More effort needed on the supply side

In a recent article for the Guardian,[1] I suggested that if observers were to ‘peer beyond the wreckage of western financial systems’, they could ‘discern the outlines of the future’. I also suggested that the end of the period of ‘global capital markets’ and the ‘financial services revolution’ would usher in a new era of social business and social investment.

Much has been made of the rising level of funds dedicated to social, ethical and environmental businesses and enterprises, but rather less attention given to the businesses themselves (the supply side). Unless the sector pays more attention, I believe this phenomenon will end in tears.

Although the full cost of the financial meltdown is not yet known, initial estimates are likely to prove low and the bill will be picked up by the taxpayer. The debts now being created need to be serviced and eventually repaid. Against this backdrop one can simply forget about expenditure on social programmes. In the face of this challenge, social business and social investment have a big role to play.

Maureen Stapleton writes in this issue of Alliance about the growth of ethically oriented funds. She notes, for example, the doubling in just two years of European SRI Funds to €2.7 trillion. SRI Funds have their place in the ‘ethical arena’, but I believe they also have great limitations – most notably the fact that their portfolios essentially mirror those of mainstream funds. I would point out other even more progressive developments, such as the first closing (at £57 million) in September of WHEB Ventures’ clean tech-oriented second fund. In Canada, Renewal Partners, which has been making social venture capital investments for over a decade, is raising its second fund. In the UK, Bridges will shortly launch the Bridges Charitable Trust, which focuses on ‘equity-like’ capital for social ventures.

Stapleton also mentions UK-based Adili, which has secured funding for its own expansion, while Divine raised funding in the USA for expansion into that market. The Ethical Property Company expects to issue up to £10 million of new share capital in the next 12 months from UK and European investors, to fund future property purchases.

Yet these organizations are exceptions to the rule. While funding has increased substantially, the stock of commercially interesting social and ethical opportunities has failed to increase at the same rate. Statistics on this are impossible to come by, but as a firm that focuses on ‘helping social businesses to succeed’, we believe a great imbalance exists. Investors (in both the private and the public sector) can inject funds at the stroke of a pen, but building great businesses takes time and effort. We are only at the earliest days of this process.

Unfortunately, those firms which do make some progress are often quickly snatched up by buyers. In the UK, the last few years have seen the disappearance of great names such as The Body Shop and Organix Brands (into the clutches of L’Oreal and Hero, respectively), and the purchase of the very large (by social enterprise standards) ECT Group (community transport) by private firm May Gurney (for more UK social businesses see These and other acquisitions are good for the atmosphere in the sector but will mean fewer high-quality sizeable social businesses to absorb the new capital. If this persists, poor financial returns will follow, thereby discouraging future social venture capital investment.

Two things are needed. First, time – something that few have but which is absolutely essential. Second, capacity building and incubation. There is a general absence of organizations that offer sizeable funds for scaling up. The minor contributions of the likes of Skoll, Ashoka, Acumen and the Schwab Foundation are just too small compared with the capital required.

I have been very impressed with the efforts of the Netherlands-based Noaber Foundation, which has been recycling capital earned in the mainstream (the founders were part of Baan, the successful Dutch software firm) into social businesses. In the government-backed arena, there are few peers for MaRS, a bold and innovative incubator of technology and social firms, based in Toronto, Canada. I am also excited by similar ventures in developing markets. Artemisia, in São Paolo, Brazil, is an impressive social business incubator, which operates in Brazil and in Senegal and France. Recently I have become aware of similar initiatives in other South American and African countries. Perhaps the developing world can show us, in the West, how to do it properly, now that we have faltered?

Let’s see.

1 Society Guardian, 8 October 2008.

First published in Alliance magazine December 2008.

Market meltdown can herald the era of social business

Peer beyond the wreckage of western financial systems and it may be possible to discern the outlines of the future. The end of the period of “global capital markets” and the “financial services revolution” is ushering in a new era – that of social business and investment.

