00:00:01
hello I'm Katherine Klein I'm the vice
00:00:03
dean for social impact here at Wharton
00:00:05
and a professor of management and I'm
00:00:07
delighted today to be speaking with my
00:00:09
colleague David Musto professor David
00:00:12
Musto chair of the Wharton finance
00:00:14
department and we're going to be talking
00:00:15
about David's most recent research with
00:00:17
several colleagues on impact investing
00:00:19
so David thanks for joining us it's
00:00:21
great to be here thank you and so you
00:00:23
have recently not yet published but put
00:00:27
out of paper contracts with benefits
00:00:30
contracts with benefits the
00:00:32
implementation of impact investing
00:00:33
research you've done with just jeffers
00:00:36
chriskate C and Ann Tucker so we want to
00:00:41
dig into the findings and what you
00:00:43
focused on but first let's start with
00:00:45
impact investing what's impact investing
00:00:48
all right well impact investing is a
00:00:51
term that's gained a lot of currency
00:00:52
recently the term itself doesn't go back
00:00:55
that far
00:00:57
it's usually sourced to about 2007 but
00:01:01
it was referring to a practice which had
00:01:03
grown significantly to that point and
00:01:07
you'll hear different definitions but
00:01:10
the definition that I think works best
00:01:13
for our research is that impact
00:01:17
investing is investing with with profits
00:01:19
in mind certainly but also some other
00:01:23
social benefits some other social
00:01:25
purpose in mind too so you could think
00:01:27
of it as as to bottom-line so it's not
00:01:29
just what we're going to want to make
00:01:30
money but let's make the world a better
00:01:32
place
00:01:33
it's you have two very specific bottom
00:01:36
lines making money and something and
00:01:38
something well-defined that you're also
00:01:39
pursuing as a social benefit and you're
00:01:42
doing both at once got it
00:01:44
and so as a finance professor what's
00:01:47
intrigued you about this topic what is
00:01:49
captivated your interest well if you
00:01:52
look at financial research and economic
00:01:57
research in general there's a lot of
00:01:59
research on managing other people's
00:02:03
money to make more money right that
00:02:05
that's a fundamental activity in the
00:02:07
economy all of us have some of our money
00:02:11
being managed by someone else and what
00:02:13
do we think they're going to do with it
00:02:13
well they
00:02:14
make more money and that's perfectly
00:02:18
fine thing to do there's a lot of virtue
00:02:21
in that but if you think about laying on
00:02:26
another goal on top of that not just
00:02:29
we're gonna deliver money but either
00:02:31
something very specific other goal in
00:02:33
mind then that really changes the
00:02:36
relationship in a number of ways and
00:02:40
it's given the the growth and impact
00:02:43
investing just how much money is now
00:02:45
devoted to funds pursuing this that we
00:02:47
it's time to take a look it's time to
00:02:50
take a look at how how do people try to
00:02:55
structure these contracts to pursue more
00:02:58
than one goal at a time and then also
00:03:00
what happens and as you think about the
00:03:04
pursuit of these two goals of a social
00:03:06
goal or social or environmental goal and
00:03:08
a profit goal do you is your hypothesis
00:03:12
that they are negatively related that
00:03:16
they're positively related that it
00:03:17
depends and it's you know and there's no
00:03:19
relationship that's you know not a not a
00:03:21
clear positive or a clear negative well
00:03:24
the initial intuition would be if I'm a
00:03:28
fund manager and I'm looking at all the
00:03:31
ways I can invest your money there's
00:03:35
many different ways and then if I trim
00:03:38
that down by any method at all including
00:03:45
which of these different ways of
00:03:48
investing from for-profit also serve
00:03:52
some other goal well i've i have shrunk
00:03:55
my investment opportunity set you could
00:03:58
call it and the best opportunity and
00:04:02
that shrunken set is is not going to be
00:04:04
better than the best opportunity in the
00:04:07
full set right
00:04:08
whether it's worse well it could be just
00:04:10
logically because you've sliced away
00:04:13
part of what you could have done
00:04:15
so the initial intuition would be you
00:04:18
have you have implemented a trade-off
00:04:22
there's a trade-off involved here right
00:04:23
you gave up some possibilities
00:04:26
because it's important to you to serve
00:04:30
to serve this additional goal and you
00:04:33
said that's the initial intuition does
00:04:34
that mean this is up for investigation
00:04:38
and we're not clear
00:04:39
well yeah it's certainly open question
00:04:42
what actually what actually happens
00:04:46
