CAPM is a tool used to assess the role of risk in asset valuation and a modified CAPM evidently can and should be used to assess risk in social valuation. Even for those who fundamentally disagree with using CAPM in social enterprise, this tool and, particularly, the discussion process have tremendous value: simple and well-used financial tools, like CAPM, provide an easy and necessary forum in which to begin the debate of risk models in social finance.

The original CAPM model focuses on an asset, project, or firm’s undiversifiable risk to investors. The model’s goal is to maximize investor return. The goal of social enterprise, rather, is much different: to blend social and financial returns. In this regard, a risk model for social enterprise must reflect this key difference. My firm, Social Asset Measurements created a modified CAPM that utilizes stakeholder specific betas (a measure of undiversifiable risk) to calculate the impact on various beneficiaries (beneficiaries may include program participants, local government, etc.). Opportunity costs are the key to this model’s measures of risk. Stakeholders often choose programs from multiple options; what is the cost of choosing one over the other? With the use of these stakeholder specific risk calculations, the CAPM creates a more-comprehensive picture of risk and value for all those affected.

The Impetus for monetizing social value was initially found in creating social value. However, monetization persists because it has the ability to value change while maintaining the ability to create key performance measures. For example, dividing total social value by the amount of hours invested by volunteers provides a measure of how effectively volunteer hours are being used to create that social value. The ability to manipulate the information provided by monetized social value is a valuable aspect of monetization. However, this flexibility exists because we borrowed from pre-existing tools, changed them to suit the needs of social enterprises, and also use them with an understanding of their limitations. Therefore, monetization serves the dual purpose of  a) articulating social value to investors, who will continue to speak in dollars, and b)  helping us generate an economy that balances social and financial returns.  The case for the prior argument appears to be generally accepted within the social finance community. I would like to focus on the second proposition.

Traditional, for-profit investors utilize a vast financial toolkit to measure such dollarized value; so too must impact investors. An impact investor’s toolkit need not reinvent the wheel. In this regard, CAPM and other financial tools evidently have a place in impact investing. Impact investors can exploit the well-developed financial toolkit’s availability, transferability, and pliability. One of the great joys (and challenges!) in social finance is the creative application of preexisting financial methods to solving social issues. Impact investing, social enterprise, and the like are guided by the application of business rigor and acumen to solving social issues.

Following the financial meltdown of the last few years, people may be wary to employ tactics borrowed from the financial system. Yet, to do so is counterproductive. Tools did not break down the financial system, imprudent use (tragically myopic and greedy misuse, to be precise) of tools created the crisis. By modifying CAPM and using it prudently, we exploit its best features while eliminating or minimizing its flaws. Using short term historical risk data, CAPM is an excellent tool for estimating an asset’s present value. While the traditional model focuses on the risk to investors, the modified CAPM will focus on the risk to the recipients of social return. Traditionally investors receive financial returns, yet, investors are not the recipients of social return. In social enterprise, stakeholders often include program participants as well as groups and institutions external to operation. This new model will focus attention towards these stakeholders who matter most.

While organizations may choose not to employ this CAPM within their valuation processes, I believe strongly that the development of modified financial tools (and public discussions like this) will help strengthen valuation within the social enterprise field. As Brian Trelstadt, the Chief Investment Officer at the Acumen Fund remarked, the creation of this modified CAPM highlights the need to a) distinguish between investor and beneficiary, investment and impact and b) account for the opportunity costs associated with a program. Clearly, organizations can learn from tools like CAPM and, additionally, from the development process of these modified tools.

CAPM is a piece to the puzzle. Impact investors will be wise to use the modified CAPM’s estimates, yet to solely rely on the model is ill-advised. No measure is perfect, the best we can do is understand the model's shortcomings and account for them in our decision making. Thus, any impact investing decision should take into account a variety of metrics. Rather than be the lone basis of decisions, the modified CAPM can greatly help investors make, understand, and articulate decisions.

Beyond guiding investment itself, the modified CAPM should greatly help organizations understand the relationship between their work and their impact. Social entrepreneurial activity is motivated by the need to deliver value to all stakeholders. However, our current risk models overlook risk to key stakeholders; a modified CAPM will surely help organizations understand these risks and maximize their impact.

The modified CAPM is, evidently, a valuable tool toward the valuation and maximization of social return. 

Note: For the counter-argument, see Michael Bowerman's Valuable or Vampire: Why Impact Investors Should Run from the Capital Asset Pricing Model (CAPM). For a primer on the Capital Asset Pricing Model (CAPM), see Wikipedia and Investopedia.

Photo credit: http://www.flickr.com/photos/masochismtango/302815420/

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