00:00:01
hello I'm Katherine Klein I'm the vice dean for social impact here at Wharton
00:00:05
and a professor of management and I'm delighted today to be speaking with my
00:00:09
colleague David Musto professor David Musto chair of the Wharton finance department and we're going to be talking
00:00:15
about David's most recent research with several colleagues on impact investing
00:00:19
so David thanks for joining us it's great to be here thank you and so you have recently not yet published but put
00:00:27
out of paper contracts with benefits contracts with benefits the implementation of impact investing
00:00:33
research you've done with just jeffers chriskate C and Ann Tucker so we want to
00:00:41
dig into the findings and what you focused on but first let's start with impact investing what's impact investing
00:00:48
all right well impact investing is a term that's gained a lot of currency recently the term itself doesn't go back
00:00:55
that far it's usually sourced to about 2007 but it was referring to a practice which had
00:01:03
grown significantly to that point and you'll hear different definitions but the definition that I think works best
00:01:13
for our research is that impact investing is investing with with profits in mind certainly but also some other
00:01:23
social benefits some other social purpose in mind too so you could think of it as as to bottom-line so it's not
00:01:29
just what we're going to want to make money but let's make the world a better
00:01:32
place it's you have two very specific bottom lines making money and something and
00:01:38
something well-defined that you're also pursuing as a social benefit and you're
00:01:42
doing both at once got it and so as a finance professor what's intrigued you about this topic what is
00:01:49
captivated your interest well if you look at financial research and economic research in general there's a lot of
00:01:59
research on managing other people's money to make more money right that that's a fundamental activity in the
00:02:07
economy all of us have some of our money being managed by someone else and what do we think they're going to do with it
00:02:13
well they make more money and that's perfectly fine thing to do there's a lot of virtue
00:02:21
in that but if you think about laying on another goal on top of that not just we're gonna deliver money but either
00:02:31
something very specific other goal in mind then that really changes the relationship in a number of ways and
00:02:40
it's given the the growth and impact investing just how much money is now devoted to funds pursuing this that we
00:02:47
it's time to take a look it's time to take a look at how how do people try to
00:02:55
structure these contracts to pursue more than one goal at a time and then also what happens and as you think about the
00:03:04
pursuit of these two goals of a social goal or social or environmental goal and a profit goal do you is your hypothesis
00:03:12
that they are negatively related that they're positively related that it depends and it's you know and there's no
00:03:19
relationship that's you know not a not a clear positive or a clear negative well
00:03:24
the initial intuition would be if I'm a fund manager and I'm looking at all the
00:03:31
ways I can invest your money there's many different ways and then if I trim that down by any method at all including
00:03:45
which of these different ways of investing from for-profit also serve some other goal well i've i have shrunk
00:03:55
my investment opportunity set you could call it and the best opportunity and that shrunken set is is not going to be
00:04:04
better than the best opportunity in the full set right whether it's worse well it could be just
00:04:10
logically because you've sliced away part of what you could have done so the initial intuition would be you
00:04:18
have you have implemented a trade-off there's a trade-off involved here right
00:04:23
you gave up some possibilities because it's important to you to serve to serve this additional goal and you
00:04:33
said that's the initial intuition does that mean this is up for investigation
00:04:38
and we're not clear well yeah it's certainly open question what actually what actually happens
00:04:46
right what actually happens to your to your pursuit of profit when you add these additional goals when you when you
00:04:53
limit what you're willing to do so yeah that's that's an open question and it's
00:05:04
also possible of course that by picking a an investment that serves a particular
00:05:13
social purpose goal this could turn out to be ex post the more you know financially profitable thing to do given
00:05:21
changes in society changes in regulation that that sort of differ the the outcomes of pride of projects in the
00:05:31
future so there's been a little research and let's we'll talk about that before
00:05:35
we get to contracts with benefit there's been a little research thing you've been
00:05:37
involved with I know probably but some of the wording social impact team to look at the you know how good is the
00:05:45
financial performance of these impact investing funds tell us a little bit about what you've found in that research
00:05:50
right so this is a project where with the social impact initiative we developed a database of funds that
00:05:59
