Chicago Booth Review Podcast Does Your Portfolio Need Impact Investments?

Priya Parrish: And people are looking for action for solutions for some way they can feel like they can improve or take away some of the anxieties we have. Our government isn't solving for these, right? There's just deadlock. And so impact investing has kind of emerged in this time as like, okay, I can do this thing, and customers have demanded it.

Hal Weitzman: Impact investing aims to serve two purposes, creating both profit and positive social outcomes. But is that really possible? Isn't there always a trade-off between profits and impact?

Welcome to The Chicago Booth Review Podcast, where we bring you groundbreaking insights in a clear and straightforward way. I'm Hal Weitzman, and in this episode we're bringing you the second of two conversations with Priya Parrish, an adjunct assistant professor of strategy and impact investor in residence at Chicago Booth.

Parrish is the Chief investment Officer at Impact Engine, a venture capital and private equity firm, and the author of the new book, The Little Book of Impact Investing, Aligning Profit and Purpose to Change the World.

Parrish argues that impact investors don't necessarily have to accept lower returns and thinks that you can make healthy returns on your investments while pursuing your social goals.

If that's the case, should we all be impact investors? Priya Parrish, welcome back to the Chicago Booth Review Podcast.

Priya Parrish: Great, thanks for having me.

Hal Weitzman: We had to have you back because last time we had such fun talking to you about The Little Book of Impact Investing, Aligning Profit and Purpose to Change the World.

And we talked a little bit last time about something that I wanted to dig into a bit more, which is this idea, you talked about how there were two goals of every impact fund. One is basically making money and the other one is basically having impact and that there's a myth, which we discussed last time, that impact investing always involves sacrificing the returns. In other words, there's a trade-off between those two goals. But you talk in the book about that's not necessarily the case. So I guess the question is, can impact investors actually earn outsized returns, in other words, better returns than they would than just putting the money in the S&P?

Priya Parrish: Yeah, absolutely. And let me explain that, but before I do, I just want to give one context of this as well or validation that we're going to focus on in this talk. How impact can drive these returns?

I personally think it's okay and it's actually a good way to invest as well to knowingly accept a lower return to have a type of impact that otherwise wouldn't be able to be had, right? It's not bad investing. It doesn't mean you're not a good investor, it's when it's intentional. It will create this kind of impact. If I accept a lower return, that's a good thing.

But that's not what we're here to talk about. So the reason why impact can actually drive a positive return has do with expertise. Let's first start with the opposite side of this is, and it's the common myth or reason as to why finance professionals will say you will lose money or you'll accept a lower return, and it relates to limiting the opportunity set.

So it comes from financial theory around modern portfolio theory around if you constrain the opportunity set, you are essentially constraining the optimization or the maximization of profit. And that is true. That is true. I won't fight that.

However, put impact aside. There is tons of evidence out there showing that sector expertise, for example, can outperform. So Cambridge Associates, big consultant, put out a study a number of years ago showing that healthcare private equity funds consistently outperform by a meaningful amount the healthcare investments in generalist private equity fund portfolios. Why is that? They understand the sector better, they understand the trends, they understand insurance and payers, they understand policy, they understand the operators and executives, customers, and that can lead to alpha, that can lead to the stronger ability to find the best companies to make better decisions and to help those companies succeed.

The same is true in the energy sector, in the industrial sector, in the financial sector, it's pretty consistent and it's consistent across asset classes. You see this in hedge funds, you see this, et cetera.

So if you think about impact, impact is essentially an area of expertise. I meet with five to 10 fund managers a week in the venture capital and private equity space, and most of the impact fund managers that I meet with, they come to me saying, "I have been professionally involved in the energy sector my entire career." I was an entrepreneur, I was an operator, I was an investor, I understand oil and gas, I understand power and energy and now I understand renewables and I have an ability to find those companies that, better than other people, that are going to outperform.

I meet people who we've been starting workforce in the future of work and all the ways, everything from AI and portable benefits is affecting the way people work in their financial lives. They have an expertise, they've been following it like no one else. And so it's these counteracting forces. If as an impact investor you can have enough domain expertise and bring with you all the normal things, the standard things that lead to being a great investor, right? You need to absolutely do good financial analysis. There's a lot of things that also have to come with it, but if you add that expertise, it can lead to outsize returns.

Hal Weitzman: Okay. But the way you describe it there, it seems like the niche is what people-

Priya Parrish: That's right.

Hal Weitzman: ... who are in these niches have this expertise. Does that mean as an investor? If I see that a big global money manager is offering an impact investor fund, I should be careful?

Priya Parrish: You should ask more questions.

Hal Weitzman: But is it likely to be not as impactful or not as financially rewarded?