With the collapse of large financial players, the very nature of unfettered financial markets is being questioned. Although the full cost of the meltdown is not yet known, we can be sure that the bill will be picked up by the taxpayer.

The banking system has been acting with an implicit state guarantee, for which the financial firms paid little – despite generating large sums for select employees and shareholders. Now that things have come unstuck, there is no recourse to the wealth that has been generated, which is a galling scenario for taxpayers. Their anger will be a feature of our political environment for many years to come.

Another feature of the financial bailout is the massive expansion of government indebtedness, especially in the US. These debts need to be serviced, and eventually repaid. Against this backdrop, one can forget about expenditure on social programmes.

The notion that society benefits so long as economic agents pursue pure profit-maximisation models and create wealth is now thoroughly discredited. So if the credibility of business has been seriously undermined, and government’s role severely limited by resource constraints, where should we look?

Civil society may have a role to play, but does it really possess the clout to address the scale of the problem? The answer would appear to come from an area that links all three main agents – state, private and civil – in our economy. The problem with the market-based system in its purest form was the complete absence of any social calculus. What we are now witnessing is likely to be the beginning of an economy where the full social impact of our businesses and our investments is taken into account. Signs of this trend have been evident for some time. A recent report by Eurosif, the Brussels-based trade body that encourages responsible finance, shows that, over the two years ending December 31 2007, socially responsible investment (SRI) funds in Europe have more than doubled to €2.7 trillion (£2.12 trillion) – representing 17.5% of European investment assets.

Two other asset classes with strong social return characteristics have also surged into the investment mainstream. Micro-finance has become an important feature in fixed-income portfolios, and alternative energy (“cleantech”) is becoming a core part of equity investment. In 2007, cleantech investment amounted to roughly $150bn (£117 bn).

At the smaller end of the scale, many new businesses have emerged, supported largely by individuals. These include retailer The Body Shop, online charity website, the Ethical Property Company, which rents to social change organisations, Divine fairtrade chocolate, and a host of others. These businesses exploit the workings of the market to deliver tangible social benefits as well as financial returns. The fact that they generate financial surpluses means they are not dependent on the state or donors to conduct their activities – a very handy feature in the tough economic climate ahead.

Charities will still play a vital role, but those dependent on state funding will be at risk. Both the voluntary sector and other civil society organisations will probably need to become more market-driven and entrepreneurial.

Another indicator comes from leading business schools, where we can observe MBAs – a very astute, ambitious group – focusing on social business or “social entrepreneurship” as a potential profession. At the Judge Business School, Cambridge, I recently met a young man with a highly marketable background in bio-engineering who was “definitely going into social business”, rather than taking the well-worn path of MBAs who sought to “make money for 15-20 years and then give back to society”. When I asked why, his answer, without hesitation, was: “Why waste those years?”

Jeremy, a friend of mine who is considered a leader in the international development field, once told me that he was taught throughout his career that the corporate sector was ill-intentioned, and that all possible solutions lie with resident experts from his world. I recall my former colleagues at Lehman Brothers saying similar things about the infinite wisdom of markets! Unlike my old Lehman friends, Jeremy is still employed. He is lucky, but also perhaps cleverer. He told me that he found that the only real solutions to today’s intractable problems lie in using the wisdom of both the market and the development sector (and others).

It is on such linkages that the social business and investment sector is based. Economic activity is an inherently “social” activity, and excluding social impact was bound to end in disaster. It is indeed a shame it took such a severe crisis to bring this point home.

First Published in The Guardian in October 2008

Social Returns: A new horizon in investment management

On Monday George Osborne, Shadow Chancellor of the Exchequer, announced his plans for a Green Environmental Market (GEM).  This GEM, supported by The London Stock Exchange, will enable investors to track and invest in green firms in a simple way.  Fiscal incentives are also promised.  Ed Milliband has for some time been discreetly pushing the concept of a Social Stock Exchange.  Later this week, at the Voice 08 conference hosted by the Social Enterprise Coalition in Liverpool, four of us will debate the merits of such an exchange—where “social” enterprises may access capital from social investors.