self-identify as impact funds and so just remember the whole structure of investing right you have the fund that
00:06:08
has investors in the fund that could be pension funds wealthy individuals endowments and so on and then the funds
00:06:15
themselves invest out the money in portfolio companies so we have the we have the invest we have the data from
00:06:27
the funds they provided to us the data on their investment out in portfolio companies and we could see the money
00:06:35
going out and you can see money coming back in and you can also see the appraisals of the companies that are
00:06:44
still in process right and so you need all those things you need money going out money coming in and value of what's
00:06:50
still there as a sort of an ongoing investment and putting it all together we asked the question well okay I can
00:07:00
see now what is being made investing out in these portfolio companies by impact funds let's write a
00:07:09
thought experiment where you're not investing out in those those impact companies you are investing in just you
00:07:15
know small stock something like that so it's something that's that's like that
00:07:19
in some way except you know it's just some benchmark easily-accessible Paris
00:07:28
investments doing relative to something yeah thought experiment where it's actually a feasible other thing you
00:07:33
could have done with your money and something that's in some ways similar and we ran that thought experiment and
00:07:38
what do we come up with well it's about the same right I mean we we do some statistical tests involved and we give
00:07:46
the details of that but the bottom line of it was about the same so you're not
00:07:52
seeing well you're doing gangbusters here you're making huge amount more than
00:07:55
whatever it was about the same right so right and so this was this was important
00:08:00
news for the field when it's reported the way in which we call great expectations came out because it was
00:08:05
some indication of it right yeah you know about that shrinkage that you serve associate with with eliminating things
00:08:12
that are not socially beneficial or maybe socially harmful and so you know about that and so okay so what's
00:08:18
happened here financial returns it's we're not we're not seeing we're not
00:08:23
seeing a degradation right right and this was looking specifically at private equity funds right that seems important
00:08:30
this is all private investment yeah these guys are these are startups yeah some of them are very big is that some
00:08:36
of these are ten employees in the portfolio company I think they got up to like 10,000 employees so they weren't
00:08:43
all tiny they're just not publicly that's right yeah that's right okay so
00:08:48
I'm you've now gone on to do new research as we're describing contract
00:08:53
benefits what was the focus of that research well okay so one thing to point out is it's that same database bigger
00:09:00
and better now yes yeah it's grown we get more more funds sharing their data
00:09:07
and partly you know they they were interested in the original research and and we presented around and and and our
00:09:14
partners helped us compile a bigger and bigger database but the point is that the database has not only that cash in
00:09:22
cash out and you know audited financials and that kind of thing it also has the contracts remember there's a contract
00:09:29
under the contracts between the fund and the portfolio company and there's also
00:09:34
the contract between the fund and its investors right you have contracts go in both directions and so this allows us to
00:09:42
see how do people as our title said implement impact investing right how do you we know how people have have learned
00:09:52
to write contracts just in the the general solving the general problem of delegated money management which is
00:09:58
which is already a complicated management and people only have to look at the newspaper to see how things can
00:10:03
blow up and that arranged in that arena and how the contract can be very important so those are that that's a
00:10:09
complex contracting environment with a long history and the question is okay this is this is taking that and adding
00:10:17
something more it's adding your investors want to see want to see not just profits but impact and then the
00:10:26
fund itself investing out in the company they also want to see not just profits but impact and of course the funds want
00:10:33
to make sure the investors want to make sure that the funds make sure right so everyone is so so so you have a sort of
00:10:43
multiplied the issues that could arise you might think well these are these are well-meaning people you don't really
00:10:51
need a contract to tell them what to do well you know a just you know once again
00:10:56
look at the newspaper to see all the times that supposedly well meeting people veered off the path that that there that
00:11:05
there you know beneficiaries thought they were supposed to stay on so so so it so it is a
00:11:12
interesting legal question what do what happens and what happens to contracting so we so we took those contracts from
00:11:22
the same database and we engaged a team of law students right so this is not just the Wharton School now but also law
00:11:31
