Impact Investment by Sasha Cohen, July 19 2017, 3122 Comments

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What is Impact Investing?

Impact investment stands in the middle of a range, with philanthropic organizations on one side and, on the other, investors who consider social, environmental and governance factors when investing in businesses. The premise is that investment return must reflect a combination of risk, return and impact. Successful strategies involve pre-investment evaluation, post-investment monitoring, measurements, transparency and accountability.

In the 19th century, foundations not the government were the first to tackle social problems (Ford, Rockefeller, Wellcome (UK)). In simplified terms, when private philanthropy could no longer meet these needs, and arguably to create system efficiencies, government stepped in (1940s) to create the welfare state. Today, private capital has come to the aid of governments overwhelmed with the costs of an aging, diverse population and a changing climate.

Impact investment is an innovation driven by four powerful factors: governments which don’t have the money, millennials who feel they want to do more than just make money, investors ($55 trillion market) who have signed up to the UN’s principles of responsible investment, and a social sector (non-profits) that wants to grow.

In 2007, the term `impact investment’ was coined at a Rockefeller Foundation meeting. “Impact Investments are those that intentionally target specific social objectives along with a financial return and measure the achievement of both,” a definition agreed to by a recent Group of 8 Taskforce report.

The financial crash of 2008 highlighted the need for renewed effort to ensure that finance helps build a healthy society. A third dimension, impact, was added to the 20th-century capital market dimensions of risk and return. Investors can screen for values, categorized as socially-responsible investing (SRI). There is also ESG (Environmental, Social, Governance) investing.

 

(source: Green Century Funds)

In December 2015, LeapFrog Investments was the first impact group to surpass $1 billion in equity commitments to impact invest.

Application of Impact Investment

Impact investing has been used for programs as varied as addressing recidivism (New York City and New York State, Peterborough UK); teen pregnancy prevention (Washington DC, South Carolina); drop-out rates from primary school (India); and job skills training for unemployed youth (UK, Germany).

The World Bank estimates that over 4 billion people worldwide are earning under $10 per day. This population is rising toward the middle class, but lacks access to essential financial tools and healthcare services; the private sector can serve these needs.

One example of a company which runs successful investing campaigns is Vital Capital, a $350 million dollar private equity fund based in Western Europe with projects mostly in sub-Saharan Africa. Vital works in renewable energy, education, housing, small business, agriculture and water, creating healthy communities. Recently, the company successfully exited two investments in Angola; both were finished within budget and time parameters, and the projects saw a return of 24 percent.

Another prime example of how impact investing works is the purchase of 165,000 acres in Washington and Montana by The Nature Company, a transaction where impact investors provided 95% of the money. This helped save millions of acres of wildlife habitat, protecting drinking water sources and eliminating the risk of development. In Washington, D.C., impact capital is being used to build green infrastructure that soaks up stormwater, a model which improves the environment while helping cities save money on expensive infrastructure upgrades.

“Individuals can be impactful investors, depending on the investments they choose,” says Leslie Samuelrich, President of Green Century Funds. “They don’t need to have $1 million or half a million dollars [to invest]. It is usually a very gratifying exchange because you get a picture of the school or a sample of the coffee bean that grows. Investors get something back.”

To Leslie’s point, many investment firms have low minimums, making impact investing more accessible. Aspiration, an investment platform launched in 2015, requires a minimum of $100; Swell, a subsidiary of Pacific Life, has a minimum investment of $500; and RSF Finance requires a minimum of $1,000.

Is Impact Investing an Identifiable Market?

Critics contend that impact investing is not a true investment category. Skeptics argue that when impact investments have below-market returns and are not scalable, they are effectively philanthropic grants. Some believe that impact investing is merely an extension of venture capital—equity investments to fund early-stage companies. Others criticize that impact investing prefers specialists and lacks diversity.

Some critics point to the fact that the majority of investments seeking impact fail to achieve both planned intent and measurable outcomes. Related is the fear that the sector risks being discredited due to rising, unrealistic expectations about financial returns. Most enterprises that seek to alleviate poverty take 7 to 10 years to come close to breaking even, constantly adapting their products, services and business processes to meet their impact and revenue goals.

There is no official governing body that regulates ESG criteria. The Sustainability Accounting Standards Board (SASB), a private, USA-based non-profit, was only recently formed in 2011. It does not have the same significance of the Financial Accounting Standards Board (FASB). SASB coordinates sustainability accounting standards rather than improving generally accepted accounting principles and SASB has not been designated by the Securities and Exchange Commission (SEC) to set accounting principles (though the SEC has its own critics, so one may contend there is less weight to this criticism). Although groups like SASB track impact investing criteria, investors still need to “look under the hood; [to confirm results] match what they are trying to do,” says Leslie Samuelrich of Green Century Funds. 

The Market Matures

As the impact investment marketplace has matured, it has become more relevant. In 2015, Cambridge Associates and the Global Impact Investing Network (GIIN) found the overall returns of impact investment funds were comparable to those of conventional funds. The study also found that smaller impact funds— those less than $100 million under management—outperformed even large conventional venture capital and private equity funds. This is a particularly compelling finding given that most impact funds in the market today are smaller than $100 million. In 2016, GIIN reported that portfolio performance overwhelmingly met or exceeded investor expectations for both social and environmental impact and financial return.

Some investors do not seek market-rate returns, willing to forgo high financial returns in favor of social or environmental outcomes. In 2016, 55% of impact investors sought market-rate returns. Another 29% targeted returns slightly lower than the market rate, while less than 16% aimed for below-market-rate returns that simply prevented investment loss, according to GIIN. 

Those involved with impact investing are trying to evolve the language of investment and introduce measurements and goals more relevant to environmental and social problems, expanding from the focus on a competitive market return. Impact investors enthusiastically showcase the effect their investments have on disadvantaged communities and developing areas. 

Abigail Noble, CEO of The ImPact, responds that, “We are letting perfect be the enemy of good when it comes to impact measurement. Instead, we need to focus on intentionality, transparency, and accountability.” Transparent reporting of impact teaches how enterprise-led solutions can help combat poverty, ensuring that successful approaches can be replicated, leading to scalable operations.

In the future, impact investment scalability will come with better recognition and better tools and support. This includes mechanisms to protect social mission in businesses, such as the new benefit corporation structure (B Corps). 

Bahar Gidwani is the co-founder and CEO of CSRHUB and early supporter of EcoPlum. In this clip, he discusses how regulated B-Corps strengthen the impact investment market, his company's introduction of sustainability ratings, and building towards a world that uses these new rating tools in addition to established credit ratings (see 13:20).

The Future of Impact Investing

In 2016, investors looking for financial returns that demonstrate social good improvement committed $22.1 billion to 8,000 investments. The emerging industry, a decade old, has at least $114 billion in assets under management. Millennials show signs that they are the most willing generation to invest in impact and take on the risks that may accompany these investments. More than any other generation, millennials believe investment decisions are a way to express social, political and environmental values. Agriculture, Energy, and Environment are their clear top interests, with Employment, Food Security, and Water not far behind. By 2050, millennials could add up to $20 trillion to these funds in the U.S, reports Bank of America Merrill Lynch.

I was taught that my “pocketbook is political”—that how and where I spend my money has political and ethical consequence. This sentiment is shared by Justin Rockefeller, co-founder of The ImPact, who says, “What one does with one’s money has moral consequences.”