This is an excerpt from Knowledge@Wharton
Demand for sustainable impact investments has grown exponentially over the past decade. Morgan Stanley reports in 2017 that 75% of individual investors were interested in an ESG (Environmental, Social and Governance) approach, and among these investors, 84% of women and 86% of millennials are leading this demand. The Forum for Sustainable and Responsible Investment and Global Sustainable Investing Alliance reported sustainable investing assets reached nearly $12 trillion in 2018 in the U.S., and $30 trillion globally.
“It’s no longer a fad. Everyone wants to do this,” said Durreen Shahnaz, founder and CEO of Singapore-based Impact Investment Exchange, or IIX, a social stock exchange and the world’s largest impact investment private placement platform. Investors are realizing that caring for the environment, or gender equity or social justice actually informs sound investment strategies and helps reduce risks, according to Audrey Choi, who is the chief sustainability officer and chief marketing officer at Morgan Stanley. Choi is also the CEO of Morgan Stanley’s Institute for Sustainable Investing, which seeks to scale solutions to address global challenges through private capital.
Choi and Shahnaz discussed how impact investing has evolved over the past decade in a recent podcast for the second season of the Knowledge@Wharton and IIX podcast series, “From Backstreet to Wall Street,” which focuses on “Women, Peace and Parity.” The series explores how innovators and entrepreneurs could build peace in a new way by addressing the root causes of inequality, and, in the process, make women’s empowerment a priority. (Listen to the podcast above; you can find the rest of the series here.)
Shahnaz stressed that the role of women in sustainable investing is crucial to the theme of women, peace and parity. Of the global investment in assets of roughly $70 trillion, only 1.3% is managed by women, and much less by women of color, she said.
That setting clearly offers huge opportunities for women to participate more in finance and investment. Women, especially those in the millennial generation, are key market drivers in global sustainable investment, Shahnaz noted. “Women across the world are set to inherit, it is said, close to $29 trillion of intergenerational wealth over the next 40 years,” she pointed out. As the first generation of millennials turn 40, they will be in the prime age of spending and investing, she added.
However, women actually invest 40% less than men do, and they are likely to defer investment decisions more to their spouses, if they’re married, Shahnaz continued. “That trend is even more so, shockingly, for millennial women, whom you would think were more empowered than our generation.”
Although big-bracket firms such as Morgan Stanley and private equity firms are entering the sustainable investing space, the shortage of suitable investment products is a limitation, said Shahnaz.
Shahnaz also raised concerns relating to other barriers: “While women are not big participants in the financial markets, they are not participating sufficiently even when they have the opportunities – what does that mean? What is the actual impact on the ground of sustainable investing? How is it different from traditional investment products in terms of its deep impact? … Why is not more happening in terms of encouraging and creating new investment products, and finding ways to take on the risk associated with those?”
“For a large amount of capital to be moved, you do need these big banks to be coming in and having more and more of a role [in sustainable investing].” –Durreen Shahnaz
The Sustainable Investing Spectrum
According to Shahnaz, Choi’s role at Morgan Stanley is precisely the kind of stimulus the sustainable investing space needs. “For a large amount of capital to be moved, you do need these big banks to be coming in and having more and more of a role [in sustainable investing],” she said.
Shahnaz noted that such investing has moved from “negative screening” in terms of shunning guns or alcohol to those framed around ESG goals, and then on to impact investing “with deep impact.”
At IIX, Shahnaz sought to stimulate such investing at the individual level with innovative financial products. Typically, individuals make one or two small investments and then wait to see the return on them, whereas “it takes a while for these to realize,” she noted. “As investors want to have more liquidity, and they want to invest larger amounts [in impact investing], you need products for them to do that.”
In 2017, IIX launched its Women’s Livelihood Bonds, which finance investments in enterprises that create livelihoods for low-income women in South and Southeast Asia. IIX raised $8 million in the first round, which is helping 385,000 women entrepreneurs in Southeast Asia. It is currently seeking to raise $100 million in the second edition of those bonds.
