ESG And The Future Of Impact Investing: A Conversation With Jim Sorenson And Terrence Keeley

At the recent Sorenson Impact Summit, leaders from across the field of impact gathered to share their vision for transformational global change, aiming to spark innovations to drive investment in urgent, actionable solutions. The event featured a fireside chat about the future of impact investing and the role of ESG with Jim Sorenson, Founder of the Sorenson Impact Group, and Terrence Keeley, finance-industry veteran and author of Sustainable: Moving Beyond ESG to Impact Investing.

Below is an excerpt from their conversation, moderated by Lauren Sercu, Co-Founder and Managing Partner of Sorenson Impact Advisory. Sorenson and Keeley discuss their perspectives on ESG, their shared passion for impact investing, and what they believe are the industry's greatest opportunities.

Lauren Sercu: I'm excited to spend this evening with two pioneers of impact investing, Jim Sorenson and Terry Keeley. Terry, please tell us about your recently published book, Sustainable: Moving Beyond ESG To Impact Investing.

Terrence Keeley: The fundamental premise of ESG investing is to do both well and good, thereby achieving a double-bottom line. It was born out of the United Nations' Principles for Responsible Investment, which started in 2005. In my book, I talk, among other things, about how indices are created. Almost all investment operates in indexed space. In contrast, impact investing is based upon additionality -- that is to say, achieving something tangible beyond financial returns, such as lower carbon emissions, more low-income housing, or healthcare services that benefit underserved communities. The ESG market is about $50 trillion, of which only $2 trillion is dedicated to impactful outcomes like these. More than $40 trillion in investments that were intended to generate double bottom lines don't. This amounts to the greatest misallocation of financial assets in history.

I like to discuss 401Ks with my nieces, nephews, brothers, and sisters at Thanksgiving. I recently learned almost every one of them owns Vanguard's ESG funds. When I asked why, they all responded, "To mute climate change" or " To help make the world a better place." Sadly, these investments will do no such thing. In fact, most of those funds they own are solely based on temperature alignment -- meaning they only invest in companies that are already prepared for the net zero transition. If we are to have any hope of achieving net zero, we will need to transform our dirty industries -- we shouldn't divest from them; we should invest in them. This would require flipping most ESG products on their heads! To do well and do good, we should invest in products that have great returns while simultaneously improving social outcomes and/or environmental sustainability. That's what ESG investing was supposed to do, but isn't.

LS: I know you two have differing views on ESG and the role it can play. Terry, can you help us understand exactly where you come out on ESG?

TK: In a typical institutional allocation to ESG, a respected firm like CalPERS calls their favorite State Street or Blackrock salesperson and says, "I'm worried about climate change." The salesperson says, "That's awesome! We're worried about climate change, too. Why don't we design a nice index for you to invest in, and that's what we'll manage your assets against?"

In the ESG industrial complex we live in, the bulk of the market is about trying to beat these types of customized ESG indexes. Too few people are asking, "What impact are my investments having? What problem have we solved? If we just do more of what we're already doing, will we solve the greatest challenges of our time?" Sadly, the answer is no, even after allocating trillions. ESG was born with very good intentions. Many good things have come out of it. But we now need to engage in honest reflection and be more rigorous about the results we're actually achieving.

LS: Thank you, Terry. Jim, I know you prioritize thematic impact investing across your investment portfolios, the exact type of investing that Terry is speaking about. I also know that you find merits in ESG. Can you share your views?

Jim Sorenson: Terry, I respect your views, and I know you're very passionate, but I disagree with you in terms of throwing ESG out. ESG is all about material risks. It's not perfect, and materiality is obviously one of the big issues of ESG. But material risks matter when you're making investments.

I have personal experiences with investments where I didn't take into account data that I knew could be material and made decisions that ultimately affected my returns. We can't be responsible as fiduciaries without taking these into account. Will they produce the same measurable impact that we have with impact investing? It comes down to our commitment to measuring and tracking those impacts. That is an evolving field in impact investing. There are efforts underway, and we're making progress.

Impact investing is not perfect, but when done right, you are going to find better returns, and you're going to benefit society. Of course, I'm highly committed to impact investing. I also firmly believe [ESG] is going to evolve. Right now, it's become politicized, which is unfortunate because the arguments lose merit when you label it. People sign up for the label because of a partisan position. This needs to be thoughtfully worked out.

