Impact Investing: Risks and Opportunities

Alex Lazarow:

Frankly, I think the thing that's getting me most excited is that a lot of these high impact businesses are scaling and demonstrating that they are the ones that are valued most by investors, by customers, et cetera. But the biggest FinTech digital bank in the world is in Brazil. The biggest EdTech company in the world came from India. These are really targeting the mass market and they are becoming the global winners in some of these spaces. And so I think that's one of the reasons that the space is going to continue growing is because it's also demonstrating, do you do both? You can build highly impactful businesses that also become really great businesses.

Michael Torrance:

Welcome to Sustainability Leaders. I'm Michael Torrance, Chief Sustainability Officer with BMO Financial Group. On this show, we will talk with leading sustainability practitioners from the corporate, investor, academic and NGO communities to explore how this rapidly evolving field of sustainability is impacting global investment, business practices and our world.

Disclosure:

The views expressed here are those other participants and not those of Bank of Montreal, its affiliates or subsidiaries.

Maria Nsouli:

Hello, everyone. Welcome to this edition of the BMO Sustainability Leaders podcast. This is Maria Nsouli from the BMO Impact Investment Fund. I have a great panel for you today. We'll be talking about impact investing and how it has evolved over the last few years. And to do so we're spanning time zones from London to San Francisco. Our speakers today are Alex Lazarow. Alex is a partner at the Global Venture Capital firm, Cathay Innovation. He's also an adjunct professor with Middlebury Institute for International Studies. He's also the author of Out-Innovate: How Global Entrepreneurs from Delhi to Detroit are Rewriting the Rules of Silicon Valley.

Maria Nsouli:

David Lowish is a founder of Atlas Impact Partners, a long-short fund dedicated to impact investing, focusing on going long companies who solve problems and short end companies which do harm. Tania Carnegie is the Global Lead for private equity and asset management at KPMG Impact, which brings together professionals and subject matter experts from across KPMG to support the delivery of the UN Sustainable Development Goals. So let's get this conversation started. David and Alex, how do you approach impact investing? David, what does an impact investment hedge fund and what are the implications of investing in public markets?

David Lowish:

Hi Maria, thank you very much for having me on your podcast, super to be here. So an impact investment hedge fund is quite simply a hedge fund that invests in publicly listed securities or the publicly listed companies and shorts those companies whose products and services do demonstrable harm to the world. And generally those are made up of environmental damages, human health and wellness damages, as well as sort of broader social inequality. Conversely, we're very proud to go long companies whose products and services help to solve many of those problems, either as regards to the environment, human health and wellness and broader social equality and mobility. We think the implications are that for public markets that this really shines a torch on the products and services which companies sell and gets people to think about the effect that these have on broader stakeholders. And we think that's something which asset holders and capital allocators and market participants in the listed of space should be doing much more often. And so it's our hope is as we get bigger and perhaps more successful that other people will emanate what we're doing.

Maria Nsouli:

Alex, while impact is not necessarily your main mandate, Cathay does take into consideration ESG while investing. Can you tell us more about how you view investing in impactful businesses?

Alex Lazarow:

Happily. In many ways I'm a closet impact investor at my firm, but our firm does care a lot about one, the businesses we select and two the impact they have, both positive and managing the negative impacts as well. In my book Out-Innovate, which you mentioned, I talk about businesses that are multi-mission athletes, essentially businesses that are taking many strategies towards one objective, building a great and impactful business and where the operational outcomes of the business are tied to the impact of the business. And that's really the lens with which I invest and how I thought about investing in companies like Chime bank, which is a free digital bank for the under-banked in the US or Sidecar, which is a radically different way of thinking about healthcare in the US and aligns incentives, is about 40% cheaper than alternatives. Or companies like ZenBusiness, which really allow entrepreneurs anywhere to start their business and run their business at a much lower cost.