right what actually happens to your to
00:04:48
your pursuit of profit when you add
00:04:51
these additional goals when you when you
00:04:53
limit what you're willing to do so yeah
00:04:57
that's that's an open question and it's
00:05:04
also possible of course that by picking
00:05:07
a an investment that serves a particular
00:05:13
social purpose goal this could turn out
00:05:16
to be ex post the more you know
00:05:19
financially profitable thing to do given
00:05:21
changes in society changes in regulation
00:05:24
that that sort of differ the the
00:05:28
outcomes of pride of projects in the
00:05:31
future so there's been a little research
00:05:33
and let's we'll talk about that before
00:05:35
we get to contracts with benefit there's
00:05:36
been a little research thing you've been
00:05:37
involved with I know probably but some
00:05:40
of the wording social impact team to
00:05:42
look at the you know how good is the
00:05:45
financial performance of these impact
00:05:46
investing funds tell us a little bit
00:05:48
about what you've found in that research
00:05:50
right so this is a project where with
00:05:53
the social impact initiative we
00:05:55
developed a database of funds that
00:05:59
self-identify as impact funds and so
00:06:03
just remember the whole structure of
00:06:05
investing right you have the fund that
00:06:08
has investors in the fund that could be
00:06:10
pension funds wealthy individuals
00:06:13
endowments and so on and then the funds
00:06:15
themselves invest out the money in
00:06:18
portfolio companies so we have the we
00:06:24
have the invest we have the data from
00:06:27
the funds they provided to us the data
00:06:30
on their investment out in portfolio
00:06:32
companies and we could see the money
00:06:35
going out and you can see money coming
00:06:36
back in and you can also see
00:06:40
the appraisals of the companies that are
00:06:44
still in process right and so you need
00:06:47
all those things you need money going
00:06:48
out money coming in and value of what's
00:06:50
still there as a sort of an ongoing
00:06:53
investment and putting it all together
00:06:55
we asked the question well okay I can
00:07:00
see now what is being made
00:07:03
investing out in these portfolio
00:07:05
companies by impact funds let's write a
00:07:09
thought experiment where you're not
00:07:10
investing out in those those impact
00:07:14
companies you are investing in just you
00:07:15
know small stock something like that so
00:07:17
it's something that's that's like that
00:07:19
in some way except you know it's just
00:07:22
some benchmark easily-accessible Paris
00:07:28
investments doing relative to something
00:07:30
yeah thought experiment where it's
00:07:31
actually a feasible other thing you
00:07:33
could have done with your money and
00:07:34
something that's in some ways similar
00:07:36
and we ran that thought experiment and
00:07:38
what do we come up with well it's about
00:07:40
the same right I mean we we do some
00:07:43
statistical tests involved and we give
00:07:46
the details of that but the bottom line
00:07:49
of it was about the same so you're not
00:07:52
seeing well you're doing gangbusters
00:07:53
here you're making huge amount more than
00:07:55
whatever it was about the same right so
00:07:58
right and so this was this was important
00:08:00
news for the field when it's reported
00:08:02
the way in which we call great
00:08:03
expectations came out because it was
00:08:05
some indication of it right yeah you
00:08:06
know about that shrinkage that you serve
00:08:09
associate with with eliminating things
00:08:12
that are not socially beneficial or
00:08:14
maybe socially harmful and so you know
00:08:17
about that and so okay so what's
00:08:18
happened here financial returns it's
00:08:20
we're not we're not seeing we're not
00:08:23
seeing a degradation right right and
00:08:26
this was looking specifically at private
00:08:29
equity funds right that seems important
00:08:30
this is all private investment yeah
00:08:32
these guys are these are startups yeah
00:08:34
some of them are very big is that some
00:08:36
of these are ten employees in the
00:08:37
portfolio company I think they got up to
00:08:40
like 10,000 employees so they weren't
00:08:43
all tiny they're just not publicly
00:08:46
that's right yeah that's right okay so
00:08:48
I'm you've now gone on to do new
00:08:50
research as we're describing contract
00:08:53
benefits what was the focus of that
00:08:55
research well okay so one thing to point
00:08:56
out is it's that same database bigger
00:09:00
and better now yes yeah it's grown we
00:09:02
get more more funds sharing their data
00:09:07
and partly you know they they were
00:09:09
interested in the original research and
00:09:11
and we presented around and and and our
00:09:14
partners helped us compile a bigger and
