Additionality

Additionality has been on my mind lately. Although the term is most commonly used in an emissions context, I believe the concept is helpful in many domains.

Let’s start with definitions. Additionality occurs when a particular action will provide a benefit in “addition” to a “baseline” alternative of taking no action. 

For example, let’s say that I invest in a solar energy project. I’ll pat myself on the back because I’m generating a financial return AND a positive environmental impact. However, if there were other investors competing to allocate to the project, then:

  • The project would’ve been built anyways, regardless of whether I invested.
  • If I didn’t invest in the project, another investor would have.
  • Taking action (investing in the solar project) would not have generated any more environmental impact than the baseline of not taking action (not investing in the solar project).
  • In this example, there would have been no additionality from my investment.

The above is a textbook example, but we find similar situations in both investing and philanthropy.

  • Within impact investing, the above example is a common situation that occurs when an impact strategy is capacity constrained or a fund is oversubscribed.
  • For portfolios of public companies/stocks, I believe the concept of additionality implies that ESG integration is more about alignment of values than effecting change. In aggregate, ESG investors may lower a responsible company’s cost of capital or vote proxies in a unique way, but even the largest investors are typically very small minority shareholders in most public companies. Thus, the additionality of individual investor decisions is either theoretical or infinitesimally small.
  • Investors invest to generate financial returns (and some may consider additionality). Philanthropists donate to generate additionality. This creates a powerful incentive for non-profit organizations to promote the appearance of additionality even if it does not exist. Some organizations generate tons of additionality and some probably generate negative additionality, so caveat dator (Latin for “let the donor beware”).

Although this post is thematic and the examples are more illustrative than practical, I hope to write more detailed posts about how investors and donors can actually evaluate the balance of need, capital, and capacity in order to get a better sense of additionality.

“Never Waste A Good Worry”

I joined a book discussion group and read the following in this week’s book: “As the world’s population reaches seven billion people, the earth is filled. Not only is the earth filled, human population is in danger of overwhelming the earth, and of making life exceedingly difficult for future generations.” The author seems thoughtful and concerned and his point seems reasonable. The only problem is that it’s completely wrong.

The aforementioned population problem (called the “Malthusian Trap”) is the crux of “Malthusian Theory,” which argues that the human population will overwhelm the available resources. These terms are named after Thomas Robert Malthus, who warned about these dangers in…1798. Or, put another way, over 220 years ago. This fear of overpopulation has been around for at least 220+ years and there are still people worrying about it. “Just wait,” they say. 

Another issue people have worried about for centuries is the national debt. Ever since Alexander Hamilton led the federal government’s decision to assume the colonies’ Revolutionary War debts (called “assumption”), Americans have been worrying about the debt. Thomas Jefferson famously opposed assumption, railed against the national debt, and even tried to pay it down while in office (just a couple years after Malthus penned his theory). Yet, like Malthus, Jefferson’s fear has not yet been realized after 200+ years. The national debt has been an issue in nearly every political election for 200 years, often framed as an imminent threat that is out of control. Yet, America grew from 13 rebel colonies to the wealthiest most powerful nation on earth. Of course, these debt worriers also say, “Just wait.”

Perhaps the global population will overwhelm the available resources or the national debt will drive America to ruin. But I wouldn’t bet on those things. I’d bet that agriculture and technology continue to improve as they always have and that we will not run out of resources. I’ll bet that the national debt will not harm the US in my lifetime. I could be wrong on either issue, but other side has been wrong for 200+ years on both issues. 

So, what does this have to do with investing? There are fears based on real risks and there are fears based on perceived risks. I obviously believe the above two issues are way more perceived than real, but there are many other less obvious examples where we tend to fear unnecessarily. Add in that humans are wired to overreact to fear, pessimism often sounds more convincing that optimism, and that we are easily seduced by logic and theories even when reality, history, and empirical evidence doesn’t agree. Clearly, there are times to be cautious and exercise caution, but not always.

To close, I’ll share that I was a worrisome kid (heck, I’m still a worrier). Whenever I shared a worry or fear with my dad, he nearly always gave me the same advice: “Matt, I’ve learned that most of my fears are never realized. Most of my worries never come to pass. I learned to ‘never waste a good worry.'”