Thought Leadership At UC Davis Graduate School Of Management: Professor Ayako Yasuda On Impact Investing

Against the advice of an early mentor, Ayako Yasuda accepted a job offer to become an analyst at Goldman Sachs after earning an undergraduate degree in economics from Stanford University.

It did not take her very long to realize that her life’s passion would lead her to a deeper intellectual journey. Her curiosity and love of learning would steer her toward the study of sectors that are critical engines of growth and innovation for the economy. Yasuda explored the hot fields of venture capital, impact funds, social entrepreneurship, private equity, and long-horizon institutional investors.

Her paper on impact investing would win her and her co-authors Brad Barber and Adair Morse the prestigious Moskowitz Prize in 2016, the only global award recognizing outstanding quantitative research in the field of sustainable and responsible investing. She not only has a proven track record in research, however. She also is a master teacher, having won the UC Davis GSM Teacher of the Year Award for her coursework with full-time MBA students.

In this interview with Poets&Quants Editor-in-Chief John A. Byrne, part of the Thought Leadership Series with UC Davis Graduate School of Management, Yasuda revisits some of her early formative decisions and what she has discovered through her years of research. She explains the difference between impact, ESG and socially responsible investing and why there is confusion in the marketplace about what constitutes impact investing vs. ESG investing.
Yasuda joined Goldman Sachs’s investment banking division in 1993 after graduating from Stanford University in 1993 with a degree in quantitative economics, After a two-year stint, she chose to return to Stanford for a PhD in economics which she earned in 2001. Armed with that degree, Yasuda joined the Wharton School at the University of Pennsylvania for eight years. She joined the UC Davis faculty as a professor of finance in 2009 where she first began teaching and researching venture capital.

John A. Byrne: Let’s start from the beginning, What was it that made you think, wow, the career of an academic is the career that I really want?

Professor Ayako Yasuda at UC-Davis Graduate School of Management

Professor Ayako Yasuda at UC Davis Graduate School of Management

Ayako Yasuda: It started with my uncle, who was a professor. I would visit my uncle and aunt in their summer home when the school was out and my parents were still working. I would bring a lot of my books. I was seven, so I would read my books next to my uncle. He would spend his day reading, thinking, and writing his books.
And as a girl, at age seven, I looked at their life and I thought, ‘Wow, this is fabulous.’ So that was sort of imprinted on me early on. And then later, I had a very excellent middle school history teacher and he really impacted me, and opened my eyes to the power of research. I was growing up in Japan in Tokyo, and he would teach a version of Japanese history that textbooks don’t really cover in detail. But it was very historically true and important. So it was kind of a courageous thing to do, and I think he taught me the importance of discovering and speaking the truth.
And then finally, the most obvious influence was my undergraduate professor, Professor Masahiko Aoki, who I had as a sophomore at Stanford University. His economics class inspired me to study economics as an undergraduate student. Although I went to Goldman Sachs against his recommendation to go straight to graduate school, I realized two years into it that he was kind of right.

Byrne: He knew you better than yourself at that moment.

Yasuda: He saw that in me and it meant a lot to me and that’s when I decided to apply to grad school and went back to study for my PhD. I never looked back because I knew that I loved research and I wanted to be like the people who inspired me.

Byrne: What was your dissertation on?
Yasuda: My dissertation was on competition in banking markets. Along with deregulation in the U.S., there was a breakdown of the Glass-Steagall act and investment banking and commercial banking were emerging. This was an area I had a lot of practitioner knowledge in from my days at Goldman. So I think it did influence the choice of my thesis. I was able to combine my academic training as a grad student with my practitioner knowledge in ways that pure academics wouldn’t really see. So I wrote my dissertation about commercial banks’ ability to leverage their relationship banking to win bids in underwriting markets.

Byrne: Right. And then your research interests evolved over time because you’ve explored the financing of startups, private equity, venture capital, and more recently you did a paper on impact investing that won a very important prize in sustainable and responsible investing.

Yasuda: Yes, the Moskowitz Prize.

Byrne: Yes, congratulations on what is a real honor. How do you jump from one thing to the next during your academic career?
Yasuda: That’s a good question. Some of them you kind of stumble upon. For example, venture capital. When I started teaching at Wharton, business schools didn’t teach venture capital But it was right after year 2000 when everybody wanted to learn what is this new thing called venture capital. So Wharton asked me to teach a course.Maybe I had some sort of a geographic cred coming from Stanford, but not a ton of practitioner knowledge.