students from from Penn's Law School who had to essentially code this other word
00:11:37
you're reading the contract and and you're seeing these terms you know terms
00:11:41
tend to be kind of boilerplate content it got one contract to the next you you use a term of your done if you use it
00:11:46
you it's probably word of this similarly one to the other so you can kind of start coding up a
00:11:50
contract they have they have a and B but they don't have C and D has this other
00:11:55
little thing going on and so you can code it up that way and then you can start asking some quantitative questions
00:12:02
about what is ultimately a textual and so the question the key question here is do these contracts how do the contracts
00:12:12
written by impact investing funds and signed look different from those in more traditional funds how do they deal with
00:12:20
the fact that there are these twin goals of impact and financial performance well
00:12:24
the main thing we see and maybe this isn't an enormous surprise but it was it
00:12:30
was interesting to see how see it play out in real life was the the direct role of impact in in the operation of the
00:12:42
funds mandated by the contracts so you know the fund will have a diligence process I think think of how a VC fund
00:12:55
operates they take pitches from easily ten thousand different startups ten thousand and so you have this gigantic
00:13:05
order flow you have to distill down to the you know ten or twenty companies who actually invest in and
00:13:15
this is this is going to be mediated by different committees invest in communities diligence committees and all
00:13:22
and you you build in you can see the contracts would build in impact assessments into the into the process by
00:13:34
which your you make it or you don't make it in in that filtering process so that's a screening process it would not
00:13:41
hurt it would not occur or screen that would not occur in a traditional PE fund right and then yeah absolutely and then
00:13:48
you also see more more governance by the fund in the portfolio companies more presence on the board I mean generally
00:14:02
you're gonna see some appetite for presence on the board if I'm investing
00:14:06
at a start-up I want to have more more say over what happens but but there's
00:14:11
even more that so it sounds like the key differences you're finding are but when
00:14:15
you compare these contracts to the contracts and more traditional funds is first of all you actually see impact
00:14:21
written into these contracts and second of all you're seeing as you said more
00:14:25
governments more attention to we're going to take a seat on the board of the
00:14:29
portfolio company for example is that is that those are key findings yeah so you
00:14:35
see that you know as we refer to that in the paper as operationalized impact right you know that this is sort of just
00:14:45
guaranteeing that it ends up being part of the process and so is your view that this is a this sort of counteracts
00:14:52
window-dressing it means that as an investor you can actually be confident that no no we're taking impact seriously
00:14:59
as we're selecting portfolio companies it's not just right you are getting
00:15:05
schpeel that's not accurate right no I would agree that that it's it's a fundamental part of the contract
00:15:11
and you know just one way to think about contracting is that you know defines which you can get sued over right and so
00:15:20
if I say that impact has to be part of the diligence process you might think well anyone can sort of wave their hands
00:15:26
at that you know oh yeah we thought about we thought about impact but you know only
00:15:33
1% of the companies make it so you know well know if you if if if we don't see
00:15:39
the paper trail of how exactly impact assessment entered into the choice of these of these funds of these companies
00:15:48
and why you chose those not others you know look we hired you for a job and you didn't do it right and that would be bad
00:15:56
and did you see differences between the funds impact funds that are you know that are most focused on profits yes
00:16:06
we're absolutely trying to get market rate returns and those which might be more comfortable with concessionary
00:16:12
returns is that an important distinction among impact investing funds with implications for how they contract yeah
00:16:18
well it's just most directly of course the compensation structure yeah will will alter a little bit in in those
00:16:28
situations right the compensation structure will will be targeted towards a potentially lower threshold of
00:16:36
expectations of profits if in those funds that are that are seeking concession returns so that means that
00:16:47
the the way that the folks who are working there the analysts the general partners are getting compensated is
00:16:54
going to be less tied to profit is that what you're saying yeah well so so essentially the the performance fee part
00:17:06
of it will kick in potentially at at a lower number and then in terms of the this impact operational operationalizing
00:17:18
impact do these funds differ this way or there are contracts more focused on impact in concessionary funds or you
00:17:27
know do they actually pay less attention to it it's building that into the contract
00:17:31
