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Investing for Good

How investments can create profit and social good

Dirty water. Pollution. Unaffordable healthcare. Governments and philanthropic organizations have traditionally provided the funding for projects targeting these and other global crises. But according to the United Nations, there’s a huge shortfall between the $1.4 trillion in current funding and the $3.9 trillion needed annually to address these challenges by 2030. A growing portion of the business community believes that private investment can bridge that gap.

Nalin Kulatilaka Nalin Kulatilaka is helping address the challenges facing the social impact investing sector. Photo by Dan Watkins

Nalin Kulatilaka, the Wing Tat Lee Family Professor in Management and a professor of finance, is an expert on social impact investing, which can describe anything from a small crowdfunding campaign to specialized funds—like Acumen and the Omidyar Network—that invest in entrepreneurial enterprises where profits come second to doing good. Kulatilaka began thinking about the potential of social impact investing when he cowrote a 2012 paper, “A New Approach to Funding Social Enterprises,” for Harvard Business Review.It identified a glaring issue: entrepreneurs need capital to grow their businesses but can’t promise the same financial returns as traditional investments, nor can their social impacts be measured easily. Without those guarantees, it’s hard for entrepreneurs to attract investors. The Global Impact Investing Network estimates there was $502 billion in total social impact investing in 2018, well short of the UN’s $2.5 trillion gap.

Now a codirector of Questrom’s Susilo Institute for Ethics in the Global Economy, Kulatilaka is helping to address the challenges faced by this still-maturing investment sector. The institute has joined the Impact Management Project, a global coalition attempting to standardize the way social impacts are measured, and hosted a business roundtable discussion about creating value for society—not just shareholders. Susilo has also joined the Wharton School’s annual MIINT competition where MBA students develop a social impact business model and compete for a $50,000 investment in their idea.

Kulatilaka discussed the origins and future of social impact investing with Questrom.

Questrom: What qualifies as social impact investing?
Kulatilaka: There is a big umbrella called responsible investing, which looks at investing in stocks and bonds that are not doing harm or trying to do good. The money invested there is estimated in the tens of trillions of dollars. More narrowly, impact investing is mission-driven investments, not public companies, where the principal goal is not profit, per se, but impact. Impact investors try to focus on domains of inequality of access. So Root Capital, for example, is looking at helping poor farmers and facilitating fair trade agriculture. There are others that look at women’s empowerment, climate and clean energy, poverty alleviation, financial inclusion, or reducing recidivism. They are trying to solve some problems of access to vital resources.

If the goal isn’t profit, what’s the motivation for an investor?
They are in many ways seeking a mission that they once pursued through philanthropic giving. Now, they’re realizing that entrepreneurs who address these missions can be more efficient: They can scale things up and pursue their mission in the longer run. There’s an implicit understanding that investors are willing to take on unseasoned risks or a concession in financial returns in exchange for the accomplishments of the social mission.

Who’s vetting these investments?
If you think about the supply and demand for these funds, the supply of capital comes from individual and institutional investors. And then the demand for the capital comes from social entrepreneurs who are trying to start and scale up businesses. Impact funds are the intermediaries that direct the capital—and they do the due diligence on the entrepreneurs, the same way as venture capitalists would, except now they’re looking at a double bottom line, with social and financial lines.

“Many trillions of dollars are going to be managed by millennials, and their objectives are thought to be quite different from their parents’ generation.”–Nalin Kulatilaka, Wing Tat Lee Family Professor in Management

Could the sector continue to grow?
There are a number of forces that make me think there is a real potential for this to take off. One is an increasing awareness among the investor communities. Many trillions of dollars are going to be managed by millennials, and their objectives are thought to be quite different from their parents’ generation. They’re much more concerned about social and environmental issues and they don’t believe that you can actually separate your money making from your philanthropy. You see this in our classrooms: students are interested in working for organizations that actually make a difference. So both from where they direct their capital, as well as where they direct their labor, they’re looking for this sector.

How can someone get involved in social impact investing?
Opening an IRA or investing in a mutual fund is investing in publicly traded companies. Their actions are often opaque to you and their social mission, if there is one, is secondary. The more comparable thing is the money that you would give to charities and philanthropy. Social impact investing will put your cause-driven, mission-driven allocation toward a longer-term, scalable model that uses entrepreneurship and business acumen to make it work. The problem is that these investment vehicles are not very well established and they’re still not available to the small investor. One accessible impact investment vehicle that is getting a lot of traction is crowdfunding. There are a number of crowdfunding tools that have been used to impact specific missions.

What work is the Susilo Institute doing that relates to social impact investing?
The Susilo Institute deals with ethics very broadly—not just individuals following their moral compass, but individuals and organizations acting in a responsible fashion. So social impact is very much within our scope. One of our big research questions is how you measure impact. If you are telling somebody to maximize profits or stock value, something that is measurable, they have targets. But if you tell people to maximize impact, and impact is not measured well, then the mission tends to drift toward something that can be measured easily. That is a problem that all of these organizations are having as they scale up.

Another project is looking at how to create incentives and corporate governance structures that would be suited for impact investing. For example, when you invest in a company, you get stocks or bonds and earn dividends or interest. But social entrepreneur enterprises typically don’t have an opportunity to sell stocks or bonds. Instead you might have profit sharing plans or count the social impact toward investors’ goals.

What do you see as the sector’s future?
My wish is to see this become part of mainstream investing, which means investors investing not just on the financial side of their brain but also the life side of the brain. You can think of it as your life portfolio and your financial portfolio become better aligned. We care about society, we care about community, environment, all those things, but when we go to invest, we pretend as if we don’t. Most of our wealth is invested by assuming this separation—and institutions are structured like that. When you look at the large financial service providers, they’re talking about how they can beat the market or give you a good financial return, whereas most of us, in our day-to-day lives, care about lots of other things. So how do we better align these things? And you see early signs of that happening because just about every fund family now has an impact fund. The danger, of course, is that this could become a fad, if it doesn’t produce an impact.

This interview has been edited and condensed for clarity.