Don’t Start Burning Down the House

Why Now Could Be the Golden Age of Impact Investing

In the last four years, ESG investing became the preferred punching bag for many on the political right, and with it, sustainable and impact investing are being dragged into the fight. The criticism is broad, and even formerly staunch allies of progressive management and values-based investing are taking a more cautious view of their initiatives. What’s more, some of the most dedicated impact investors—including me—will admit certain criticisms are warranted.

To be sure, those seeking to do business with the Federal government or build a business with taxpayer subsidies will be challenged in the period ahead, perhaps for quite some time. The current administration has made clear they will not favor policies aimed at slowing climate change, nor will they defer to broader science and innovation initiatives. Getting out of the Paris Climate Agreement and halting Federal funding for key initiatives will have a chilling effect on certain technologies and US businesses.

Before we assume the worst from the pundits, let’s focus our attention on reality, and begin by remembering that there are several modes of deploying capital for good. Most importantly, impact investing and ESG share heritage, but they are cousins, not twins. Impact investors focus most on what the company does, ESG analysts care about how they get it done. Despite what we’re hearing from Washington and certain state legislatures, in my view it’s actually a great time to seek out profitable impact businesses, both in the public and private markets. A business that can thrive today, while facing intense scrutiny from Capitol Hill, and in the absence of tax rebates, subsidies, and grants, is surely a great opportunity for investors. Indeed, I could argue that this may be a clarifying moment for those of us seeking to change the world through business.

As the Austrian economist, Joseph Schumpeter, who coined the phrase “creative destruction" wrote in 1942,

. . . a capitalist economy is and cannot be stationary. Nor is it merely expanding in a steady manner. It is incessantly being revolutionized from within by new enterprise, i.e. by the intrusion of new commodities or new methods or new commercial opportunities . . .

Or, as Nina Blackwood, the first MTV VJay might have said a mere 40 years later, video killed the radio star, but it launched an entire industry (and some incredible visuals). Why should impact investing be held to a different standard?

Any impact business already tackling today’s problems has the vision to be thinking about how to overcome tomorrow’s hurdles. They are our biggest and best future investments, especially since many of these kinds of ventures will no longer be eligible for government subsidies. To make up the shortfall the successful ones will need to seek support from the private sector—meaning organic demand for their products and return-seeking capital from investors. Businesses that will thrive without government subsidy will be far more robust and successful over the long term.

Yes, it’s true that many investors are currently reluctant to consider impact investments not just because of the new administration’s activities, but because of their own antipathy toward the sector. And certainly some of that antipathy is understandable, if not merited. We are in the third “green investment” cycle. Many false promises have been made by impact investing’s cousins ESG and Sustainability. Celebrities launched investment funds, which is a sure sign of a frothy market. Not all that criticism and skepticism is warranted, though most of it certainly is worth consideration.

We have to admit that during the past few years, the valuations placed on some impact businesses, particularly in the clean tech sector, became wildly extended. As I have written about elsewhere, some of this excess pricing was due to the zero interest rate environment which ended only two years ago. Meanwhile, more than a handful of funds from well-known investment firms over-promised and under-delivered, on both returns objectives and impact outcomes. In some cases the issue was created by investment funds that were more about marketing than returns. Impact was in demand, it was cool, but too few investors stopped to ask if the specific investment thesis was either profitable or truly purposeful. Often the honest answer was “unclear.” That dynamic, on top of accusations of greenwashing and “woke capitalism,” has left some investors with a severe lack of confidence.

To me, the market environment around impact investing is opportunistically reminiscent of the stock market boom in the 90s, and the bust that followed in 2000. Then, as now, companies were subject to overvaluation, and investors made poor stock or fund selections based on business models and ideas that were never going to pan out.

On the other hand, some high quality companies and game-changing innovations were born of and came out of the tech bubble. Just like Carlos Santana, one of the greatest guitarists of all time, revived his career in 1999 by listening to his producer, Clive Davis, and pivoting into collaboration with both the iconic Eric Clapton, and the icon-to-be, Lauryn Hill, successful tech companies of the late 90’s listened to the market and learned to pivot. The then struggling Apple Computer launched the iMac G3, which revived the brand and the company in 1999. Eight years later, they launched the iPhone.

Here’s another example: In 1998, IBM sold off the remains of its suffering PC manufacturing business, and by 2003 had launched in the consulting sector. Today, they are one of the sector’s leaders. If we look at the 90’s and early 00’s as an object lesson, the next step for impact investors is to ask two questions: How are we measuring success in the future, and who should we be collaborating with?

Successful sectors and industries are driven by one of two things: business leaders identifying and building a better mousetrap, like Walmart and then Amazon did in retail, or entrepreneurs creating something new and developing a market. Impact has the potential to do both by tackling the hardest challenges we now face and at the same time, creating new, profitable commercial enterprises. At the end of the day, impact investing will motivate the most capital to solutions when it is seen as just good investing.

If we agree that making any kind of change at scale is unlikely to happen without the engagement of the private sector, then, contrary to opinions in the popular press, it’s a great time to invest in authentic and impactful businesses. Good fund managers are paying attention, and they’re the ones who will come out of this period with strong returns. Impact investing may currently seem like a risky endeavor, but in a few years, it may turn out to be the best bet of them all.

If you’re willing to risk your capital, then you have to consider new markets, evolving technologies that support or go after those new markets, and high-quality companies growing by capturing the market. And you have to know when to move on. We’re in a moment of incredible conflict and uncertainty. The best way to move things forward is to approach investment with the expectation that there are problems in the world that need to be solved, there are entrepreneurs and established companies seeking to solve those problems, and there’s astute capital that needs to be motivated to solve those problems. Now is the time to motivate it.

And lest we forget, in a capitalist economy, an industry is rarely—same as it ever was: Bill Gates replaced An Wang, just like Nina Blackwood replaced Alan Freed, yet technology, innovation, and business, like good music, still thrive.