A look into the utility curve between social utility vs financial return. A macro view of the impact investing space. Example investment options for EAs looking to do good while earning a return. This is my first post for the EA Forum, on a topic that I’ve been quite interested in. I’ve studied rationality online for the last 3 years, honed my investment strategies for the last 10 years, and last May I joined the EA Toronto community. Feedback and criticism is welcome, would love to hear your thoughts on this topic!
There is an old question in Effective Altruism asking if it is better to donate today or donate in the future1. The answer depends partly on:
- The impact of money on your considered cause now vs in the future
- The rate of return you expect to make on your capital (money)
In this post, I’ll be investigating how impact investing can confound this concept - by generating a return on capital and creating philanthropic utility.
According to the Global Impact Investing Network (GIIN), impact investments are “Investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.”2
In 2016, surveyed investors contributed an additional $22B towards impact investments3, while annual charitable donations summed $410B. The investment in impact investments is projected to grow about 17% annually, while charitable giving rises at under 5% annually. From a pure ‘access to capital’ perspective, impact investments should be a material consideration.
Compared to traditional investing, impact investments totalled >$114B in 2016, just 0.16% of the $69.1T total global assets under management4 that year. So we’ve got a growing segment of capital directed towards ‘good’, with massive room for growth. I’m interested.
Let’s compare three options for our dollars:
- Traditional investments. Earn 1-2% in money markets, 4-5% in bonds, ~7% in equities. Unknown social utility
- Charitable giving: Lose 100% of your money. Plus generate some kind of social utility
- Impact investing: Earn some kind of market rate, plus some kind of social utility
*Not to scale
Is it possible that impact investing could earn comparable market returns while creating social utility high enough to entice EAs?
A Rational Take on Investing
First off, let’s level set on two concepts around investing:
- Investors trade off risk and reward. You’ll have to pay me more to invest in your asset if I think there is a higher probability of losing money. Yes, this is expected value. At its most efficient, the market offers investment options along this risk/reward frontier. Individuals try to find investments offering greater rewards given risks
- The ‘reward’ aspect of an investment, is actually an expense on the asset itself. The asset is paying you to use your money. There is plenty of nuance as you consider derivative value, but I’m pretty sure this is a fundamental truth
Apply these two concepts to impact investing. Give an investor a choice between a traditional investment and an impact investment, with exactly the same risk and reward. In this example, let’s talk about bonds.
Coal company ($1000): 5% interest * 1% risk of default = $49.50 expected return
Solar company ($1000): 5% interest * 1% risk of default = $49.50 expected return
To an investor who doesn’t care about non-monetary utilities, these investments are interchangeable. To an EA, it looks more like this:
Coal company ($1000): 5% interest * 1% risk of default - $10 environmental damage = $39.50 expected return
Solar company ($1000): 5% interest * 1% risk of default + $5 utility of clean energy capabilities = $54.50 expected return
I’m still new to EA, so those estimates of energy utility are based off of nothing, but serve to illustrate the point. Any investor comparing the total benefits from either investment, should prefer to buy the solar bonds over the coal bonds.
If the solar company needed to raise $40M, they will be paying out $2M in interest, same as the coal company. Do they need to? In an efficient market (that considers all utility), they could theoretically lower their interest rate until the expected total return equaled that of the market.
- The investor receives less financial benefit, but the same social utility
- The company is able to fund itself for less
This relationship implies that impact investments should always offer a lower financial expected value inverse to the social utility it provides. An investor could always invest in the coal company, then donate their earnings to their favourite AI safety project. Is there any benefit to combining financial with social outcomes in the capital markets?
The Inefficient Real World
The real world is filled with uncertainty, and true risks, rewards, and external utilities are all difficult to measure. Neither companies nor investors will assess these influences the same, which creates opportunities.
Since valuation of social utility is something that EAs do really well, I suspect we should be able to identify some outstanding opportunities to earn a greater return relative to an under-valued social utility, while avoiding sectors that have already discounted the financial return relative to an over-valued social utility.
In my initial exploration of this space, there seem to be huge disparities between investment opportunities. It seems that most investors don’t count the social good side of the equation, leading to great investments offering the same returns as traditional investments, while also generating great social utility. Is the overall utility high enough to compete with other EA causes? If you’ve got capital sitting around, are impact investments better than index funds?
Lets zoom in.