Alex Lazarow:

And so that's really the philosophy with which I think about the business, where the operational outcomes tie to the impact. But as a firm, we've also layered on questions of ESG. A lot of our companies are reporting on the impact metrics, but also thinking about what are the ways they can also improve as an organization through, for instance, their impact on the environment, limiting travel, those kinds of things, but also driving diversity as part of it. And so that's really the lens, I think, as a VC, we have the opportunity to select businesses that if successful, where they're operational outcomes tie to impact, and as they scale, those will scale as well. But also managing some of the negative downsides that invariably exist in every business, to mitigate that. That's the lens that we take internally.

Maria Nsouli:

Tania, any other trends that you see emerging in the market?

Tania Carnegie:

Thanks Maria. There is tremendous momentum around climate, with over two thirds of the world's GDP now covered by net zero targets, over 1500 corporations making net zero pledges, that includes many asset owners and asset managers who've made similar commitments. This is just such a top of mind focus area for so many. And as we are counting down the days to COP26 in November, we further expect there will be additional and increasingly aspirational global commitments made.

Tania Carnegie:

Now from an investment perspective, this creates a great deal of opportunity because the effort, the cost and the complexity of achieving these pledges is quite significant. So we need a lot of innovation in the form of new technology, new types of companies, things that we haven't even thought about yet in order for these innovations to be scaled.

Tania Carnegie:

And this, as I said, presents such a great opportunity for private equity and venture capital investors in particular, those who are very climate focused and we are seeing in particular activity in private equity as our clients are looking to and working to create a very comprehensive approach. But in addition to climate, there's also a lot of urgency and momentum around market-based opportunities to address social and economic inequality and to make sure that there is a just transition, which also has significant implications for individuals and communities.

Tania Carnegie:

Just the last trend I wanted to mention that we think is really important is one around collaboration, as we've seen a great willingness for firms to collaborate around impact investing and ESG. These are areas that are rapidly evolving with many areas of common interest, and we're playing an active role to move the industry forward in conjunction with our clients. By working together, we can get further, faster.

Speaker 3:

David, an interesting analogy comes from Sir Ronald Cohen, the father of impact investing. He likened him the emergence of impact investing to the emergence of tech investing and venture capital. The development of VC was a result of investors accepting a new risk return paradigm. With impact investing, he adds an impact dimension to the equation, which is viewed as a way of boosting return potential while also hedging against the downside risk. With your experience at Generation and now Atlas, you've been at the forefront of this movement. Can you please share your thoughts on how the industry has developed?

David Lowish:

Yeah, certainly. There's sort of a couple of things to say. I do believe that actually one of the prime drivers for those who are approaching this from pure financial background is the idea of risk and mitigating risk. And ultimately more, it sort of comes down to common sense. Any company selling products, using that to generate profits that they return to their shareholders is dependent on some sort of license to operate, right? And if that license to operate is dependent on public ascent or the ascent of elected political authorities or indeed of kind of public opinion, it generally makes sense if the products or services which are being sold, do something good. That's the way in which we're likely to retain your license to operate over a long period of time, either through direct regulatory support or indeed through public opinion, which manifests itself in financial terms, in terms of market share and ultimately incentive revenues.

David Lowish:

And so we think that approach around risk management is something which is still valid. And so if I'm thinking about sort of being a steward of other people's capital and indeed my own capital for a long period of time, there is just a sort of a common sense, which tells me that I should be trying to invest in those companies that actually will have a license to operate for a long period of time because they're doing something which is useful for one of a better world.

David Lowish:

I think where people have started to take things further is that actually in the past two years, you have seen that particular sort of technology buckets and in particular around green energy, that those have actually become significantly more price competitive. And so on top of this issue of kind of pollution and damage to the environment with people have become much more aware of, as the world has just become much more transparent, you're also sort of seeing a commercial snowballing around lower cost of ownership. And that's everything from solar panels down to electric vehicles, and the future around hydrogen, which makes large parts of the economic value chain of green investing or impact investing much more interesting commercially. And I think it's that fusion of the two, that sort of that license to operate through public opinion and regulatory possibilities, as well as for pure economics of many of the sectors that we're interested in and becoming more interesting, which is having an effect perhaps more rapidly than people would have thought.

