Risk-Return-Impact: The New Driving Force
Do you want to have an impact on the world? To help change it for the better? You can by seizing your role in the “Impact Revolution.” In my last blog, I introduced you to this concept, and today, I’d like to start digging a little deeper.
The fact is, we cannot change the world by throwing more money at old concepts that no longer work. We need new concepts and approaches. I began to realize that we needed a system that aligned the interests of business, investors and entrepreneurs with those of government, non-profit organizations, philanthropists and impact enterprises. And it needed to be one that would drive them to work together to improve lives and the environment. But what could that look like?
The answer turned out to be very simple: social initiatives needed to be connected to investment, which would enable entrepreneurs to finance purpose-driven businesses and charitable organizations.
It would allow us to harness entrepreneurial talent and innovation to tackle old problems in new ways.
Just as tech entrepreneurs were able to bring about change with the help of investment capital, impact entrepreneurs can make progress in overcoming the most pressing issues of our time. When faced with huge social or environmental challenges, we must adjust our approach to investment in order to tackle them.
What Does Impact Mean?
New words are coined to capture new ideas, which is as true of economics as in the world of scientific discovery.
In 2007, at a meeting hosted by the Rockefeller Foundation at its Bellagio Center in Italy, “impact investing" was coined as a term to replace "social investment.” In its simplest terms, impact is the measure of an action’s benefit to people and the planet. It goes beyond minimizing harmful outcomes to actively creating good ones by creating positive impact. It has social and environmental dimensions.
“Social impact” refers to the improvement in the well-being of individuals and communities and the enhancement in their ability to lead productive lives.
It represents genuine social progress: educating the young, feeding the hungry, healing the sick, creating employment and providing livelihoods for the poor. “Environmental impact” is just what it sounds like—the positive consequences that business activity and investment have on our planet. Put simply, are we preserving the planet and passing it on to future generations, so they can benefit from it.
Impact needs to be brought to the heart of our society and take its place at the center of our economic system. Our current system encourages decisions based on how to make as much money as possible with the lowest level of risk. We need to shift to a system that encourages making as much money as possible but in a way that is consistent with achieving the highest impact and the lowest level of risk.
Impact must become ingrained in our society’s DNA, part of a triple helix of risk–return–impact that influences every decision we make regarding consumption, employment, business and investment. It needs to become a driving force of our economy.
When we follow this new model, the social and environmental benefits of our decisions become central to our thinking rather than a mere afterthought. But to channel this new way of thinking into social and environmental improvement, we need to be able to measure impact dependably.
Though we take the prevailing model of risk and return for granted, it wasn’t always the dominant model. Up until the twentieth century, business owners and investors only measured how much money they stood to make when deciding how to allocate capital. It wasn’t until the second half of the twentieth century that the measurement of “risk” was formally introduced and that it became natural to quantify risk and look at its relationship with return.
Risk is defined as the likelihood of adverse outcomes that could cost investors their money. It sounds like an indefinable concept, and it used to be considered unmeasurable, but the academic community eventually found ways to standardize its measurement across all forms of investment; by the end of the twentieth century, everyone was talking about and measuring it in the same way.
The measurement of risk has had profound implications for the investment community. It introduced new theories like portfolio diversification, which gave rise to new asset classes that came with a higher level of risk but also disproportionately improved returns. These new asset classes included venture capital, which funded the Tech Revolution, private equity and hedge funds. It also allowed new investment themes to take hold, like investment in emerging markets, which funded globalization.
If we fast-forward to the present day, we see that the same revolution that risk brought is now being brought by impact. Investments are increasingly examined for their positive and negative impact, and investors and businesses are becoming interested in factoring impact into their decision-making.
Is impact harder to measure than risk? Not at all—in fact, one can argue that it is easier. All over the world, people are developing methods to measure it. (I’ll share more about the importance of measuring impact in an upcoming blog next week.)
The Way Forward
Our system is more than two centuries old. Our problems have changed, and so too must our response. Our current economic system generates negative impact and relies on government and philanthropy to solve the problems it creates.
To tackle the scale and severity of the social and environmental issues we face, we must adjust our approach to investment and reshape our economic system. The shift to optimizing risk–return–impact, which is led by entrepreneurs and investors, will have a much-needed and transformative effect on the flow of capital in our economies.
Evidence of the Impact Revolution is already clear in the growing recognition among consumers, employees and investors that businesses have an obligation to serve not just their shareholders, but their customers, employees, communities and the environment; that impact needs to be a crucial part of everyone’s mission. We are at a point that is equivalent to the moment when the idea of risk gave rise to venture capital and investment in tech companies, but this time it is the idea of impact that is giving rise to impact investing and changing the world of investment.
This change is reflected in the over 2,600 investors from more than 70 countries who have signed up $90 trillion of assets to the Principles of Responsible Investment (PRIs), which encourage signatories to invest responsibly and create a more sustainable global financial system.
It is also reflected in the $31 trillion that is already invested in targeting environmental, social and governance improvement.
It is captured in the letter which Larry Fink, the CEO of Blackrock, the world’s largest asset manager, published in 2018 stating that “society is demanding that companies, both public and private, serve a social purpose” and that “to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”
This change can have hugely positive consequences for how we invest, how we do business and how we spend our money. It will shift our economies to deliver a transformative impact on billions of lives and the planet. The Impact Revolution brings risk–return–impact to the center of our decision-making to change our whole economic system. It leads all of us as employees, consumers, entrepreneurs, investors, businesses, philanthropists and governments to create tangible and measurable impact. To create the kind of world we want to live in we must shift impact to the center of our consciousness. And this shift starts with each one of us. Find out more—read IMPACT and become a part of the Impact Revolution.