The Impact Investing Space
Almost all activity in the impact space is done by large institutional investors (fund managers, 67%), and foundations (11%). 37 of the 208 investors surveyed by GIIN had over a half billion dollars invested. Many of the private debt or equity offerings are available to accredited investors too, which means you are welcome to play if you’ve got $1M in the bank, or a salary of $200k plus.
Sadly, that criteria disqualifies me, but didn’t stop me from checking out the options available to these larger fish. ImpactBase.org has a great listing of 446 impact funds that invest in particular areas. Investors here have to decide between:
- Risk-adjusted market returns (371 funds) or Below-market returns (83)
- Impact area: eg: Basic services, Environmental, Access to Finance, etc
- Asset class: Private Equity (288), Fixed Income (130), Real Assets (97) or others
- Geographic region
Most investment options here have minimum investment requirements with 5 or 6 zeros. Consider the ThirdWay Africa Impact Fund, seeking to raise 150M towards funding the creation of self sustaining businesses in African communities. The minimum buy-in is $2M, and the average investor has put in $15M. This fund targets the same rate of return as similar-risk assets in the market.
Small Fish Investment Options
Let’s ignore the big kids for a minute. What kind of investments are available to someone who isn’t a millionaire?
A quick google search reveals many public funds for ‘social responsibility’. You can invest in companies or funds with lower than average carbon emissions, good track records with human rights, or even only female CEOs. Many large financial institutions offer these products, including RBC, Wealthsimple, and Vanguard. The problem is, they aren’t impact investments. There isn't really a measurable social good created, just an assurance that they aren’t doing bad to the world.
For true impact investment options, I found two sources for Canadians:
1. The SVX Social Venture Connection, a stock market of sorts that lets you invest directly into Canadian companies with a social impact. This was created in 2013 by the MaRS Center for Impact Investing, the TSX (Toronto Stock Exchange), and the Canadian government among others. As of this writing, there are 3 options on it:
- A 5%, 5 year solar bond, putting renewable energy into the electrical grid
- A bond to start a social community in Guelph, ON
- World Tree, a company with a potential 23% annual return that offsets a lifetime carbon footprint with a $2,500 investment
2. OpenImpact, a website that lists impact investment options, but doesn’t help facilitate the investment. Of the 46 open investments, just 17 are open to retail investors (an average person). Of those options, none looked particularly enticing to me
I think it’s also worth mentioning that there is an impact investing consultancy in Toronto called GoodInvesting, that offers to help find the right impact investments for you (for a price). I’ve got a consultation with them next week to learn more.
An interesting investment option
I posted in an earlier thread about my current favourite option - World Tree. I think it is simply a very cool, impactful investment, offering a high enough return to find a niche in my portfolio.
World Tree plants acres of Empress Splendens (non-invasive trees of the Paulownia family) to sequester carbon and later sell the wood for a profit.
- Buy in is $2,500 per acre
- You see no return until the trees reach maturity and are harvested 10 years later
- The farmer keeps 50% of the profit, and you split the remaining profit with World Tree 50/50
- The trees regrow up to seven times, continuing to sequester carbon, provide sustainable lumber, and support farmers (they keep 100% of profits after the first harvest)
- I’ve calculated the return to be 23% based of a $3/board foot lumber price. The current price is about $7, and the trend is rising
- This is a risky investment with no proven business model, no existing North American market for the wood, and one could totally lose their entire investment. Discount the expected value accordingly
However, from an ecological perspective, it seems very promising too:
- Average carbon offset programs cost about $10/tonne of CO2 removed
- Cool Earth is one of the best programs, and was estimated to operate at $1.34/tonne5
- World Tree appears to operate at $1.76/tonne - this is using numbers from their website
- One acre of 140 trees should sequester enough carbon to offset one’s lifetime carbon footprint
Disclaimer: I’m not recommending this as an investment, but if it is legit, it seems like a very interesting model for impact investing.
I’d love to see a world with lots of high impact investment options, accessible by the masses. When comparing the current offering of impact investments against some of the best charities, they seem to fall short. But when comparing them against current financial options, there are more than a few that look like worthy additions to a portfolio. This brings me back to the initial question of donate now or invest now, donate later. What do you think?
Please share your thoughts in the comments - especially if you found some cool investments, or are interested in investing in general!
- GIIN: https://thegiin.org/impact-investing/need-to-know/#what-is-impact-investing
- GIIN 2017 Annual Survey:. https://thegiin.org/assets/2017%20Survey%201%20Pager.pdf
- Giving What We Can on CoolEarth: https://www.givingwhatwecan.org/report/cool-earth/