“It is often said that actions speak louder than words. But in law, words can speak louder than actions.” Wharton Social Impact WISE Fellow Edward Grigg, LLM candidate at Penn Law, reflects on the importance of legal documents in the field of impact investing.

Reading legal documents is not as exciting as watching Mission Impossible. But it can be much more impactful. Legal documents reflect the ambitions of parties that sign them. For this reason, the text of an agreement is often the best place to start when assessing a party’s commitment to impact investing.

Impact Investing

Impact investing means different things to different people. For some, it represents the core of their investment philosophy. By deploying capital in a targeted way, they aim to maximize social and environmental gains, not just financial returns. For others, impact investing is more of an ideal. Although they may pursue it, their investment strategy does not require it.

Wharton Social Impact Initiative (WSII) is dedicated to researching impact investing in all its forms. I joined WSII as a WISE Fellow to research how investment agreements address and measure impact. It is often said that actions speak louder than words. But in law, words can speak louder than actions. The strength or weakness of contractual provisions provide written proof of a party’s dedication to social impact.

Take renewable energy, for example. If the operating agreement of a fund only mentions renewable energy in passing, then its commitment to environmental impact is minimal. By contrast, if the agreement includes a contractual provision that requires the fund to invest exclusively in renewable energy, then its commitment is significant.

Analysing investment agreements can provide real insight into how different parties address social impact. My legal background meant that I was well placed to carry out this analysis. As part of a WSII research team, I reviewed a wide range of documents to assess the form and substance of their commitment to social impact. These documents included operating agreements, private placement memoranda (PPMs) and limited partnership agreements (LPAs).

Lessons Learned

The experience taught me three lessons.

1. Impact investing can have many forms.

Funds may target specific sectors (like sustainable fishing), pursue particular goals (like job creation for low income communities) and make certain demands from the businesses they invest in (like requiring women to fill 30% of senior management positions).

This diversity explains why impact investing is sometimes referred to as ESG (environmental, social, and corporate governance) investing. In my experience, however, ESG only captures part of the picture. The reality is that impact investing takes many forms, reflecting the many ways in which impact can be achieved.

2. Impact investing is a serious enterprise.

Over the last 20 years, critics have claimed that managers often talk up impact investing to “greenwash” their funds, making them seem more serious about social impact than they actually are. This criticism is misleading. Based on my research, many funds have a genuine commitment to impact that goes beyond mere greenwashing.

3. With that said, impact investors can stray from their core focus.

Today, hedge funds typically charge a 2% management fee and a 20% performance fee (taking 20% of all profits made above a certain threshold, known as the hurdle rate). Some of the impact funds I researched had rather more generous fee structures. One included a 3% management fee. Another did not have any hurdle rate.

Provisions like this risk reducing a manager’s incentive to deliver good returns. They also steer more capital into the manager’s hands. Neither of these outcomes is necessarily bad, but both raise the question of whether the fund is geared towards achieving the most good possible. Going forward, it will be interesting to see what norms develop around management remuneration in impact investing.

Overall, my time at WSII has been invaluable. By researching impact, I have had the chance to make an impact myself. I have learned a great deal, developed new skills, and built friendships across my team. The mission was satisfying, stimulating, and thankfully, not impossible.

— Edward Grigg

Posted: August 14, 2020

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