00:09:17
bigger database but the point is that
00:09:19
the database has not only that cash in
00:09:22
cash out and you know audited financials
00:09:25
and that kind of thing it also has the
00:09:27
contracts remember there's a contract
00:09:29
under the contracts between the fund and
00:09:32
the portfolio company and there's also
00:09:34
the contract between the fund and its
00:09:36
investors right you have contracts go in
00:09:38
both directions and so this allows us to
00:09:42
see how do people as our title said
00:09:46
implement impact investing right how do
00:09:48
you we know how people have have learned
00:09:52
to write contracts just in the the
00:09:55
general solving the general problem of
00:09:57
delegated money management which is
00:09:58
which is already a complicated
00:10:00
management and people only have to look
00:10:02
at the newspaper to see how things can
00:10:03
blow up and that arranged in that arena
00:10:06
and how the contract can be very
00:10:07
important so those are that that's a
00:10:09
complex contracting environment with a
00:10:11
long history and the question is okay
00:10:14
this is this is taking that and adding
00:10:17
something more it's adding your
00:10:20
investors want to see want to see not
00:10:23
just profits but impact and then the
00:10:26
fund itself investing out in the company
00:10:28
they also want to see not just profits
00:10:31
but impact and of course the funds want
00:10:33
to make sure the investors want to make
00:10:35
sure that the funds make sure right so
00:10:37
everyone is so so so you have a sort of
00:10:43
multiplied the issues that could arise
00:10:46
you might think well these are these are
00:10:49
well-meaning people you don't really
00:10:51
need a contract to tell them what to do
00:10:53
well you know a just you know once again
00:10:56
look at the newspaper to see all the
00:10:58
times that supposedly well meeting
00:11:00
people
00:11:02
veered off the path that that there that
00:11:05
there you know
00:11:07
beneficiaries thought they were supposed
00:11:09
to stay on so so so it so it is a
00:11:12
interesting legal question what do what
00:11:17
happens and what happens to contracting
00:11:19
so we so we took those contracts from
00:11:22
the same database and we engaged a team
00:11:26
of law students right so this is not
00:11:29
just the Wharton School now but also law
00:11:31
students from from Penn's Law School who
00:11:34
had to essentially code this other word
00:11:37
you're reading the contract and and
00:11:39
you're seeing these terms you know terms
00:11:41
tend to be kind of boilerplate content
00:11:42
it got one contract to the next you you
00:11:45
use a term of your done if you use it
00:11:46
you it's probably word of this similarly
00:11:48
one to the other
00:11:49
so you can kind of start coding up a
00:11:50
contract they have they have a and B but
00:11:53
they don't have C and D has this other
00:11:55
little thing going on and so you can
00:11:58
code it up that way and then you can
00:11:59
start asking some quantitative questions
00:12:02
about what is ultimately a textual and
00:12:07
so the question the key question here is
00:12:09
do these contracts how do the contracts
00:12:12
written by impact investing funds and
00:12:16
signed look different from those in more
00:12:18
traditional funds how do they deal with
00:12:20
the fact that there are these twin goals
00:12:22
of impact and financial performance well
00:12:24
the main thing we see and maybe this
00:12:27
isn't an enormous surprise but it was it
00:12:30
was interesting to see how see it play
00:12:32
out in real life was the the direct role
00:12:37
of impact in in the operation of the
00:12:42
funds mandated by the contracts so you
00:12:46
know the fund will have a diligence
00:12:49
process I think think of how a VC fund
00:12:55
operates they take pitches from easily
00:12:59
ten thousand different startups ten
00:13:02
thousand and so you have this gigantic
00:13:05
order flow you have to distill down to
00:13:07
the you know ten or twenty companies who
00:13:11
actually invest in and
00:13:15
this is this is going to be mediated by
00:13:19
different committees invest in
00:13:21
communities diligence committees and all
00:13:22
and you you build in you can see the
00:13:24
contracts would build in impact
00:13:27
assessments into the into the process by
00:13:34
which your you make it or you don't make
00:13:37
it in in that filtering process so
00:13:40
that's a screening process it would not
00:13:41
hurt it would not occur or screen that
00:13:43
would not occur in a traditional PE fund
00:13:46
right and then yeah absolutely and then
00:13:48
you also see more more governance by the
00:13:55
fund in the portfolio companies more
00:13:59
presence on the board I mean generally
00:14:02
