An Introduction to Early-stage Impact Investing | Katherine Klein and Tyler Wry

What Is Impact Investing?

Dan Loney: Impact investing is an important way to support initiatives that will have positive impact in the environment or society. But where do we stand right now with it, and what do you need to know if you’re thinking about getting involved, especially at the early stages? Pleasure to be joined here in studio by Katherine Klein and Tyler Wry. They are faculty co-directors of the Impact Investing Research Lab here at the Wharton School. They also have a new book, An Introduction to Early-stage Impact Investing.

Great to have you both with us here today. Let’s start with where impact investing stands right now. There’s been what feels like a much more increased focus on this as a component of people’s investing module over the last decade or two.

Tyler Wry: Yeah, 100 percent. If we look at the history of impact investing, the term really only started to crystallize around 2007. In terms of investing overall, it’s a fairly recent phenomenon. And if you plot out the assets under management, it’s really grown exponentially in that time. Last year was the first time in history that impact investing has over $1 trillion in assets under management collectively around the world. It’s big, it’s growing. And the idea is you can leverage private capital for public gain. This is a way to create impact at a large scale that’s not possible with just government alone or business alone or nonprofit alone.

Loney: Katherine, what’s the importance of doing this book at this moment?

Katherine Klein: We were excited to do this book at this moment, given interest in business schools and among the public in impact investing. We wanted a how-to book that was not just a user’s manual, but that had a lot of practical how-to knowledge and rigorous, academic-backed research to really guide people in understanding impact investing.

We see just a huge number of students at Wharton, both undergrads and MBA students, who want to get into the field. [We wanted] the ability to provide some how-to from every stage of the process. What is this thing? How do you get started as an investor? How do you do due diligence? How do you assess impact, etc.? That was part of the story we wanted to tell here.

Loney: Tyler, when somebody is considering this is as a component in investing in fund, what are some of the things that they should think about first?

Wry: It depends a little bit on where you want to make your impact. If you look at different impact investment funds, like any fund, they’re going to have a different thesis. There’s going to be some that are focused on environment, financial inclusion, some that are focused on biotech, med tech, hard tech, a lot of AI stuff coming up as well.

You should also think about the geography of where you want to make impact. What is the functional area, where is the geography, and then what stage of company do you want to try and support? This could be right down to pre-seeds. I’m a founding partner in an investment fund called Critical Venture Partners, and we do pre-seed impact investing. But you could also look all the way up to growth equity. Maybe you want to look at the models and the firms that are performing really well, and then allocate capital to help them grow and make a real dent in the world.

Loney: Are you seeing firms or funds that maybe haven’t gone down the impact road that now want to look at and maybe build into their structure?

Wry: Oh sure, yeah. We have traditional funds that are opening up impact sleeves. You can see that in VC, private equity, in larger retail products. Once you start to get into the larger retail stuff, it starts to get a little bit fuzzy. What is ESG investing, and what is impact investing? And those are actually different.

ESG would focus on the internal operations of the company, make sure it has good environmental performance, social impact and governance, whereas impact investing is much more about the outputs that the company is creating. You specifically target companies that, through their productive activities, are making positive change in the world.

The Value of Impact Investing

Loney: I noticed that in the book, Bobby Turner wrote the foreword. I had a chance to meet him a few years ago at the Global Forum down in Miami. If you can talk about how he is such a great example of what impact investing can do for communities and for companies as well.

Klein: Bobby, who’s a Wharton alum and a real leader in impact investing, tells his story of graduating from Wharton, very focused on, “Let me make a lot of money.” As he tells it, it’s like, “Yeah, I was successful, and I wasn’t satisfied. It wasn’t meaningful to me. I wanted to have more positive impact in the world.” Bobby tells this story, “I got more and more involved in philanthropy, and ultimately more and more frustrated with philanthropy.” He would say he wanted to make a bigger difference, and thought that he could do so by marshaling investment capital, which was his expertise, and figuring out how can we use investment capital to propel positive impact and positive financial returns.

He’s done it with his particular expertise, with a focus on real estate and real estate development. I think one of the things that Bobby does really well, and it is a useful story and insight about impact investing, is his firm brings together people who have a lot of content expertise on the problems they want to solve. How do we help communities? How do we create more affordable housing? How do we create more workforce housing?

