UCLA Anderson Professor of Finance Bhagwan Chowdhry (@bhagwanUCLA), along with his co-author, Assistant Professor Shaun Davies (@LogicalShaun) of the Leeds School of Business at the University of Colorado, published today a piece in the Stanford Social Innovation Review titled “So You Want to Invest to Make Impact?” In their article, the pair distinguish between two types of “impact investors,” defined as investors who seek to achieve both a financial return and a measureable social impact. The authors opine that the two types of impact investors — FLIIs (free lunch impact investors) and PIIs (philanthropic impact investors) — have different agendas and should expect different results.
The article contains a thought experiment:
Suppose an investor has the opportunity to invest in a project that will earn him more than an appropriate return — the opportunity cost of his capital — given the project’s risks. Clearly, the investor will find the project attractive and will invest. If the project also produces a valuable social good, that’s icing on the cake.
These are exactly the types of investment opportunities that FLIIs are looking for—they earn a fair return, and the investment also produces social good. They pat themselves on the back for “doing good,” but there is nothing fundamentally meritorious about their actions. After all, they are not unlike other niche investors, who for example invest only in technology or in companies that start with the letter A. They have a strong affinity for investing in companies that are oriented toward a social goal, but they demand market returns. FLIIs are not willing to make any sacrifice (except perhaps some portfolio diversification) to further a social goal.
Now suppose an investor has the opportunity to invest in a different project, one that will not earn him the opportunity cost of his capital. From solely a profit-motivated perspective, the investment is not particularly attractive. But suppose that this project also produces social good valued by the investor and that the investor’s appreciation of that exceeds the financial losses. What can we say about these types of investments?
These investments are meant for PIIs, who understand and appreciate that furthering a social goal may come at the expense of maximizing profits. As such, PIIs are willing to forsake some financial gain if it means furthering a cause they believe is important.
Chowdhry and Davies conclude that distinguishing investor types serves an educational purpose. They suggest that FLIIs may genuinely desire to make an impact “even if it is costly,” and they require market returns “because they have been told to expect them.” “Consequently,” Chowdhry and Davies say, “the reach of their investments is falling short and preventing meaningful impact.” So, by making them aware of the tradeoff, it is expected that many would modify their investment strategies and move from the FLII category to the PII category.
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