Priya Parrish: If the team, let's say they manage billions of dollars and they're a global asset manager, but they're talking to you about an impact fund and they're a group of people in that big firm that all they do is this and they have the expertise, then I think that's a great starting point.

But if they're just saying they're sheer dominance and size is the expertise, personally, I wouldn't say that is worth my time.

Hal Weitzman: Okay. So the idea the way that impact investors could earn outsized returns is by going with basically a niche unit or company that really understands what impact investing is and the way to combine having maximum impact with generating maximum returns.

Priya Parrish: Yeah, it's how having an expertise in a sector or theme or market or even a geographical market, it gives you an unfair competitive advantage. That is what it is.

Now, the underlying investor, like the individual or the endowment, or pension, what they need to then do if you want to successfully be an impact investor is you need to curate a portfolio of many specialist funds, because again, I'm not here to refute modern portfolio theory. It's true, you are limiting opportunity set. And so you don't want to be an investor who all you do is climate or all you do is future work. You have cut out, right, a huge percentage of the investible universe, but you want to find the expert in all of these areas, and again, put impact aside, that is how some of the smartest institutional investors build their portfolios period.

Hal Weitzman: Okay. So the way you describe it, we talk about, you talked about healthcare and healthcare niche investors and how they can generate outsized returns relative to their industry.

The way you describe it sounds almost like impact investing is just another asset class like real estate or crypto or art. It's just something that builds out your portfolio. Is that the way to think about it?

Priya Parrish: I wouldn't because real estate, asset classes are markets and impact is a strategy. It's an approach to investing in a market. And so you can take this approach across any asset classes. There are impact real estate funds focused on affordable housing or green building.

There are impact venture funds that might focus on financial inclusion and FinTech or climate tech. There are impact public equity funds that focus on shareholder engagement. There are impact private credit funds that focus on lending. And so you can apply that approach to pretty much any asset class and have that expert lens within it.

Hal Weitzman: But I guess if you can earn outsized returns by impact investing, does everybody need a little impact in their portfolio? Is that what you're saying? Because in the same way that you would want to generate those outsized returns in other areas, should we think of impact, there's something that we should have almost regardless of whether you think the impact is important or not, it's just a financially astute thing to have?

Priya Parrish: I do believe that fundamentally just investing in experts is a smart way to invest and that's where I think it is this hidden gem or overlooked advantage.

Again, put whatever your values or goals are aside, everyone should be paying attention to impact investors because our goal, we are, and it takes a lot of work. It's not easy, but you end up with an advantage if you actually understand why there is a certain market failure, why there is an unmet need, you're going to have more insight into what the solutions are. So yes.

Hal Weitzman: Right, so we could call it market failure, but you might not even think it is a market failure.

Priya Parrish: Market opportunity. Sure.

Hal Weitzman: It's an opportunity. I was going to say, you talked about renewable energy. I mean you could imagine, just to play devil's advocate, you can imagine someone who's a real oil and gas freak but is savvy enough to realize that other people care about renewable energy and have demands for if you're building a data center, you have to build it with renewable energy, powered by renewable energy. So at least they can see that other people care about it. And so that's enough to move you and that will be the same with other kinds of social impact, right?

Priya Parrish: Sure, that's right. And I think fundamentally, I always try to remind folks that there are a lot of ways to make money and there are a lot of ways to lose money, right, and impact is just bringing a new tool in your toolkit to that. But it's a lot of the same fundamentals.

Hal Weitzman: Okay, but that's interesting you say about a way to lose money because

Priya Parrish: A lot of losing investments out there, that's the truth.

Hal Weitzman: Well, you're talking about expertise. I mean if someone's making outsized returns, that means other people ain't, right?

Priya Parrish: That's right. That's markets.

Hal Weitzman: That's the market, right. So there is a little bit of a reputation perhaps among some people of impact investing has that it's not like you said right at the beginning, "You can have impact, but this is not a way of making money. It's a way of having impacts." It's almost, I mean, to be unkind you say it's sort of replaces your charitable giving. That's something we talked about the last time you were on the show. So I'm wondering if the way you've framed it about expertise in investing means that some of that bad reputation may actually just come from people who don't have expertise.

Priya Parrish: It's warranted. So we have to step back and we can only do it for maybe 30 seconds here, but I have a whole chapter in the book about it, which is why now, this is an idea and approach that's actually been around for decades, but why is it growing so quickly right now? And you have to step back and look at what's been going on in society and I think the way people feel, and people are looking for action for solutions for some way they can feel like they can improve or take away some of the anxieties we have, whether it has to do with the rising costs of child care, greater health issues. I mean all the different anxieties to social media and loneliness to climate. I mean you pick it.