Maria Nsouli:

Yes, definitely. You do see an acceleration in the take-up in this type of reasoning. Alex, this emergence of a new model makes me think of your book. In Out-Innovate, you explore how you think investors can get comfortable with new frameworks and approaches that are not necessarily the Silicon Valley model. How'd you see this applying to impact investors?

Alex Lazarow:

First, some context, in my day job investing in startups outside Silicon Valley and around the world and also in my work teaching entrepreneurs, many of which are going to move back home or move somewhere to build a business, I was getting really frustrated that everything we knew, or at least we thought we knew about startup best practice was rooted in a particular time and place so combined today and for a very particular type of asset-light software based startup that wants to grow extraordinarily fast. And yet around the world, the best entrepreneurs are building a tougher ecosystems with less capital, with less depth of trained, been there, done that start up human capital and more macro economic shocks, or what have you. And that's what led me to write the book and really explore this emerging set of best practice. Interviewed about 200 entrepreneurs, many buildings, some of the most successful businesses around the world, but also some of the ones that I believe are also the most impactful, targeting mass market problems, fulfilling and creating industries and healthcare financial services what have you, and building their local ecosystems at the same time. And so I actually think there's quite a lot of overlap between the work I was looking at and these emerging set of startup entrepreneurs from around the world and the growth of the impact industry.

Alex Lazarow:

And what they were doing was, one, building different types of businesses. And I alluded to this earlier with this question of these multi-mission athletes, but they are creators of industries, often targeting the mass market and often doing so in these higher impact industries. I'll give you one data point. In Silicon Valley, less than 20% of startups and unicorns are in industries like financial services, healthcare, anything in the environment, education, et cetera. In many emerging start up ecosystems the numbers are flipped, over 70% on those same criteria in Sub-Saharan Africa, for instance. So one, their really different types of products and companies, second is they're building the companies differently.

Alex Lazarow:

One of the strategies that they're using is instead of taking this blitz scaling unicorn Chasey model, they're building on sustainable foundations. Doesn't mean they're not growing. They're still trying to grow very, very quickly, but they're doing it without burning at excess capital, without having a business model that requires venture capital to acquire users on unprofitably. And when needed, they're taking a little bit of a longer timeline. And the third, the methods with which they scale, leverage being multi-market from the get-go, leverage distributed teams and give a lot of vectors for impact as part of the strategy they build. So those are just a couple samplings of areas that I see entrepreneurship shifting to. And I think these are strategies that impact businesses are thinking very deeply about, and it can be very helpful tools to do this.

Alex Lazarow:

And by the way, just one reflection, we've talked a little bit about trends in the industry and to your last question about Sir Ronald Cohen, who was one of the people actually that got me into the world of impact. My first job out of my MBA was with Bridges Venture, a fund that he had been a part of and started. I think there's a lot of things that are going to continue accelerating this movement around the demographic shifts of wealth and becoming a priority for investors, a shift in how businesses define, like what the round table, the business round table, lasted last year around saying, "Hey, look, the purpose of the corporation is not just profit. It's a bunch of these other things."

Alex Lazarow:

And frankly, I think the thing that's getting me most excited is that a lot of these high impact businesses are scaling and demonstrating that they are the ones that are valued most by investors, by customers, et cetera. Some of the ones that I alluded to earlier, but the biggest FinTech digital bank in the world is in Brazil. The biggest EdTech company in the world came from India. These are really targeting the mass market and they are becoming the global winners in some of these spaces. And so I think that's one of the reasons that the space is going to continue growing is because it's also demonstrating, do you do both? You can build highly impactful businesses that also become really great businesses.

Maria Nsouli:

There's no doubt that impactful environmentally focused businesses are benefiting from tailwinds, such as an increase in green policy measures. What are some investment opportunities you see emerging in the next five years?

David Lowish:

We think that there's a plethora of things which are emerging. As I was sort of saying before, cost dynamics in large parts, sort of the green value chain, that is only beginning to have a pretty transformational effect on very, very large markets. We think that there will continue to be opportunities in renewable energy, solar wind, increasingly offshore wind, but also in perhaps less well known technologies, like for example, fuel thermal, which is a fantastic provider of baseload power.

