He fears impact investing is at risk of losing sight of why it started or remains different
For decades, the only financial instrument used to improve social and environmental conditions were 100 per cent lossmaking grants to charities. When the term “impact investing” first gained currency a decade ago, it symbolised a revolution in generating impact through the use of diverse financial instruments with a wider set of organisations. As social and environmental challenges around the world continue to grow, impact investing is an exciting opportunity to build more inclusive economies.
Impact investing encompasses widely differing approaches. While the integration of ESG (environmental, social and governance) factors in institutional portfolios has been welcome, this differs from impact investing as there is no direct way of measuring the impact. Most impact investment to date has been in just three sectors — microfinance, social housing and energy. All good, but risks in these sectors have been offset by grants and loans provided at below market rates (concessional finance).
Social enterprises deploy innovative market-based solutions that respond to demand from low-income populations for affordable, reliable products and services. A few enterprises have achieved significant impact by providing access to finance, healthcare, agriculture and last-mile distribution. But it typically takes them seven to 10 years to break even, during which time they depend on grant funding and concessional finance.
But most promising social enterprises remain limited in scale because they cannot access such long-term concessional finance, as investors are seeking at or above-market rate returns. In the UK, impact investment almost entirely comprises short-duration debt with interest rates of 6-12 per cent. While this responds to the short-term cash flow needs of social enterprises, it constrains their growth, prevents them building reserves and can result in higher prices being charged to low-income customers.
By contrast, impact investing in emerging economies is mainly a venture capital model of buying shares in social enterprises. Social enterprises typically follow a “low and slow” growth path, reflecting high costs associated with innovation, marketing and lack of infrastructure, as well as low revenues associated with the affordability of their products and services. This performance is not aligned with the returns most impact investors are seeking.
Most promising social enterprises remain limited in scale because they cannot access long-term finance at below-market rates
With impact investing at an inflection point, change is needed in three areas. First, we must have more long-term concessional finance — from foundations and governments — to grow social enterprises to a point when they can accept impact investment on the right terms.
Second, impact investors need to deploy more diverse financial instruments and structures suited to the needs of social enterprises. These include long-term flexible finance, as well as investment vehicles that enable funding over an indefinite period — or at least 15 years.
Third, to earn the label “impact investor”, an investor must be transparent about how considerations of impact are factored into due diligence, decision-making, monitoring and reporting overall performance.
I fear impact investing is at risk of losing sight of why it started or remains different. It would be a tragedy if the innovation and entrepreneurship that led to impact investing ends up failing to solve inequalities.
Chris West is a partner in Sumerian Partners, a London-based capital manager and adviser on philanthropy
He plans to collaborate and share his fund’s approach to impact assessment with the industry
The scale of the challenges we are working to address demands we question the notion of some in impact investing that market-rate financial returns and positive social and environmental impacts cannot — and perhaps should not — coexist.
The notion that scaling impactful companies requires conceding on returns rests on the assumption that impact is something that happens outside normal business. Of course, social enterprise can catalyse new and effective approaches, but it is not the only model that works. Every business, large or small, has an impact; the questions are: how big is that impact, and is it positive or negative?
The Rise Fund’s purpose is to seek out and grow businesses that create impact aligned with the UN’s Sustainable Development Goals. An example is Cellulant, a Kenyan company that provides digital payment tools. One of its products is Agrikore, a blockchain-based mobile platform to help distribute fertiliser subsidies directly to farmers and provide an easy way for them to sell their goods. Used by more than 7m farmers, these tools help them increase yields and reduce costs, raising household income and enabling spending on education, healthcare and other basic needs.
Unfortunately, the biggest disconnect today in impact investing is not the specific kinds of capital available but the fact that global needs are immense yet the resources devoted to them are so meagre. While it is true that social enterprises need different types of capital, there is also an urgent need for impact investing at scale.
There is more than $1.8tn in capital on the sidelines in private equity alone, and that doesn’t include the trillions more in institutions around the world not yet invested. We need to come up with a model that channels this capital towards solving these global problems, and to do that we must show investors we can drive impact at scale and produce market-rate returns.
We need to prove we can accurately evaluate positive and negative impact and that we do not need to sacrifice returns
This approach doesn’t negate the importance of philanthropy and government funding — both critical, as not every issue can be solved through commercial investment — nor does it obviate the role of investment that allows for concessional returns.
I agree with Chris that we need more effective ways to evaluate impact: rigorous, research-driven methods that are consistent across industries and businesses. That is why The Rise Fund developed an impact assessment methodology that shows how core products or services deliver positive social and environmental outcomes.
We apply the same diligence and discipline to impact assessment as we do to traditional operating and financial analysis. We commit up front to delivering a specific level of impact, and by knowing what the biggest drivers of that impact will be, we can hold ourselves accountable to those goals. We plan to collaborate with others and share the approach with the industry, governments and business.
We must harness the power of the private sector if we are to solve the complex global issues of our time. To do that, we need to prove we can accurately evaluate positive and negative impact and that we do not need to sacrifice returns in pursuit of it.
We need to change institutional investors’ understanding of what is possible, and demonstrate that pursuit of impact and pursuit of returns are not mutually exclusive.
Bill McGlashan is chief executive of The Rise Fund, a San Francisco-based global impact fund led by private equity firm TPG Growth