TK: Jim, we have no disagreement on risks and materiality. The last three chapters of my book explore how we can fund the United Nations' Sustainable Development Goals. At the end of the day, we need to find $3.5 trillion of private capital a year. Given there is $220 trillion under the direct control of institutional investors and ultra-high-net-worth individuals, the allocation to true impact that is needed amounts to 1.6% per year.

We need to think more clearly and be more vigilant about keeping promises, which is where too many ESG funds have gone awry. It's now too easy to call investment products "sustainable." When you read the small print and examine what your funds are doing, you'll see there is nothing sustainable about how the assets are deployed. There is no additionality.

I want to make sure we understand how we are aligned. There are many opportunities and valid investment theses which simultaneously serve the underserved and generate good financial returns. The Sorenson Impact Foundation has proven how one can do well and do good.

JS: I love your passion. We know ESG has "arrived" because of the controversy around it. We can improve it. We share a passion for impact investing. How do we create more products and more intermediaries, and more on-ramps for investors to be able to become impact investors?

TK: And it's every asset class. It's not just public and private equity. There's a lot to do in fixed income, cash, infrastructure, and real assets that genuinely are value-generative and have additionality.

LS: How do we get capital to flow to the solutions we're talking about? Terry, you've worked with some of the largest institutional allocators globally -- universities, pension funds, foundations, etc. What is the state of the field as it relates to those large allocators, and how do we get them to drive capital toward impact investing?

TK: We need to think creatively and meet people where they are. I have had the privilege of serving on the Board of Trustees at the University of Notre Dame. Notre Dame has the No. 1 performing college endowment in the country, even though they employ a Catholic values screen. Annualized returns over the last 20 years have been close to 13%. The CIO, Mike Donovan, will tell you, "We do not intend to invest for impact. We want to maximize returns subject to our moral values because we know we're going to do something really good with the money, such as give needy kids scholarships. Our job is to maximize profits consistent with our Catholic values -- nothing more."

That said, a growing number of institutions know their long-term returns very much depend upon solving long-term problems. For example, insurance companies prefer a world with fewer catastrophic storms, while most pension managers and sovereign wealth funds will do better if there is no social unrest and peace among all nations. Fortunately, for institutions like these, there is the green bond market. Green bonds will probably constitute a $10- to $12-trillion market in the next decade. In the process, they will transform a lot of industries' communities. More institutions should be asking, "Since we need to own a lot of fixed income, why not own more green bonds?" This is a very promising opportunity.

Similarly, we have a major housing affordability problem in the United States. This can be largely solved through the type of things Zita [Cobb] talked about -- community-focused investments that solve community problems profitably.

LS: Jim, you've been watching the impact investing ecosystem since its infancy. What do you see as the industry's greatest opportunities and challenges going forward?

JS: It takes time. When we made the decision to move forward with the foundation, we wanted to do it across asset classes. We wanted private equity, public equities, value, growth, hedge, fixed income -- I don't know that we would have been able to do that five years earlier. There weren't products, fund managers, or options out there.

This is the biggest challenge and the biggest opportunity. Investors are going to create the demand. We need to continue to build the products, the intermediaries, and the ecosystem. Certainly, the needs in the world are ever-increasing. I feel deeply that most people if they had a choice to invest and get good returns on something that benefited society or invest for good returns on something that didn't have any real positive impact, they're going to choose the things that benefit society.

I'm optimistic that if we can enable and create the ecosystem -- and that takes real collaboration from all stakeholders -- we will see the type of adoption that Terry is talking about beyond $3 trillion a year. I'd love to see the day when we have enough products out there that impact can be a part of every investment decision.

LS: Well said, Jim. I think building the ecosystem and demonstrating the proof points is what we will need to catapult this industry. One final question: If the world could know one thing about impact investing, what would you want it to be?

TK: Ultimately, we will get the world we deserve. If we are mindful of our consumption patterns, how we raise our children, how we care for our communities, how we invest our capital, and how we vote our shares, we will achieve a more inclusive, sustainable, and prosperous world.

JS: There's a place for everybody in impact investing.