But after I taught the topic for several years, I thought why not do research? I also wrote a textbook that helped me really think about it as a more academic subject. And then venture capital sort of bled into private equity. My more recent interest in impact investing again came from my existing work in venture capital. Investing is a topic that a lot of people are interested in, but a lot of people are confused about.
Often it’s confused with ESG investing, but they are very different. And in fact investing in a way that’s done most commonly is in the private markets. And because venture capital is private capital, some of the most well-known impact funds were VC funds which I knew a lot about. I was very curious. Can sustainable finance make a real difference? Because there are skeptics as well. Is it really something that can have a broader impact on society and the environment?

Byrne: Now I believe one of the things you discovered is that impact investing funds have a lower internal rate of return than traditional venture capital funds. Does that matter? Because the less tangible benefits of investing in an impact fund may matter more to the individual investor than the actual return. 

Yasuda: Yes, I think that’s exactly why it matters. I want to be a little bit careful here because there is also this notion of doing well by doing good. That’s like a mantra.  Impact investing is investing with an explicitly dual objective of trying to get a financial return and also generate positive impact, social impact or environmental impact. 

Related but different is something called socially responsible investing or ESG aware investing. So the first one, let’s call this person Sam. So Sam is guided by a lot of ethical principles. He feels it’s ethically wrong to invest in private prisons, for example. So he doesn’t want private prison operators in his portfolio. That’s how he exercises  his social responsibility. Sam is a socially responsible investor. A lot of people would say the same thing about gambling or more recently fossil fuel. 

So that’s a class of investment that’s practiced through exclusion. I don’t want to invest in something. Now the second person I want to bring up is Inger. And Inger wants to make clean water access more equitable for societies of all different backgrounds. So she wants to flex her financial muscle by backing startups that do that. She might invest in companies that build and distribute water pipes in developing countries where clean water is not widely available. 

Or you might be able to do more rainwater harvesting and that would conserve a lot of water. And that’s actually relevant here in California, too. So that’s the different between Sam and Inger. Inger is what I call an impact investor.

Sam has a conscience that he needs to alleviate. You know what I’m hearing? So one is like a positive tilt to something that she wants to allocate. Someone wants to alleviate conscience by eschewing something. So both are ethical investors but practice their investing in opposite ways. 

Byrne: Then you have ESG. 

Yasuda: Exactly. ESG, so because ESG, I’ll call her Ellen, okay? Kind of easy to keep track of. Inger for impact investing; Sam for socially responsible investing, and Ellen for ESG. So Ellen feels there’s a lot of disruption because of climate change, and we need to make changes to account for climate change. For Ellen, the goal is for the whole economic system to decarbonize. There’s a lot of risk that my portfolio is exposed to, and I want to climate proof my portfolio to minimize her risk. So Ellen wants to manage ESG risk, that’s her goal. So three investors, very distinct investment objectives, all very valid. But they don’t necessarily agree on what to invest in or what to not invest in. They’re all under this big umbrella of sustainable finance. That’s a big problem because every time we lump them together or we talk about one result, we amplify the confusion. 

So one common confusion is to say that ESG funds that invest in stocks that are highly rated ESG but fail to generate positive impact can lead an investor to conclude that impact investing doesn’t work. But these are not impact funds. They are catering to Ellen; they are not catering to Inger. So that’s one very common confusion. 

Byrne: As you point out, socially responsible investing is more likely to occur in a public setting while impact investing is more likely to occur in the private markets among venture capital funds. Therefore, it’s less visible to the public. 

Yasuda: Yes, less available to investors who might feel like Inger, but given the non -accessibility of venture funds, they might end up looking for things in what’s called sustainable, you know, Morningstar might say, these are sustainable funds, and they might decide to invest in them thinking that this is making a difference for the world. But what it might be doing instead is mitigating risk for your portfolio. So there’s this mismatch about the role and the responsibility of finance as a matchmaker between these different types of investors with their own objectives and the companies that want to achieve these goals. 