David Lowish:

We are also actually quite excited around a lot of things that are a little bit less glamorous, but nonetheless have a significant impact on CO2 emissions at the system level. So we sort of think about things in the industrial space, like for example, whale ways, like for example, building efficiency, installation materials, lighting systems, a lot of these things that are sort of based on saving and avoided energy usage and energy wastage are pretty interesting to us.

David Lowish:

And then finally, we'd see a number of digital technologies that help to make things more efficient. Be that online supermarket, for example, which using algorithm end up wasting much less food than the traditional supermarket model or online ticketing platforms devoted just to the railway industry, to get people out of cars and into trains in much greater numbers than we've ever seen before. All of those things are sort of thematic areas around avoided CO2 emissions, which we think are actually just as important as green energy per se. So we're excited about that.

David Lowish:

And then clearly also within a human health and wellness, sort of a plethora of models offering people faster diagnostics, more targeted treatments to previously very difficult to treat diseases, many things around preventative medicine and preventative behaviors, which we are quite excited about. And so we think that there's a very fertile area for us to mine over the next five, 10, 15 years, which is really exciting for us.

Maria Nsouli:

Alex, do you want to maybe add on what you're seeing at Cathay and then VC?

Alex Lazarow:

I believe that in many cases it's easy to say in the investing world that the private market can solve it, but it ignores the critical role of government and ecosystem builders and regulation in creating a catalyst to support this budding industry. And I'll give three quick examples.

Alex Lazarow:

One on the regulatory front, a model that I think can become very powerful when creating new industries are sandbox environments. So we've seen this succeed in the FinTech world with experiments in the UK, but also in Southeast Asia, like Singapore. Where the regulatory body sets up an environment where you could try a different type of model with a different type of customer base in a constrained way where we see what happens, we test it. And it isn't based on what regulations might have existed before it's actually tested in partnership with the regulator. And then at the end of a time period, within a constrained amount of customers or size of product, you make a decision on whether or not to go forward. And this really allows more experimentation in a way that is in partnership with, rather than an opposition to the regulator.

Alex Lazarow:

The second are programmatic processes that can be built. One thing that I'm really excited about is Aadhaar in India, which is universal ID, on top of which a lot of technologies have built something called the India stack, which is a bunch of APIs that allow anyone tied with the ID to have a basic bank account, and a number of other things. And on top of that, that's kind of an ecosystem upon which you can support a number of new apps and new models that we so far have not imagined.

Alex Lazarow:

And the third, which is more of an ecosystem builder lens is thinking about what I call older siblings. I think in many startup ecosystems, what really catalyzes is having a couple of companies scaling to become very, very large and in so doing, training the next generation of founders, giving angel investors some capital through the exit of the first company and that kind of starting the flywheel.

Alex Lazarow:

And so one of the recommendations I would make in the impact investing world is making sure that it's not just about having the pipeline at the beginning, but it's making sure the middle size companies that are starting to break out really have the support they need to scale and become massive. Because that'll be one of the ways that we're going to want to have role models to have folks that are trained in the space, et cetera, that will help kind of create this perpetual flywheel. So those are three thoughts that I would suggest to try to continue building an ecosystem where regulators and government can play an important role.

Maria Nsouli:

Tania, would you like to add anything to that?

Tania Carnegie:

Thanks Maria. So to add that the regulatory landscape is evolving very quickly. We are seeing the regulatory landscape change quite significantly in Europe, and that is having an impact on funds and fund managers around the world. We're expecting further changes to the regulatory landscape in the US and Canada. And a lot of this regulation is focused on transparency, which is going to help bring in more investors, which is ultimately a good thing. But just as influential as the regulatory landscape, we see the direction that's being set by investors is so critically influential on what happens in the impact investing space. In particular, as these investors are evolving their own investment strategies around issues like climate, as we spoke about a moment ago, and then this has a ripple effect on fund managers.

Tania Carnegie:

Also just wanted to pick up on a point that was made earlier about the link between impact and value creation. And we see this as being a really big focus area and also another big catalyst for the movement of more capital into the impact investing space. It's very clear that investors do not need to make a trade off between impact and returns. In fact, there's a tremendous opportunity for outsized performance.

