Back to Basics: a VC's Perspective on ESG Investing

In 1970, Nobel-Prize Economist, Milton Friedman, famously declared that the only social responsibility for businesses is to increase profits for its shareholders. Yet, this age-old adage is increasingly being challenged. Today, the idea of impact businesses has gained some traction. Even BlackRock, the world’s largest asset manager, has pushed for a global impact standards criteria better known as ESG (Environmental, Social, Governance). The message seems to be loud and clear: social impact and long-term returns can go hand in hand.

Impact or ESG investing is conventionally a practice of channeling investments into value-aligned firms to generate social or environmental impact while generating financial returns.

Societal challenges, such as the lack of access to education and financial capital, remain pervasive in the ASEAN region. Yet while many governments in the region face fiscal constraints in tackling these hurdles, the private sector has been increasingly robust in meeting such societal challenges through impact businesses. According to Nomura, financial inclusion has been steadily improving in the region with the rise of financial services that provides alternative lending solutions. The bank says that investment in this sector accounts for 44% of total impact investments in the region between 2007 and 2017. The world of Venture Capital is catching on too. In recent years, there has been investor appetite in the ASEAN region for microfinancing options, online education as well in firms with environmental sustainability in mind.

What if there is another way of looking at impact businesses? The notion of social impact is broad. Does impact only imply environmental stewardship? Does it mean helping the poor and needy? Regardless of what impact businesses attempt to achieve, the principle of any impact business must be built on one key measure, good corporate governance.

Kolibra and its partners echo the zeitgeist as well, however with a twist. A lot of emphasis on ESG investing has been placed on the social and environmental aspects. Teezar Firmansyah, a partner at Kolibra, says that: “Beyond just the window dressing of impact that is popular, the “Governance” aspect of ESG must not be overlooked.” ESG is broad, but good corporate governance is imperative in generating long-term impact. He asserts that integrity, good governance, and upright principles ultimately allow firms to stay in the long run to make the biggest impact. “For example, helping farmers is not through running a charity for them. To truly make an impact is to set up opportunities for them to ensure that their incomes double or triple” says Mr. Firmansyah. Beyond just generating long-term returns, companies with professional integrity benefit all stakeholders through the employment they generate and the value they add to society. To Mr. Firmansyah, that is the essence of impact investing.

Creating impact through good corporate governance means active management by investors in the boardroom. It starts with prudent due diligence to filter out good companies from the crowd. According to a study by The Economist, the average VC screens 200 target companies annually, but only invests in 4 of them. VCs and investors ultimately have some sway on which direction a firm is going. Impact is generated when investors take on an active role in fostering trust through thoughtful interpersonal relationships with its founders and collaborating to build a sustainable business. It also means taking the hard route by being an activist and speaking out when founders lose sight of the founding integrity in pursuit of short-termism. This pursuit of impact is subtle but pragmatic. Venture investing is ultimately a long-term project. Sowing the seeds, ensuring companies grow well, and maintaining the future sustainability of the firm are the fundamentals of all good business practices. This is what generates both good returns and sizable impact.

These strategies for impact are not new. If anything, it goes back to the fundamentals of investing. Nowhere is this better exemplified than in the impact created by Muhamad Yunus. Through his enterprise, Grameen Bank, he helped to pioneer the concepts of microfinancing and microloans. Grameen Bank helped to provide capital for the poor without the need for collateral. Under good governance, the bank was able to balance its mission of impact while generating value as well. The pioneering impact of Grameen Bank won Mr. Yunus the Nobel Peace Prize for promoting bottom-up economic development.

Moreover, the impact of good corporate standards is backed up by studies. Consulting titian, McKinsey, found that in a study of more than 1,100 company directors, boards with better corporate governance such as “better dynamics and processes” report higher financial performance compared to their peers.

The conventional wisdom that defines good business practices is changing rapidly. Larger demographic change will bring about new attitudes and preferences. Moreover, with a young population in the ASEAN region hungry for a taste of greater socio-environmental impact, impact business growth may materialize. However the fundamental KPI for any business is constant, only good governance can yield long-term returns and broader impact. Milton Friedman’s thesis above is often a misquoted one. It is not about the pursuit of profit above integrity and social responsibility. In context, what he meant was this: the social responsibility for businesses is to play by fair rules to increase profits for its shareholders and benefit its stakeholders.