you're gonna see some appetite for
00:14:04
presence on the board if I'm investing
00:14:06
at a start-up I want to have more more
00:14:09
say over what happens but but there's
00:14:11
even more that so it sounds like the key
00:14:13
differences you're finding are but when
00:14:15
you compare these contracts to the
00:14:17
contracts and more traditional funds is
00:14:19
first of all you actually see impact
00:14:21
written into these contracts and second
00:14:24
of all you're seeing as you said more
00:14:25
governments more attention to we're
00:14:28
going to take a seat on the board of the
00:14:29
portfolio company for example is that is
00:14:32
that those are key findings yeah so you
00:14:35
see that you know as we refer to that in
00:14:38
the paper as operationalized impact
00:14:40
right you know that this is sort of just
00:14:45
guaranteeing that it ends up being part
00:14:47
of the process and so is your view that
00:14:49
this is a this sort of counteracts
00:14:52
window-dressing it means that as an
00:14:55
investor you can actually be confident
00:14:57
that no no we're taking impact seriously
00:14:59
as we're selecting portfolio companies
00:15:01
it's not just right you are getting
00:15:05
schpeel that's not accurate
00:15:06
right no I would agree that that it's
00:15:09
it's a fundamental part of the contract
00:15:11
and you know just one way to think about
00:15:15
contracting is that you know defines
00:15:17
which you can get sued over right and so
00:15:20
if I say that impact has to be part of
00:15:23
the diligence process you might think
00:15:25
well anyone can sort of wave their hands
00:15:26
at that
00:15:27
you know oh yeah we thought about we
00:15:29
thought about impact but you know only
00:15:33
1% of the companies make it so you know
00:15:35
well know if you if if if we don't see
00:15:39
the paper trail of how exactly impact
00:15:43
assessment entered into the choice of
00:15:47
these of these funds of these companies
00:15:48
and why you chose those not others you
00:15:51
know look we hired you for a job and you
00:15:53
didn't do it right and that would be bad
00:15:56
and did you see differences between the
00:16:00
funds impact funds that are you know
00:16:04
that are most focused on profits yes
00:16:06
we're absolutely trying to get market
00:16:07
rate returns and those which might be
00:16:10
more comfortable with concessionary
00:16:12
returns is that an important distinction
00:16:13
among impact investing funds with
00:16:15
implications for how they contract yeah
00:16:18
well it's just most directly of course
00:16:21
the compensation structure yeah will
00:16:26
will alter a little bit in in those
00:16:28
situations right the compensation
00:16:29
structure will will be targeted towards
00:16:34
a potentially lower threshold of
00:16:36
expectations of profits if in those
00:16:42
funds that are that are seeking
00:16:44
concession returns so that means that
00:16:47
the the way that the folks who are
00:16:50
working there the analysts the general
00:16:53
partners are getting compensated is
00:16:54
going to be less tied to profit is that
00:16:56
what you're saying yeah well so so
00:16:59
essentially the the performance fee part
00:17:06
of it will kick in potentially at at a
00:17:10
lower number and then in terms of the
00:17:14
this impact operational operationalizing
00:17:18
impact do these funds differ this way or
00:17:20
there are contracts more focused on
00:17:24
impact in concessionary funds or you
00:17:27
know do they actually pay less attention
00:17:28
to it
00:17:29
it's building that into the contract
00:17:31
well I say that in that case we didn't
00:17:34
see a whole lot of statistically
00:17:36
significant difference there's some
00:17:39
suggestive things but I think this is
00:17:40
where I don't want to go too far in the
00:17:42
limb of course we're always hoping to
00:17:44
build out our database and get more and
00:17:46
more more and more documents - to help
00:17:52
strengthen our sample size it's probably
00:17:56
a good time to mention that we are
00:17:57
always at the Wharton social impact
00:17:59
initiative and you know in collaboration
00:18:01
with you and others really eager to
00:18:02
continue to build out our funds so if
00:18:04
there are impact investing fund managers
00:18:07
listening to or ultimately reading a
00:18:09
transcript of this interview we want
00:18:11
your data to it reach out to us well yes
00:18:12
it's certainly for publishing in any
00:18:15
economics journal in the academic
00:18:20
environment people want to see you got a
00:18:23
representative sample not representative
00:18:26
in all the ways you can come up with and
00:18:29
then of course big enough that your
00:18:31
statistical tests have have the power to
00:18:33
to draw a distinction so going back to
00:18:36