Is this just another bidding war between the two major parties trying to out-do each other in bold initiatives?  Or is something more sustainable under way?   In my view, we are witnessing the birth of a new investment concept namely, the social dimension to financial investing.

On entering the financial markets in the 1980s as an equity research analyst with PaineWebber, the influence of risk, or volatility, on financial returns was the “new frontier”.  Fortunately, I had recently left business school and was fully clued up on beta and its impact on returns.

Decades of portfolio management thinking has developed around the concept of beta.  Certain investors might have a higher tolerance for risk, purchase riskier assets and thereby, over time, enjoy commensurately greater than average returns.  But these did not come for free; they were merely a compensation for the incremental risk assumed.

This has led to different risk profiles leading to vastly divergent portfolios.  Those of pensioners would be heavily tilted towards lower risk assets; government guaranteed obligations, high-grade corporate debt, and perhaps some blue chip equities, while those at the other end of the spectrum, would contain high-risk assets such as growth stocks, riskier classes of debt, venture capital etc.

Now we appear to be crossing a new investment frontier.  Sophisticated investors are voluntarily taking social, ethical and environmental “returns” into account in their investment decisions.  These decisions have led to the very rapid growth of the socially responsible investment (SRI) fund management sector.  This has mushroomed from zero to around £6 billion (IMA, Q4 2007) between 1984 and today.  In this segment investors seek to varying degrees to deploy investment strategies that contain social, ethical or environmental elements.

There are varying approaches to SRI.  One is called “negative screening”, wherein certain equities are excluded from investment based upon criteria of a purely ethical nature.  Many proponents of the SRI approach argue that over time such an approach will actually yield better risk-adjusted financial returns, because social or ethical and environmental businesses are operating in sync with longer-term fundamental trends.  Furthermore, these advocates contend that such companies are less likely to be prone to the kinds of accident which destroyed Enron.  Another segment of the SRI market is commonly referred to as the “engagement” sector, where investors engage with corporates to improve their moral behaviour.  Again, it is argued that this will also improve financial returns over time.  However, there is little evidence that SRI funds consistently outperform the mainstream.  On the other hand, there is little evidence that they under-perform the market.  Thus investors in SRI funds, secure social returns for free.

There is also a growing number of companies that transparently offer investors below-market returns, which are increasingly being invested in by investors who are looking for social returns.

A good example of this is the Ethical Property Company (EP), on whose board I sit.  EP has raised equity (roughly £10 million) from small investors and a few institutions in the UK.  This is then leveraged with debt to purchase commercial property, which is then let to “social change organisations” (like Oxfam, Greenpeace, etc.) at a meaningful discount to market rents and managed in a more environmentally conscious fashion.  Investors in these shares have, over time, earned a 5-6% return (half in dividends).  This is a discount to listed property shares, but the investors make this trade-off consciously in order to gain the social returns generated by EP.  Other examples of investable companies that offer a social return would be Cafédirect (Fairtrade hot beverages) and Divine Chocolate (Fairtrade chocolate).  Rational investors will make such trade-offs in cases where they value the social returns generated more highly than the financial returns forgone.

In the early days of social investing, it was common to disparage such social investors. I believe that they are, in fact, making a sophisticated and rational trade-off between incremental financial and social returns.  Companies and observers who continue to disparage such choices do so at their peril. Each of us, in our everyday lives, “purchases” social returns.  We do so through charitable donations, in buying higher priced fair trade foods, through the installation of un-economic (still) solar panels on our roofs, etc.  This is normal behaviour from an increasingly affluent society and is beginning to extend into the investment sphere.

Firms such as Investing for Good have sprung up to try to measure these returns.  In various discussions with private bankers, IFAs and other financial intermediaries I have discovered a booming demand for such “socially advantaged” products.  I confidently predict that measuring, accounting for and reporting on such social returns will be one of the fastest growing fields in the investment management industry over the next few decades.  This is hardly surprising in our increasingly wealthy society, where non-financial returns are taking on an increasing importance.