well I say that in that case we didn't see a whole lot of statistically significant difference there's some
00:17:39
suggestive things but I think this is where I don't want to go too far in the
00:17:42
limb of course we're always hoping to build out our database and get more and
00:17:46
more more and more documents - to help strengthen our sample size it's probably
00:17:56
a good time to mention that we are always at the Wharton social impact initiative and you know in collaboration
00:18:01
with you and others really eager to continue to build out our funds so if there are impact investing fund managers
00:18:07
listening to or ultimately reading a transcript of this interview we want your data to it reach out to us well yes
00:18:12
it's certainly for publishing in any economics journal in the academic environment people want to see you got a
00:18:23
representative sample not representative in all the ways you can come up with and
00:18:29
then of course big enough that your statistical tests have have the power to to draw a distinction so going back to
00:18:36
your findings what do you think are the implications that you've you know at the
00:18:40
highest level what have you learned from this research from this from analyzing all these contracts what do you think we
00:18:46
learn from this research I think that the main the highest level punch line would be that I think I think you put
00:18:56
you put it well there about this question of window dressing and you can imagine a pension fund or some other
00:19:05
investor saying investing in a fund that that identifies as an impact fund say well look what we did you know we're
00:19:15
making the world a better place well you know what what's really happened here I
00:19:20
think you need to look very closely at what and what they really legally agreed to to to draw any conclusions about what
00:19:31
the pension fund has really done by investing your money this way and now that we see if you break open these
00:19:38
contracts that in fact there is a lot of commitment to the social benefit in these in this contracting environment
00:19:47
it's showing us that this is is more than just optics got it yeah that's an
00:19:55
important finding to be sure what do you think are the the most important questions for researchers to study you
00:20:04
know impact investing is a new field getting the data together is difficult it's part of the reason we've been
00:20:09
working on this so much what are the important questions for researchers in your field or maybe other fields to
00:20:16
tackle as impact investing grows and importance well certainly one thing we want to address is the success towards
00:20:26
the non financial goals right I mentioned the previous research well that was all about the financial goals
00:20:34
yeah and as we said well that's half the other half is course gonna be company
00:20:42
specific the goal is going to vary you know funds have different sorts of goals and within the fund the companies invest
00:20:49
out into have different goals that they would they would typically commit themselves to performance their key
00:20:59
performance indicators are going to reference a benchmark that they can be measured against well okay so that's
00:21:09
that would seem to be the other shoe here right you know get those benchmarks look look at their performance how do
00:21:16
they do you know how what kind of success are they having toward towards these goals yeah yeah those are
00:21:25
important and big questions I think it's interesting to me as a professor of
00:21:29
management talking with you as a professor of Finance that I think this question of how do companies manage
00:21:34
these dual goals are they achieving these dual goals when is their trade-off when is it or not these are topics that
00:21:41
I think are interesting too you know academics across disciplines whether you're in management whether you're in
00:21:46
marketing whether you're in finance you know I think that's that's the the it's
00:21:52
just it's very interesting to see a common question attract so much attention from different researchers and
00:21:56
obviously important research still to be done to to really tackle that but it sounds like
00:22:02
so what we've seen from the research that you've done these these these two
00:22:06
papers one some encouraging news yeah you're probably making market rate returns or in investing that's what the
00:22:13
initial findings would say to the legal contracts are building an impact you can
00:22:20
you can have some confidence that impact is being taken seriously I think what you're saying is number three would
00:22:26
really like to know more about what does that impact actually look like yeah which is an important challenge an
00:22:32
important issue in the field of impact investing to be sure yeah absolutely I just say it because it varies so much
00:22:37
one company to the next how how can we make sort of aggregate statements about this we'll have to see I mean we want to
00:22:46
get the data take a look and report back to you great well thank you so much for
00:22:53
talking with me it's great to have you with us thank you well it's great to be here great thanks
00:22:59
for more insight from knowledge at Wharton please visit knowledge Wharton UPenn edu
00:23:08
[Music]