing capital flow? Integrating sustainability into the overall investment approach.
This will encourage more investors to invest in companies who have considered social and environmental factors. The demonstration of extra-financial performance (EFP) is fundamental to the value proposition of SRI. If this can be demonstrated, then investors will shift the investment focus onto long-term performance and integrate EFP factors. The most important characteristic of a sustainable investment strategy is that it explicitly aims to create value that is either social or environmental. A conventional investment strategy does not. In this context, sustainable investments are expected to deliver risk-adjusted returns in line with the market over a reasonably long investment period, and EFP in the form of environmental, social and other added value.
What needs to change before this approach becomes mainstream? We are missing a standardized framework, evaluation and rating methodology for the assessment of sustainable investments. There is also insufficient data about sustainability indicators on a global scale, particularly on companies in emerging markets. The sustainability indicators and material ESG risk considerations available need to be integrated in analysts’ company valuations. This will help investors consider these factors when making decisions.
There is undoubtedly a shift change as more business people incorporate social and environmental factors into their operations. New breeds of business people in Asia I have met, are forfeiting parts of their profits and moving away from established models of philanthropy. Instead, they are taking corporate and social responsibility to the next level. They focus on paying their employees a fair wage, providing social support (e.g. child day care, literacy classes, medical services), and ensuring their subcontractors do the same. This is not led by marketing executives or pressure from NGOs, but by the CEOs, driven by their values. Many also believe that this will benefit the business.
These are the sorts of innovations and ideas that we wish to share throughout our network, which is why we hold the UBS Global Philanthropy Forum every year. We gather 200 experts, philanthropists and clients to share best practices and new ideas. Instead of foundation representatives and industry professionals, this event gathers the philanthropists themselves for a two day exchange on how they view the world and what can be done to make it better. Sharing knowledge is important in a sector where many foundations or businesses are tackling the same problem.
The power that investors and the business community have is immense. The financial industry should convince mainstream investors that there is significant untapped value, both financial and extra financial, by taking environment and social impact into account. Then, they need to build the necessary infrastructure to serve them.
Only then we can start to unlock some of the capital necessary to help the solve some of the world’s most pressing problems.
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of UBS AG.
 Monitor Institute (2009); JP Morgan (2010)