And not to say that we're in a totally unique time, but I think one thing that's unique at least about in the US is I think people do feel like, again, it doesn't matter where you fall on the political spectrum. Our government isn't solving for these, right? There's just deadlock.

And so impact investing is kind of emerged in this time as like, okay, I can do this thing and customers have demanded it. But if we rewind, and I started in this space when I was 20 years old in the early 2000s, and it was the place where... By the way, impact that, that term didn't exist. ESG didn't even exist. It was called social responsible investing. And it was the place that attracted people who did not know how to invest, who had no financial experience or they timed out and they were failures.

I'm being completely honest, and the returns were not there. I left that world very early and I was really young just getting in it. I had no finance background as well, and I noticed that problem. It's why I came to Chicago Booth, because I said, "If we're going to get this right, at the end of the day, if these are investment strategies, you need to be good investors."

And so I wanted to go get the training. I ended up in the hedge fund industry. I ran a single family, I went 180. I was like, let me become a good investor in order to become a good impact investor. It's essential. And because of this societal context and this, and part of it's generational, it's absolutely millennials and Gen Z who are saying, "I want my values to align not just with how I spend, not just how I invest by the way, which is part of this, but it's where I work and how I work."

I teach impact investing at Chicago Booth. And I can tell you that I see countless students who they could get jobs or they came from jobs at XYZ, big PE firm or investment bank, and they don't want to leave that skill set behind, but they want to apply it to something good.

And so the shift here is it is now a positive selection bias. It is talent arbitrage. Some of the best and brightest in finance and in the investment industry today, they don't want to be in this industry if they can't do it with impact.

So it has fundamentally changed, but I would say 20 years ago, no, the talent would've probably led you astray to some pretty bad returns.

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Priya, we talked there about how the world of Wall Street essentially changed with all sorts of people coming in with ideas about purpose and things they wanted to achieve socially, how much, I'm thinking about the other side as well, the investors, the people who are giving them their money. There's also a huge demand there that's pushed impact investing, right?

Priya Parrish: Yeah, you're right. So the supply of talent and then the demand from an investor, essentially the clients. It used to be that when you were to ask about impact, whether it's your financial advisor or the manager of your pension, it was pretty quickly dismissed as that will lose you money. And thanks to a number of larger investors as well as smaller investors, just consistently persistently demanding it and in fact voting with their dollars, leaving their advisors, leaving those institutions if they didn't give them something.

Eventually, like I said, the largest asset managers, they all have products. They realized this is a big enough business and if we don't have a solution, we will lose assets.

And so both of those things have been really important ingredients to get to this point where we have a lot of great investment products and funds that are supported by investors and are managed by really talented professionals. It's ripe, it's investible today.

Hal Weitzman: Okay. Some of the period you've talked about, you said it's really grown, has been a bull run, right? And I'm guessing that in a bull run it's somewhat easier to sell. This kind of people are feeling more generous and they're feeling wealthier and they feel like, "Oh, maybe we'll try something a bit different." So things like impact investing, and by the way, also things like crypto are more likely to attract investment when the stock market is going up and has been for a while. Is it harder when things are more uncertain in the market?

Priya Parrish: Yes. That's generally true of anything. Like you said, the movement of capital.

Hal Weitzman: Yes. Okay, so I can take point.

Priya Parrish: So impact investing-

Hal Weitzman: Is impact investing specifically a harder sell when we're not in a bull run?

Priya Parrish: When we have had soft patches in investment markets in the past, impact investing in ESG suffered a slowdown. And in the last few years-

Hal Weitzman: Just to clarify, so you mean a slowdown more than the rest of the market or about the same?

Priya Parrish: I don't know if I can quantitatively say that, but it was a noticeable slowdown. I don't know the answer to that.

In the last several years, and we've seen public go up, but private markets have been trickier. Some of the most difficult markets for venture capitalists, especially in the last couple of decades, and we have not seen that same slowdown.

In fact, impact investing is one of the investment strategies that continues to gain new investors and new dollars and new slots. So in many ways, I think the last several years has been a sign for me that there is enough credibility, enough demand, enough stickiness, enough talent that we can withstand the ups and downs of markets because that is what a market is. It goes through cycles, and continue on our path and trajectory. So it is different this time.

Hal Weitzman: You talked about there's the huge number of options and now big if you want to go with an impact investing fund with a big established financial firm, you can. Or you can go with a small niche firm like we talked about at the beginning.

If impact investing is all about human capital ability, expertise, how does a typical retail investor, I'm not talking about pension fund, I'm talking about you and me. How do we identify that? What should we be looking for that would tell us this is a fund with expertise that's worthy of your investment?

