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Empathy Return on Investment (EROI)

There is universal consensus that investing approaches must be modernized for the 21st century. The notion that investors can be purely financial motivated will soon be an ancient frame of mine. Across all markets, broader social and environmental concerns are be factored into investing strategies.

Investors are beginning to bite at the social impact apple. The Global Impact Investing Network (GIIN) estimates that by April 2020 the size of the impact-investing market, assets dedicated towards social and environment gains alongside financial returns stood at $715 billion in April, a 42.4% increase from 2019. By 2025, the social impact market is poised to hit $1 trillion.

As assets gravitate towards social investments, the question is how we capitalize on this momentum to make our investments truly altruistic.

Considering broader altruistic goals in finance is welcome news. The rise of social impact investing has prompted a long overdue rethink on sustainable and long-term investing. Far too long, investors have ignored value-based factors to their detriment or fought to undermine its idea labelling it as simply an exercise in virtue signaling.

It’s becoming clear for many considering non-balance sheet driven objectives can be beneficial for not for the globe, but for the bottom line.

But for socially conscious investing to be carried out properly we must also change how we measure our successes. Despite new enthusiasm, proper guardrails and guidelines around social impact must be put in place. As Wendy Abt, founder of Strategic Investment Advisory argues, “a confusion about impact investing’s key principles and practices has it headed for a fall.”

In other words, considering ESG (Environmental, social, and governance) factor, implementing responsible investing framework, and sounding the alarm on climate portfolio related risks will not be enough to sustain social impact investing for the long term. These are strategies still predominantly driven by boosting financial performance with a hope for making a marginal societal difference after investor pick up financial gains.

Another hurdle to further adoption is organization’s internal assessment of their social impact goals. Many companies struggle mightily how to define, measure, and improve on their own positive social missions. Mission statements are often misaligned with their core business goals (i.e. Exxon’s ambitions to be more carbon neutral) or lacking proper benchmarks to judge progress (i.e. Nike’s work on factories in Asia).

Additionally, the current lack of clarity of social impact term will hinder social progress. Seeing the ambiguity and amorphousness in the lexicon of social impact investing will either scare off investors or make them put forth lukewarm commitments. This is already evident as investors in a 2019 RBC study noted shifting terminology as a key barrier to considering additional social investments.

Furthermore, there is also the possibility that they will soon measure the progress the same way they measured things in the past – by a strictly return on capital investment. As seen by many of BlackRock CEO Larry Fink’s interview where he hopes to have ESG as another “metric on the balance sheet.”

Social impact and responsible investing need to be a long-term commitment buoyed with continued enthusiasm and a proper framework. Stripped of the narrow view of only chasing profit.

EROI – the path forward

There needs to be a new way to measure progress with our allocation of capital.

We cannot create new benchmark with the old frame of thinking. Nor can the status quo of measuring progress be enough. Asset consultants such as Mercer, Russell, Towers Watson have developed their own way of measuring of social impact and responsible investing’s funds with the same arbitrary guidelines they assess the quality of traditional funds. Despite noble and well intentioned efforts, their barometer for success is usually incomplete as their small teams simply don’t have the bandwidth to provide a qualitative assessment of each product as they suggest they do. Their ranking system provides more confusion than clarity.

Data vendors and metric tools focused on social impact and ESG are also lackluster with their efforts. Many suffer from the same shortcoming of ambiguous definitions and standards on core metrics such as diversity, gender, carbon foot printing, and proper governance with each having varying sets of ranges. The Wall Street Journal found that scores from the top data vendors were only correlated 68% of the time.

There must be a new innovative yardstick. One that can deduce our understanding and care for the investments we make. Establishing a criterion to evaluate the power of our purpose is crucial to pushing forward the social impact conversation.

An empathy return on investment metric may be the key.

A prominent buzzword in our age of self-help, empathy is a crucial component in providing and investing in others. Empathy is the practice of understanding and sharing the feelings of others. A person, place, or organization are empathetic if they possess a deeper observation of the outside world. You embody empathy if you can feel the pain of others even if it doesn’t directly impact you. As novelist Mohsin Hamid puts it, “empathy is about finding echoes of another person in yourself.”