Maria Nsouli:

Do you see impact investing as becoming the new normal?

Tania Carnegie:

I absolutely do see impact as becoming a part of the new normal. And this is based on the demand and activity that we're seeing both from GPs and LPs and the diversity of impact investment approaches that are being taken by the large GPs, and this will serve to attract a wide range of investors. The opportunity here is massive.

Maria Nsouli:

Alex and David, do you care to chime in?

Alex Lazarow:

Echoing Tania, I also believe that impact investing is here to stay. However, I actually think we need a broader vocabulary. I think impact investing is a very broad word that describes a lot of different approaches, much like private equity is often associated with LBO private equity, but in fact, the word private equity also includes things like venture capital, which I practice and a variety of other things.

Alex Lazarow:

There's everything from foundations that use grant making tools and partnerships with the private sector, all the way to things like generation investment management and the work that David's doing with his new fund as well. And then some of the work that I've done at Cathay and previously at Omidyar Network. And I think within that spectrum, I think that what we'll see going forward is also a greater vocabulary to describe some of the different things that are happening and how you might think of it. Because I actually think that in some ways, and in some practices of impact investing, there is in fact no trade off between returns and impact.

Alex Lazarow:

But I actually think like when taken as a whole and some of the other approaches that exist, the reality is not totally cut and dry on how it works, and in some cases, and the business world can be a really tool to have social impact using business models, but it does not a panacea for everything. And so I suspect we're also see greater ways to think about what are some of these levers we can pull? What are some of the strategies and investment? Where they're appropriate, where they're not et cetera, but I also share the optimism to believe that as a sector and as a movement to push towards both using business in a more productive way to doing what you do of also being part of the ecosystem and creating an ecosystem. But also where it's really appropriate to solve direct problems in ways that historically has not been. I'm greatly excited about that, by the plethora of ways [crosstalk 00:24:21].

David Lowish:

Maria, I think that's a great question. I think the answer is yes, right? So ultimately impact investing is not something we should be restricted to any one particular asset class. We think that it should certainly not necessarily just be the preserve of venture capital and private equity. We're striking out in this in the hedge fund space, the listed long-short space. But we think that long only equities credit everything down to money market. Short duration money market fund should corporate an element of impact analysis. There's no reason why I couldn't have run a money market fund with sort of 30 year commercial paper, restricting myself to investing in those companies that are doing something which is positively impactful and avoiding those companies which are negatively impactful. So we think this is actually something which becomes pervasive across the whole of the portfolio, basically. We think that that's sort of good for the planet and good for the world.

Maria Nsouli:

Thank you, David. This has been a great conversation. Thank you everyone. It's always a pleasure to speak to all of you and hope we can do this again very soon. Thank you everybody for listening and have a good day.

Alex Lazarow:

Thank you so much for having us.

Tania Carnegie:

Thank you, Maria,

David Lowish:

Thank you very much for having us and really appreciate you doing this podcast.

Michael Torrance:

Thanks for listening to Sustainability Leaders. This podcast is presented by BMO Financial Group. To access all the resources we discussed in today's episode, and to see our other podcasts, visit us at bmo.com forward slash sustainability leaders. You can listen and subscribe free to our show on Apple podcasts or your favorite podcast provider. And we'll greatly appreciate a rating and review and any feedback that you might have. Our show and resources are produced with support from BMO's marketing team and Puddle Creative. Until next time I'm Michael Torres have a great week.

Disclosure:

The views expressed here are those of the participants and not those of Bank Montreal, it's affiliates or subsidiaries. This is not intended to serve as a complete analysis of every material fact regarding any company, industry, strategy or security. This presentation may contain forward looking statements. Investors are cautioned not to place undue reliance on such statements as actual results could vary. This presentation is for general information purposes only, and does not constitute investment, legal or tax advice and is not intended as an endorsement of any specific investment product or service. Individual investors should consult with an investment tax and or legal professional about their personal situation. Past performance is not indicative of future results.