I worry that this confusion around ESG might be in mismatching. Another kind of confusion is a lot of people say that divesting from oil companies doesn’t make the world greener. And that’s probably true. But then you can’t conclude that impact investing doesn’t work because divestment is not impact investing. matters. People find that if you invest in ESG funds, you may earn as good a return as if you invested in traditional funds. And that’s where you would be doing well by doing good comes in. 

That’s probably a reason why asset managers love to say why not have the best of both worlds. But there is a mistake in saying that because ESG ratings are not measures of corporate goodness to society. They are actually measures of how resilient a stock holds its value against all the ESG-related risk. It measures the sustainability of your portfolio. And that’s what they say if you go to the rating agency’s website. But again, something gets lost in translation. I meet a lot of people who tell me that they think ESG ratings measure the goodness of companies. 

So one danger is that some people look at that and think, ‘Oh, this is a proof that all sustainable finance is greenwashing. It’s just marketing.’ They are very cynical about it. Another danger is to say that look, since we can do that in public equity, then why do I have to sacrifice any returns to really do good?

So coming back to the paper, I think it’s important because unlike ESG funds or divesting, we actually hand collected and studied impact funds. So these are funds that are VC funds that invest in startups whose very business idea itself is supposed to generate impact. 

We find that investors in those funds are willing to pay for the positive impact by accepting lower financial returns. They value the outcome in and of itself. So they might not be wealthier, but they are happier. 

Byrne: So they’re getting psychic income as an offset. 

Yasuda: Yes. In finance, we often equate happiness with a dollar and sometimes it might be a good approximation but ultimately we all maximize our own utility, our own happiness and we define it in many different ways. 

Byrne: Of course, socially responsible investing has been with us for a long time. There are people who didn’t want to invest in countries that practice apartheid, or in companies that make and sell tobacco for many years. But impact investing is a new and hot field. What makes it so hot? Are there newer generations of investors who are very concerned about what impact investments have on societal problems? 

Yasuda: I think one keyword is externality. Cleaner air or cleaner water benefits everybody, not just the company’s shareholders, not just company employees, not even just the company’s customers, but the whole community. 

Although socially responsible investing has a long tradition as ethical, the big difference is Sam’s way of doing it by protesting against apartheid. It’s about how you feel you’re doing the right thing. So it’s about input. It’s deontological, as espoused by the philosopher Kant. And that’s also very important. We all want to feel we are doing something right. 

There is a generational shift to focusing more on outcomes. And maybe some people say some of that’s also related to, let’s say, tech billionaires becoming philanthropists. They are doing a lot of impact-related investments. But I don’t want to attribute it entirely to tech billionaires. I think there is a broader generational preference in younger people to be focused on outcome rather than just intention. 

Byrne: That’s an interesting distinction again. Now there are relatively few people who can invest in a VC fund, which often requires a very significant investment. So does that naturally mean that impact investing is less accessible to an average investor than other classes? 

Yasuda: I can give you a two-part answer. Impact funds as VC funds remains less accessible than say investing in a mutual funds that does exclusionary screening. There are some more retail oriented VC impact funds that start at about $25,000. 

It’s still large but not as large as a million dollar minimum. That said, I think one other really interesting finding in our paper is that the willingness to pay varied a lot. Pension funds are a possible channel through which we as a society could invest in impact. 

People who are beneficiaries of pensions don’t necessarily make the decisions. But actually pensions were so instrumental in the rise of VC in the U.S. So one small rule change in the late 1970s that allowed pensions to invest in venture capital immediately meant much larger capital flows to VC firms, fueling the growth of the VC industry and Silicon Valley. 

Pensions represent intergenerational capital. If we tap into that to invest in something really innovative, it could have this dynamic effect with huge benefits. On one hand, pensions are often politically pressured to contribute to economic prosperity, especially in their region. So they do invest in community-oriented impact funds. But on the other hand, we find that European investors are much more willing to pay than Americans. 

And part of it is because a lot of U.S. investors have this really strict fiduciary duty that prevents them from considering non-financial factors when they make investment decisions. They’re supposed to make purely financial decisions when they invest. But what’s a purely financial decision? Short-term financial return maximization could also lead to long-term return destruction if we are not allowed to consider the impact of company activities on the environment.