There’s just tremendous expertise that Bobby’s firm is trying to bring to bear on their investment strategy so they can make strong financial returns and real impact. That’s a short overview of what I would say Bobby’s doing, and that’s generalizable to a lot of impact investors.

Loney: One of the things that I picked out in the book that I wanted to talk to you about is opportunity. Certainly, there are so many opportunities in this realm right now, and you do have to take the time about looking and picking the right opportunity, don’t you?

Wry: Oh, 100 percent. It’s like any type of investing. There’s going to be way more companies, way more opportunities that you could support than you actually can. You have to be really, really focused in terms of, where do you want to look? And then, how are you going to recognize quality?

When you’re talking especially early-stage impact investing, which is what the book focuses on, this gets really tricky because not only do you have to project out on financial metrics like any other investor would, you also need to try and project out on social impact. And that gets really, really tricky. We have some frameworks in the book that try and help with that, but to actually do good social impact measurement and good social impact projection, this is something that is really tough, and it’s really costly. It’s a big challenge for the field going forward.

Loney: I think we talked about it a few years ago, but for a long time people wondered if impact investing can be profitable. We know that it is the case.

Klein: It is the case. What I would say is, yes, you can do good and you can be profitable. It’s certainly not lockstep and guaranteed, right? You talked about non-impact investors getting into impact investing — creates interesting tensions. At every stage of a company’s growth, there are likely to be questions of, should we do this? Will it be more profitable for us to do this? And will it sacrifice impact or not? So yeah, it’s challenging. It’s challenging to do both well, but we see many examples of companies and firms doing both well.

Wry: There’s a concept in impact investing called collinearity of financial returns and impact. In academics and statistics, if things are colinear, they vary completely with each other. One is almost a function of the other. If you look at some impact investing opportunities, there will be high colinearity. Think about a company that has designed something that abates carbon and turns it into methane gas that you can use as a clean fuel for the shipping industry. The more that company grows, the more money they make, the more impact they make.

On the flip side, you could think of something like microfinance, where there are some microfinance banks that make a lot of money, and there’s other ones where they’re trying to help the poorest of the poor, women, rural populations, and that becomes really hard. There are financial trade-offs that associate with that. And that’s a trickier place to try and make impact as well as return.

Opportunities for Growth

Loney: How much growth are we seeing in terms of different avenues coming into impact investing? It seems like with the growth of focus on environment, on our culture, on society, that there are new avenues popping up almost every year.

Klein: I think that’s true, and we’ve certainly seen growth. This is a challenging period in the United States as there’s some sense of priority shifting, and how that plays out for impact investing, I don’t think we know yet, right? It could drive more capital into impact investing. I want to make an impact. I like this opportunity. I’m not seeing so many other opportunities. Maybe government is actually doing less, and we ought to really double down on what private capital can do. Or it may sway people to say, “Well, impact, I don’t know.” So, I don’t know. That would be my prediction. It’s hard to predict, which is no prediction.

Wry: It’s tough, right? You can price risk; you can’t price uncertainty. It’s just inherently unknowable. So, I don’t know. We’ll see where it goes. I think, like almost anything, the change will make some opportunities more attractive and some less attractive. There’ll probably be a little bit of reordering in terms of where the money’s going, and it’s unclear if we’ll see growth in the field or if we might see a little shrink.

But I think it definitely puts a point of emphasis on why this is so important right now. If we’re going through a time where the government’s retrenching its efforts to do some of this stuff, how can we bring private capital to the table to step into the breach and hopefully do stuff that’s innovative, efficient, and impactful?

Klein: While impact investing is a newer term over the last 20 years, there has been a long, long history of thinking about social responsibility and the ethics of capital for decades, maybe even centuries. So, I don’t think that this consideration is going anywhere. Investors are always going to think, “Am I comfortable with where my money’s going?”

Loney: What do you hope that people who read this book will take away from it?

Klein: I think the shortest answer to that is, I hope people who read this book think impact investing is possible and understand that it’s challenging. It is not easy. It takes a lot of thought. It is a complex process to balance and prioritize both impact and financial performance, but it is possible.

Wry: I think it’s the same thing. The only way this field is going to continue to grow is if we have a pipeline of smart, motivated young people who are choosing this as a career. And to the extent that we can help them understand the blocking and tackling of doing this stuff in practice, and making them good candidates as they go into funds, or start their own, or even go into industry, and try and do this stuff, all the better.