Priya Parrish: Yeah, I think that's important to ask because unless you're accredited or a qualified purchaser, investor, you can't invest in venture capital or private equity, and that is where a lot of some of the most clear impact investment funds are.

However, there are mutual funds, there are ETFs, and I think the tricky part there, to be honest, is that I think there is a bit more marketing on that side of it, and it does tend to lean more towards ESG investing. Which from the last time we chatted, we talked about how ESG investors, they're considering these facts, but it's not necessarily with an objective to create a certain type of impact.

And I think you have to believe and approach it in two ways. One is that there is systems change. A lot of the emergence of this and the stickiness of this investment strategy and industry is because all these dollars have moved, and even if you look at ESG, which is the cousin to impact investing, the trillions of dollars that have moved there has been an important shift towards the largest asset managers in the world saying, "We better offer something."

And so just putting your money behind things that are having some intention of doing this is having a positive effect. Even if it's, there's a very fair criticism, I'm investing in this ESG fund and it's invested in Coca-Cola, there's fair criticism. We could have a whole topic on that, a session on that, but there's something going on there.

The second thing you have to believe and do is that no matter how small you are as an investor, your voice matters. You should call iShares or Vanguard or whoever it is, and you should ask them or whoever manages your 401k. I see this fund is labeled this way. What does it mean? Can you tell me," and I don't agree with that. I would like to see this because it is that demand that has created this emergence and we are, you are the client to these firms, and unless you pick up the phone or write the email or tweet it or whatever you do, the change won't happen.

And the same thing. You can vote your proxies, you can participate in shareholder resolutions. You can directly engage with public companies and private companies. So there is always something you can do.

But we can start even smaller, which is who you bank with, who you bank with. That bank is where they're lending to, and there are certain banks who are lending to industries that you don't agree with, and there are certain banks that are lending in your local community and creating jobs and houses. You have a choice, and so you don't have to be extremely wealthy.

And the last point I'll make is that aside from your own money, we are all active citizens and workers and wherever we are, and so where you work, you should ask them, "What are they doing?" Where's their money invested? Who is it benefiting, and who is it hurting? And you can make a choice and your voice really, really does matter.

Then you can walk out those doors and work somewhere else, live somewhere else. If it's not aligned and I'm making it seem easy, I understand there's a lot that goes into that. We all don't have that privilege, but the point I'm trying to make is that I think we have more agency and more power than this massive investment industry wants to think we do. We are their clients.

Hal Weitzman: I'm thinking as you're talking, if I can take my political views, my social views and build a portfolio that reflect, that enhances those, that gives impact to those ideas, are we all impact investors or could we all be impact investors? Is it going to be like voting but with our money instead of with our votes?

Priya Parrish: I do believe so. In my professional career, I have been asked before to manage portfolios that are based on values that are not mine, and I very willingly want to support that because I believe investors have a right to have their capital aligned with their values.

For example, there are impact investors out there and whether they call themselves or not, my point is there are investors out there who want their portfolio to reflect pro-life values. There are those who want to reflect support of the gun industry and the opposite sides of those issues as well. Let's protest against that. We don't want these things to exist.

And the impact investment industry in many ways has responded favorably to all of those sides saying, yes, if that's what you want, there is a way to do it. It's all about that matchmaking and transparency, and so it doesn't really matter what your values are.

The point is that you have a right in the investment industry should be able to respond and do it that way. That's why I say it's a big umbrella and a big tent for impact investors. This is not for some segment of society. Your money is actually already having an impact.

The opportunity is for the investment industry to finally bring some transparency to it. We all have a right to know what our mutual fund is invested in, and we have a right to walk with our dollars into something that's more aligned. And so that's the paradigm shift, and I think that's what the impact investing community builders and field builders like myself are trying to do is to try to put that pressure because this is not some technologically advanced thing to do. This is all very possible, and I believe everyone's right.

Hal Weitzman: Is there some kind of a website where you can go and put in your portfolio and it will tell you what impact you are having? Has someone invented that or you could go and say, "I'm interested in XYZ," and it will spit out a portfolio for you that's impact focused.

Priya Parrish: I don't have the answer to that, and I wish I did. I think there have been many attempts.

Hal Weitzman: If somebody's listening to this and invents that makes a lot of money, I want some of that money.

Priya Parrish: Give me a call too, yeah.

Hal Weitzman: Okay. Priya Parish, it was so much fun having you back on The Chicago Booth Review Podcast. Thanks for joining us.

Priya Parrish: Great. Thank you for having me.

Hal Weitzman: That's it for this episode of The Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research.

This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe and please do leave us a five-star review.

Until next time, I'm Hal Weitzman. Thanks for listening.