your findings what do you think are the
00:18:38
implications that you've you know at the
00:18:40
highest level what have you learned from
00:18:42
this research from this from analyzing
00:18:44
all these contracts what do you think we
00:18:46
learn from this research I think that
00:18:48
the main the highest level punch line
00:18:51
would be that I think I think you put
00:18:56
you put it well there about this
00:18:58
question of window dressing and you can
00:19:00
imagine a pension fund or some other
00:19:05
investor saying investing in a fund that
00:19:10
that identifies as an impact fund say
00:19:13
well look what we did you know we're
00:19:15
making the world a better place well you
00:19:18
know what what's really happened here I
00:19:20
think you need to look very closely at
00:19:24
what and what they really legally agreed
00:19:26
to to to draw any conclusions about what
00:19:31
the pension fund has really done by
00:19:33
investing your money this way and now
00:19:36
that we see if you break open these
00:19:38
contracts that in fact there is a lot of
00:19:40
commitment to the social benefit
00:19:44
in these in this contracting environment
00:19:47
it's showing us that this is is more
00:19:50
than just optics got it yeah that's an
00:19:55
important finding to be sure what do you
00:19:58
think are the the most important
00:20:01
questions for researchers to study you
00:20:04
know impact investing is a new field
00:20:06
getting the data together is difficult
00:20:09
it's part of the reason we've been
00:20:09
working on this so much what are the
00:20:12
important questions for researchers in
00:20:13
your field or maybe other fields to
00:20:16
tackle as impact investing grows and
00:20:18
importance well certainly one thing we
00:20:20
want to address is the success towards
00:20:26
the non financial goals right I
00:20:28
mentioned the previous research well
00:20:31
that was all about the financial goals
00:20:34
yeah and as we said well that's half the
00:20:39
other half is course gonna be company
00:20:42
specific the goal is going to vary you
00:20:45
know funds have different sorts of goals
00:20:47
and within the fund the companies invest
00:20:49
out into have different goals that they
00:20:53
would they would typically commit
00:20:56
themselves to performance their key
00:20:59
performance indicators are going to
00:21:01
reference a benchmark that they can be
00:21:05
measured against well okay so that's
00:21:09
that would seem to be the other shoe
00:21:12
here right you know get those benchmarks
00:21:14
look look at their performance how do
00:21:16
they do you know how what kind of
00:21:19
success are they having toward towards
00:21:21
these goals yeah yeah those are
00:21:25
important and big questions I think it's
00:21:27
interesting to me as a professor of
00:21:29
management talking with you as a
00:21:30
professor of Finance that I think this
00:21:32
question of how do companies manage
00:21:34
these dual goals are they achieving
00:21:36
these dual goals when is their trade-off
00:21:38
when is it or not these are topics that
00:21:41
I think are interesting too you know
00:21:43
academics across disciplines whether
00:21:45
you're in management whether you're in
00:21:46
marketing whether you're in finance you
00:21:48
know I think that's that's the the it's
00:21:52
just it's very interesting to see a
00:21:53
common question attract so much
00:21:54
attention from different researchers and
00:21:56
obviously
00:21:57
important research still to be done to
00:21:59
to really tackle that but it sounds like
00:22:02
so what we've seen from the research
00:22:04
that you've done these these these two
00:22:06
papers one some encouraging news yeah
00:22:09
you're probably making market rate
00:22:10
returns or in investing that's what the
00:22:13
initial findings would say to the legal
00:22:18
contracts are building an impact you can
00:22:20
you can have some confidence that impact
00:22:22
is being taken seriously I think what
00:22:24
you're saying is number three would
00:22:26
really like to know more about what does
00:22:27
that impact actually look like yeah
00:22:29
which is an important challenge an
00:22:32
important issue in the field of impact
00:22:33
investing to be sure yeah absolutely I
00:22:35
just say it because it varies so much
00:22:37
one company to the next how how can we
00:22:41
make sort of aggregate statements about
00:22:44
this we'll have to see I mean we want to
00:22:46
get the data take a look and report back
00:22:51
to you great well thank you so much for
00:22:53
talking with me it's great to have you
00:22:54
with us thank you
00:22:55
well it's great to be here great thanks
00:22:59
for more insight from knowledge at
00:23:01
Wharton please visit knowledge Wharton
00:23:04
UPenn edu
00:23:08
[Music]
