Finding Impact on the Efficient Frontier

Finding Impact on the Efficient Frontier
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Let me explain the title first, starting with a general historical definition of the words: "Impact on the Efficient Frontier," to specific current usage: I mean the current buzzwords for all kinds of purposeful money practices, which boil down to: "impact investing."

Originally impact (impingere) was the measure of a hit, but when technology (think steam engines and smokestacks over sweatshops) was seriously impinging on human life it took on a more philosophical meaning: the deeper affect, the impact on the human soul; and later as humanity woke up more: the impact on the environment (e.g. the measurable carbon footprint).

What about the word "efficient?" The Latin verb "efficere" just seems to have meant getting something done period. As consciousness advanced we added a judgment on the deed: measuring the least time, money, and/or resources wasted in the doing.

We think of the "frontier" as the wild border or no man's land between two countries. But oddly enough, in terms of financial models it is not the most dangerous place to be but the most efficient! It defines the border between too little risk to accomplish (efficere) your financial goals, and more risk than you need to take to get the job done.

The question I am posing is this: can an investor invest efficiently (on that efficient frontier) while considering the affect of the investments? Or, put another way: is there a neutral to positive correlation between the human and environmental impact of an investment and the financial risk/return?

The answer would be yes if the manager/investor manages all the other factors well. The answer will be a resounding YES! when investors wake up and recognize that companies who waste resources, degrade the environment and exploit humanity are unlikely to be as successful with customers in the long run ( a good place to see how companies compare is

Economists standing behind Milton Friedman and the former Fed Chair, Alan Greenspan, would have been stacked strongly on the No side. But this is changing (see ) as regular people recognize that companies cannot forget about their impact on society and the environment without paying a price, and economists are noticing that short term focused incentives are not good for anyone but the 1% .

The knee jerk reaction to this is to get mad and call for an end to shareholder capitalism: capitalism that favors the shareholders above all other stakeholders. This is understandable, but I would like to propose a both/and solution, a hybrid that maintains the interests of investors alongside the other stakeholders (employees, community, environment, customers etc.). After all, happy employees and consumers should result in successful businesses. It sounds so old-fashioned but it is true. We just lost sight of it because of the naïve conviction that the leaders of big corporations knew how to run businesses.

Now, Slow Money and Patient Capital are important concepts in the Impact World, implying that trading is for greedy guts, who don't get it, and we should rather own what is good long term and stick with it. My perspective is exactly the same in terms of private investments that need long term care.

However, for public markets there needs to be a different way to put this long term philosophy into practice. In public markets our goal is simply to support the true value of firms that are benefiting society and the environment. Our long term approach is to maintain a universe of positive companies on our research site: ( ) and continually monitor their prices. If any of them lose value in an unwarranted way we want to own them and support their reversion to a proper price. Similarly if they are suddenly overvalued we expect a reversion and want to benefit our investors by taking some profits. They remain on our watch-list long term but our job is to lead the positive impact market by continually shepherding each position toward a price that is true.

By comparing the aggregated ratings on CSRHub with stock performance, we believe a pattern will emerge where the highest Environmental/Social/Governance ratings will show superior risk/return profiles. This is supported by data from Trust Across America (see ) and HIP investor ratings (see, ). Positive impact is already showing itself to be a factor in finding the "efficient frontier."

When I decided to leave the big banks and develop solutions for impact investors in 2007, I had clear goals in the front of my mind: How can we use smart tools learned from traditional investing but applied now to a new universe of impact investments? Can we create a combination of investments that works as an efficient frontier: getting the desired performance efficiently without too much risk and with the highest possible standards for desired impact on society and the environment. The more investors and companies wake up to the unsustainable nature of the current shareholder capitalism that plays recklessly with our future, the easier it will become for impact managers to succeed at finding impact on the efficient frontier.

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