We find that it’s restricting pensions not to make impact investments. Pensions might sound kind of boring, but they are a very important source of capital. So in the 21st century, I think a potential paradigm shift could happen if a change in a rule allows pensions to invest in impact funds without breaching their fiduciary duty. 

Byrne: I would think that one obstacle to a major change like that is the way we think of success financially. Right. Right. I mean, fund managers are routinely judged by the returns they provide. And when you look at those returns, they do not account for, let’s say, returns given to society. 

Yasuda: Right. They only account for the actual rate of return that an investor gets. To the extent that your success in the field is measured by your returns to investors, there seems to automatically be a discount, at least psychologically, to impact fund investors, and a disincentive to allocate too much money into that category of investment.

I think it gets amplified in public stock markets. So it might be easier in private ownership. We also find that if you are a mission-based organization, you are more willing to pay.

Byrne: That makes sense. You are able to justify those investments because you’re in a business of measuring non-financial outcomes.

Yasuda: I’m currently giving students a project to value a company called Sweetgreen. It’s a casual lunch food restaurant chain, but they receive some impact investment as a private startup. They are healthy, they are sustainable, and they also prioritize sourcing food locally. The company went public a couple of years ago at a very high valuation. But now the valuation is not so high. And the question is, ’Is that a fair valuation in a public stock market?’ And it’s also true that because the stock price has gone down, the company is now discussing whether it should ditch some of those non-financial goals in order to thrive as a public company. 

So when you’re faced with real-time competition and every day its reflected in your stock  price, it’s a harder thing to do. And perhaps in the hands of private owners who have articulated dual objectives, it might be where when you see a return differential, that might be where it can be more sustainable.  But I will also give you a second answer to your question. What can we do in public markets? An activist ETF allows investors to target an index. As long as they’re tracking an index return, an activist ETF would try to use their voting power to nudge the management toward better social or environmental policies. That’s an interesting model because they’re not trying to beat the market; they’re trying to track the market, but they’re asking investors, if you put your money in our ETF, then we will gather our voting power to nudge the management toward what we believe would generate more impact.
So that’s something that everybody can participate in. And it’s very nascent at this point, but I think it has the potential to introduce this type of dialogue to the mainstream public market.

Byrne: I wonder if what we need is an assessment of the value of the social good an impact company does because then that can be applied to the actual return and make lower returns appear more acceptable to impact investors. Because there obviously is value that’s un-captured by the social good a given company may be providing.

Yasuda: I completely agree. I think that’s the next challenge that the impact investing sector faces: coming up with measurements that are universally accepted and measurable. That’s where the battle is.
There are attempts to measure things, but when we have hundreds of different measures, it becomes very difficult to do the type of standardization that we take for granted as financial investors.
So research, I think, needs to go there. I myself am trying really hard to come up with the clever measures that we can establish in an academically accepted way. Academics do play a role there. And once we start to document these things sector by sector, maybe it could become more accepted in practice as well.

Byrne: Do you think there’s tremendous growth ahead for impact investing? More and more people want to put their dollars where they can have a true impact on society. And I would think we’re going to see the proliferation of more funds for people who don’t have large sums of money so they can actually partake in.

Yasuda: I think it depends on how many Ingers there are out there, as opposed to Sams and Ellens. And it’s a great empirical question. There are a lot of Ingers out there, especially in a younger generation. So then whether impact investing grows as a sector really depends on a few things.
One, I think it really needs to be articulated as something different from ESG or SRI. That cannot be overemphasized. Right now there’s so much confusion among academics, practitioners and consumers.

Number two, I think to help make that distinction clear, policymakers can play a role there. European regulators are a step ahead in asking the funds to clarify themselves. What are you? You can’t just say I’m a generic sustainable fund. What kind of sustainable fund are you? The SEC has started to move in that direction, but I think there’s so much to do to get to a place where Inger and Sam and Ellen can just open up a website and easily find the right funds that reliably serve their objectives.

To do that, I think we need to have very clear labels and ask investment managers to actually commit to what it is that they’re doing. You can’t be doing ESG one day and then impact another day and back to ESG the next day. There are some investment firms that say this is an impact investing fund when in fact they’re investing in ESG companies.

Byrne: Well, Professor Yasuda, thank you so much for spending your time with us today. It has been a great pleasure.



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