In Step with the Broader Capital Market
“One of the things that Morgan Stanley has focused on over the last 10 years is, how do we bring sustainability issues – environment issues, social issues, good governance issues – into the mainstream markets?” said Choi. It helped that the sustainable investing space already had access to “philanthropic capital, catalytic capital or blended capital, and specialized vehicles that find ways to harness capital market-type structures to achieve high impact,” she added.
In addition to those, there was a need to bring private sector capital “not just into the deep impact areas, but to bring impact into mainstream capital markets,” Choi said. That was the thinking behind Morgan Stanley’s efforts to integrate such capital into core financial products. “We’ve been focusing on the areas where you can achieve the kinds of returns and risk profiles that are consistent with traditional financial expectations and markets, while also driving sustainability,” said Choi.
Comparable Returns, Lower Risks
Morgan Stanley’s research and analysis over the past decade has found that compared to traditional investment products, “sustainable investments essentially have the same return profile, with significantly less volatility,” said Choi. Those findings are contained in a study it recently released of 11,000 different investment strategies, comparing sustainable investments to traditional ones.
“It’s part of the reason why more and more assets have been coming into sustainable investing,” she continued. “Investors have started to realize that caring about the environment, thinking about social justice, gender equity and other issues around social impact can actually help your investment strategy. They can help you be aware of risks and opportunities earlier, and make sound investments.”
“Investors have started to realize that caring about the environment, thinking about social justice, gender equity and other issues around social impact can actually help your investment strategy.” –Audrey Choi
Drawing from that, such investors want to focus on companies and investment strategies “that do think deeply and with rigor around environmental and social concerns,” Choi continued. “[Alongside], we want to make sure that we’re not supporting or not investing in various trends or industries that we don’t believe in, and that we don’t want our capital to support.”
Not all the investing that goes under the guise of impact investing is actually so – a practice Shahnaz called “impact washing.” She noted that some funds that claim to do impact investing are actually making emerging-market investments, which have been around for many years, she said. “You cannot call emerging-market investment impact investing,” she added. “It’s about thinking about that 99% of the world’s population who are left out from the financial markets. Investing in a hospital in Bangladesh doesn’t make it impact investing. Is that hospital [focusing on] the rural poor, and getting them the health care that they need?”
According to Shahnaz, it is important for funds to clearly define their goals and measure the outcomes to remove such ambiguities. Choi agreed that the sustainable investing and impact investing community must be rigorous in both the clarity on the financial expectations and returns of different strategies, and the impact achieved.
“Just because you’re adding the word ‘impact’ or ‘sustainability’ into the sentence, it’s not some magic Dumbo’s feather that should make you suspend disbelief, and suspend all of the regular things that you would do to kick the tires on any investment or grant, or other strategic initiative that you would be taking on,” Choi said. “You have to be incredibly clear as to why you’re investing, and what kind of capital you’re investing.”
Choi saw the impact washing phenomenon as a wake-up call for the impact investing industry. “This is a critical moment for the industry, where we and the whole investment community have to hold ourselves to very high standards for the clarity, the disclosure and the rigor around both the financial proposition that any investment is offering, and the impact proposition that investment is offering, and helping align the right investors with the right tools.” She also urged impact investing participants “to focus on vocabulary.” She noted that “ESG investing, sustainable investing and impact investing are not all the same things” but are often used interchangeably in conversations.
A Decade’s Worth of Takeaways
Choi described the philosophies that guided Morgan Stanley when it created its Global Sustainable Finance Group 10 years ago. It began by understanding the “comparative advantage” it could bring to those investments, and where it could make the most contribution.
“We’re self-aware that we’re not a philanthropy,” Choi said. “We’re not a mission-driven investor that is just controlling our own capital. We’re a large financial services institution, and where we felt that we can make the biggest contribution to the field is by focusing on the skills that Morgan Stanley has, which is helping match capital with sources of capital and uses of capital.”