Empathy can be a powerful tool for investors. For starters, empathy sparks curiosity. A key tenant of empathy is having interest in new things. Looking for new experiences and realities translates into having a better understanding of the needs of the world. If investors are more curious, they are likely to consider broader goals then they would if they stuck in their rigid frameworks. They are also likely to uncover new opportunities for their portfolio.

Building standardization around empathy can be based around the three core versions of empathy. According to psychologist Daniel Goleman and Paul Ekman empathy can be bucketed into the following groups: cognitive, emotional, and compassionate.

Cognitive Empathy: can also be defined as perspective-taking. This type of empathy puts you in other people’s shoes. Allowing you to see their perspective. Investors can be evaluated on how often they and their project connect outside their surroundings. For example, if a fund spearheads research projects or deploys capital in an area outside their focus and sustains this investment over time, this can beconsidered cognitive empathetic. Alternatively, if an investor re-shapes internal cultural and hiring practices to bring in new backgrounds that can also be a sign of understanding cognitive empathy.

Emotional Empathy: This type of empathy is when you understand other people’s pain. You may not have experienced someone sense of hardship, but you comprehend the agony one has. Even social impact investor rarely interacts with the people of the project they are helping. Better emotional empathy is the investor curious in agricultural and farmland meeting with farmers who’s crop yield have been eroded by climate change or ineffective trade policy. Another form of emotional empathy is interacting with those who have lost jobs before making an allocation to job re-training programs. Or meeting with those who are priced out of their homes before you put capital into affordable housing projects. Understand these experiences can be crucial to maximizing investments towards these initiatives. As investor, it can be pivotal to understanding the underlying problem.

Compassionate Empathy: This type of empathy encapsulates the active part of empathy. Where one is taking action to help. This is likely the easiest part of an EROI framework to measure. After one undergoes research on prospective investments and interacts with those who would potentially be a beneficiary the next step would be to make investment. Investments would be evaluated under this part of EROI only after we see if they have taken the steps to be cognitively and emotionally empathetic. Then there can be an assessment if the actions address the need of the underlying potential beneficiary of the investment.

Benefits of EROI

There are several advantages for investors to utilize an EROI framework. Having an EROI to consider alleviates the burden of investors to jump over arbitrary non-financial benchmarks and scores. As mentioned, rating agencies and third-party vendors have been unsuccessful in creating metrics that are altruistic driven. This ultimately hinders an investor hoping to be mindful of how their capital is allocated. EROI is truly measured on non-financial indicators. Unlike the other benchmarks and guidelines, there is no haziness about its true intention.

Considering EROI improves the entire process of investing. Having a strong EROI signals the investors better understands an investee, the product or program they are pushing, and the larger impact they can make.

EROI amplifies social impact. Faring well under an EROI assessment means investors understand the pressing issues at stake and are committed long term to pushing capital in areas where the most good can be done to help with that challenge. It means they have done the extra layer of research and understand the benefit their investment can make.

Finally, EROI is also not mutually exclusive from considering ROI. The past decade, and especially during the pandemic, of social impact investing has shown you don’t have to take a hit on performance when supporting benevolent causes. With sinking energy and industrial prices this trend will likely continue. Thus, it is possible to evaluate the capital prospect of an investment and its impact on underserved community or under addressed issue at the same time. Plenty of small and large organizations such as UBS, Goldman Sachs, Patagonia, and the World Wildlife Fund have proven this.

Conclusion

In its early stages, EROI may not be easily quantifiable. Like any metric, it will not provide the complete story. But unlike the other social metrics, its intentions are pure and clear. The three-tied EROI framework details what conditions need to be first me to considered successful under this rubric. Further, passionate souls and curious minds can productively debate better ways to shape this metric to better assess how empathetic an investment or investor is. The path towards a more just approach toward investing should be taken seriously. No pushback should be muzzled. That would run counter to the notion of empathy!

It is clear we are building a better model for investing. All over the world, investors are finally considering the components to a more sustainable and equitable future. In order to effectively move forward, investors need to be more connected with the recipients of their capital. They need to understand their motivation, story, and goals. The only way to do this is with more empathy.


About the Author

Shounak Bagchi is a global finance consultant. He focuses on sustainable investing, climate risks, and the importance of empathy. You can find more of his work and thoughts at @shounakb1086 and his bi-monthly newsletter https://honestwednesday.substack.com/