Making Sense of the Many Kinds of Impact Investing
JANUARY 28, 2016
Everyone agrees that impact investing is on the rise. According to the Global Impact Investing Network, the market for impact capital, currently sized at $60 billion, could grow over the next decade to $2 trillion, or 1% of global invested assets. But despite this growing interest, impact investing still faces a significant stumbling block that limits the flow of new capital into the field: not everyone agrees on what “impact investing” actually means.
Currently, impact can mean anything from venture investments in new health technologies to microfinance loans in Peru; from affordable housing in the US to renewable energy in India; from social impact bonds to private equity funds that create jobs. That’s just the beginning of the confusion—even if you accepted that such diverse investments should all be grouped into one category, how do you even measure and compare impact anyway?
Faced with this uncertainty, most investors have chosen one of three options. First, they search for examples of impact within their existing portfolios, bringing no incremental capital into the field. Second, they deploy a small amount out of an experimental or mission-motivated pocket, which still holds back enormous amounts of capital. Or third, and more common, is that they sit on the impact-investing sidelines. None of these are ideal outcomes.
In order to free up all the dry powder waiting for the right impact opportunity, the investment industry needs to help investors clearly articulate three guiding principles behind their investments: what kind of impact they want to have, how deep or broad their intended impact is, and the level of risk they are willing to accept.
Type of impact
Each investor will have their own conception of the social good they are trying to achieve. Investors might have a geographic focus: they may care more about developed or developing economies, or a particular country or community. They may have a thematic lens: improved healthcare, educational reform, financial inclusion, climate change and so on. The investor might want to fund the invention of new solutions or she might simply want to improve the practices of existing businesses. There is no right or wrong impact class—what matters is identifying preferences. We think a good start is to assess investors’ preferences across five catagories:
Place: Investments in companies or projects that are located in a particular place (or benefit a particular group of people).
For example, the Hoxton Hotel, located in one of the poorest neighborhoods in London, created about 40 entry-level jobs with 73% of the wages going to those living in low-income neighborhoods. Another example would be the Calvert Foundation’s Women Investing in Women Initiative, which allows individual investors to make loans to women in developing markets to access clean energy.
Process: Investments that pay careful attention to business practices, such as “fair trade” coffee, equitable labor practices in a supply chain, or buy-one-give-one models that provide access to goods and services to those in need.
For instance, Triodos Sustainable Trade Fund provides finance to farmers whose cultivation practices are more sustainable in places like the Palestine Territories, Thailand, and the Dominican Republic, avoiding traditional chemically-intensive fertilizer in delicate ecosystems. Or take Warby-Parker, which provides a pair of reading glasses in developing countries every time it sells a pair of its own glasses.
Planet: Investments that have a clear and measurable environmental benefit, either through the preservation and restoration of critical natural habitat, or the measurable reduction of carbon dioxide through new energy efficient products.
The Lyme Timber Company is a private timberland investment management organization that acquires and sustainably manages land with unique conservation value in the United States and Canada. BrightPower provides comprehensive energy efficiency audits and heating and lighting retrofits for multi-tenant affordable housing in the New York metropolitan area.
Product: Investments in products or services that have positive social benefits.
Springboard Education provides after-school educational enrichment programs to 3,000 students at 50 public and charter schools in 11 states in the United States. Ziqitza Health Care Limited took a largely patchwork network of local ambulance companies in India and created a national ambulance and emergency medical services company with world-class medical standards.
Paradigms: Investments that attempt to change an entire system for the better.
Revolution Foods intends to alter the system of childhood nutrition in the United States by providing healthy, nutritious school lunches in public and charter schools. The Gates Foundation’s investments in Zyomyx and Alere both seek to transform the cost and accessibility of point-of-care diagnostics in emerging markets.
Intensity and immediacy of impact
Having identified what kind of impact the investor seeks, the second question is to understand the intensity and scope of the desired impact, for which category of beneficiaries the impact is targeted, and over what timeframe. Some investors might want to support strategies that generate critical long-term change, such as essential preventative healthcare for hard-to-serve populations, as primary-care provider Iora Health seeks to do. Others might seek smaller incremental changes that benefit a broader set of beneficiaries with more immediately noticeable change, such as the introduction of a new educational technology like Kinvolved that improves attendance in public schools. Depth, breadth, and the time horizon of impact can help further guide where investors would like to place their money.
Impact risk profile
With every impact investment there is not only financial risk, but also impact risk: will the desired impact be delivered? Investors should ask what existing evidence they need to see before they make the investment, or what metrics they will expect to see after the investment has been made that can demonstrate progress. For example: there is reasonable evidence that providing healthy school lunches can make a difference in the childhood obesity epidemic in the United States, while there remains a debate whether access to toilets in slums in emerging markets will reduce incidence of diarrheal disease, which is why Sanergy is such a high risk investment from an impact perspective.
By identifying where to invest, the desired intensity of impact, and an investment’s risk profile, investors can start to identify “impact asset classes,” and then look within their financial portfolio, asset class by asset class, to find impact opportunities that map onto their financial risk and return objectives. Ultimately, asset managers can develop a matrix with financial asset classes (e.g., cash, fixed income, private equity, etc.) down one side and impact classes (e.g., place, process, planet) across the top.
A foundation president with a strong risk orientation who cares about transforming the education system could, for example, use the matrix to find an equity investment in a fund that seeds “paradigm” ventures in education. Or the CIO of large hospital’s pension plan could use the matrix to identify a debt fund that lends to locally-based companies (the “place” category) with strong socially responsible business practices serving the hospital, with cascading impact on the entire hospital ecosystem, from the sustainability and nutrition of the food served to patients, to the employment and environmental practices of the outsourced laundry services.
But defining clear investor impact preferences and how they fit into their financial portfolios alone will not be sufficient; for this ecosystem to be successful, advisors, fund managers, and the underlying companies will need to find ways to remain faithful to the investor’s intent around impact. As it stands now, absent meaningful measures of social impact and incentives to achieve them, there is little to require anyone to comply with an investor’s impact objectives beyond achieving the minimum. This is not to say that all impact investments need to deliver the impact promised; all investments carry a risk of poor return. But without a mechanism to align all players in the impact value chain around an investor’s expectations, the field risks an impact “race to the bottom” where funds or companies do as little as possible to comply with an investor’s objectives. A comparable concept to “fiduciary duty” — call it “impact fidelity” — is needed to bind different actors to attempt to achieve the impact preferences that an investor articulates.
As impact investing gains traction with mainstream investors, the field needs to develop tools that can help investment professionals categorize and understand the potentially limitless combinations and permutations of impact-investment options. Asking a few straightforward questions and thinking about a well-defined set of impact classes–combined with the concept of impact fidelity–should get more investors off the sidelines and into the impact investing game, with enormous consequences for human progress.
Brian Trelstad is a partner at Bridges Ventures, a specialist fund manager dedicated to sustainable and impact investment. Find him on Twitter @trelstad