In other words, it aims to combine the goals of sustainability and impact with the way it focuses on capital markets, and in “helping investors find the right investments,” Choi explained. Those principles shaped the creation of its ‘Investing With Impact’ platform, she added.
Today, one dollar of every $4 under professional management is focused on sustainability or ESG investing, compared to one dollar out of every $10 a decade ago, said Choi. She recalled that a decade ago, the conversation about impact investing was predominantly about private equity investments that only were accessible to a few, very high-net-worth individuals, or mission-driven institutions.
“Investing in a hospital in Bangladesh doesn’t make it impact investing. Is that hospital [focusing on] the rural poor, and getting them the health care that they need?” –Durreen Shahnaz
Morgan Stanley wanted to “democratize” such investing, she said, and in 2013, it set up its Institute for Sustainable Investing. It surpassed its initial goal of committing $10 billion in sustainable investing within five years with more than $25 billion of assets under management in sustainability at the five-year mark, she added. Also, over the past decade it has lowered the initial investment requirement for investors from between $400,000 and $600,000 (for two products) to $5,000.
In her journey over the past two decades, Shahnaz realized that women entrepreneurs are likely to be less successful than men in raising capital for their ventures. She related such a tale from her first venture in handmade goods in New York, where Silicon Valley venture capital firms showed little interest. “It is very hard to go out there as an entrepreneur and to be saying you’re going to have a sustainable business, which is doing good, but you’ll make money for the investor,” she said. “It is doubly hard when you’re a woman. And it’s three times harder when you’re a woman of color.”
Shahnaz was wiser when she launched IIX 10 years ago. She decided to stay in the background as IIX went about its pitches. “I had Caucasian men, Indian men and Chinese men fronting me so that they would be talking to the investors,” she said. “So, immediately, a huge risk factor would go down. If an Indian man is talking to an Indian investor, all of a sudden the risk factor goes down. And if a Caucasian man is talking to an Asian investor, the risk factor goes down.”
Shahnaz admitted that although that decision to stay in the background was “a positive one,” it was “a hard thing to do.” But it made sense to her when she realized that it was not about her being the entrepreneur. “It is about changing a system. And it’s about bringing millions of people, and women, into a system which they’re barred from. If that means I have to stay back and get them in front, I will do it.”
Today, IIX has “many stakeholders and well-wishers,” and in addition to its Women’s Livelihood Bonds, it has the largest equity crowdfunding platform in the world for impact investing, she said.
Challenges Ahead — and Hope
Going forward, in order to create more pathways to connect the back streets of underserved communities with the Wall Streets of the world, Shahnaz saw a need “to bring everyone together, from bankers to lawyers to philanthropists to investors, governments and businesses.”
Choi pointed out that several years ago, Morgan Stanley had founded its Multicultural Innovation Lab, “specifically to focus on the fact that we felt that there are entrepreneurs of color or women entrepreneurs who aren’t getting the same access to capital.” Its Innovation Lab enables entrepreneurs of color and women entrepreneurs to spend some time in residence with Morgan Stanley every year, where they get advice from Morgan Stanley experts and others in its network – and also make investments in them, she said.
Choi is optimistic about the future for sustainable investing in part because of “the inputs and excitement of the next generation.” She noted that over the past six years, Morgan Stanley has had a partnership with Kellogg School of Management for a Sustainable Investing Challenge, where graduate students around the world are invited to submit their best ideas “for a financial product to be scalable, to ultimately grow up to be a real capital markets instrument that aims to be profitable.”
Choi captured the spirit of the students who participate in the Sustainable Investing Challenge by recalling conversations with them. “When we say ‘Wow, this is so exciting. Why were you interested in doing something that combined finance and impact in this way?’ So often, they look at us almost befuddled and say, ‘Well, why would you not?’”
The next generation wants to integrate sustainability into its investment decisions, she said. “They expect to have sustainability options in their retirement plans that their employers offer them. They are three times more likely to choose their employer based on sustainability. They’re twice as likely to choose products based on sustainability. And they’re also twice as likely to boycott product, companies or investment strategies that don’t think about sustainability.”