So, in the new investment frontier, portfolio and share analysis will not only look at varying tolerances for risk but also divergent preferences for social, ethical and environmental returns.  These returns are extraordinarily difficult to measure; it is impossible, for example, to compare the social worth of a school in Burma, with that of a 1% reduction in a company’s carbon footprint, or indeed an investment in a clean water supply in Mali.  These are complex and probably unanswerable questions, but investors are demanding answers, or at least some guidance.  Sophisticated firms servicing the investment community would do well to try to meet these needs.

Perhaps it’s time for me to go back to business school?

First published in the Financial Times in March 2008.

Reply to Klaus Schwab’s: too much focus on big companies.

In the January/February issue of Foreign Affairs magazine, Klaus Schwab, founder of the World Economic Forum (WEF) writes passionately about Corporate Social Responsibility (CSR), its background and the important positive changes large companies can make in the global business and economic climate.  His contribution and that of the WEF is an indisputably valuable one.  Nevertheless, with the famous star-studded annual WEF about to take place in Davos, Switzerland, I found it necessary to critique the article.  The full contents of my proposed letter to the editor of Foreign Affairs magazine are attached below.  In short, Schwab’s article, like the WEF, is simply too full of the politicians and the large companies who have got us into this mess in the first place.  Its great that they are meeting to ponder how to improve things (and work on their ski technique!), but if we are looking for inspiration we need to look to genuine social entrepreneurs, with less of a stake in the status quo.
For the full text read on.
To the Editor:
“In “Global Corporate Citizenship” (January/February 2008), Klaus Schwab, of the World Economic Forum (WEF), does a creditable job of explaining the nature of corporate social responsibility (CSR) and why it is in the interest of corporations to undertake this activity.

Schwab lays out a history of CSR and conveniently begins in the 1970s, when the WEF began its involvement in this area.  This misses out, as many observers do, the substantial and well-documented CSR activities of companies from the Victorian era, or perhaps even earlier.  The WEF has played a useful role in this field, but it is important to be thorough about the historical context for CSR.

The arguments made by Schwab that corporations see this as in their own interest, rather than from a “defensive or apologetic perspective” are constructive in intent, yet he fails to adequately explain why this is so, apart from some sense of “duty”?.  We believe corporations now act in this way because of vigorously competitive markets for three vital stakeholders: investors, customers and employees.  Each of these groups, to an increasing extent, care about positive corporate action on CSR.

My main critique however lies in Schwab’s excessive focus on large corporations.  The examples he uses, Nestle, Microsoft, AIG, Deutsche Bank and Nike all represent some of the world’s largest corporations.  It is marvellous that they act positively and I commend Schwab in forcefully arguing that they can make a substantial impact.  However, it is my contention that such institutions rarely lead the way on social innovation, and that by focussing on large corporates only, Schwab, like most commentators, is missing much of the story.

For inspiration here we must look to more entrepreneurial firms such as The Body Shop or Ben & Jerry’s.  They played a fundamental role in introducing ethical considerations into the UK and Us consumer products markets, respectively.  The pioneers behind them, Anita and Gordon Roddick and Ben Cohen and Jerry Greenfield are genuine social entrepreneurs.

Business maybe can “help save the world”, as the title of the article suggests, but the models for doing so are unlikely to come from those with the biggest stake in the status quo.  My years as an equity research analyst on Wall Street have convinced me that large companies are rather bad at being entrepreneurial.  They will react to entrepreneurs, as has the UK coffee market, to the growing market penetration of the fair trade company, Café Direct.  Similarly, The Body Shop and Ben & Jerry’s were in later years, acquired by larger firms (L’Oréal and Unilever respectively).  But if we are looking to be inspired, I believe it’s the smaller social businesses which will offer leadership.  It’s no surprise that Muhammad Yunus and Grameen Bank won the Nobel Peace Prize, as Schwab himself mentions, and not Bill Gates and Microsoft.