Investing For Impact

Kanwal Cheema
CEO & Founder of
My Impact Meter
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Philanthropists have been around for millennia, but they became organized in the beginning of the nineteenth century. By the twentieth century, they were contributing to alleviate social problems quite significantly and started getting government support in the form of tax breaks. However, by the 1930s, the governments realized social problems were much bigger and needed active government involvement. By the 1940s, many welfare states started being formed to provide a safety net for their citizens. Even then, more than half a century later, social and environmental problems remain a major global issue.

According to Sir Ronald Cohen who is the chairman of the Social Impact Investment Taskforce (SIT) established by the G8, the common problem with Philanthropic organizations all over the world is that they have no money and no scale. He justifies this by pointing out that whereas 50,000 organizations in the US alone have made over $50,000,000 of sales over the last thirty years, only 144 not-for-profit organizations have made revenues past that point. The available capital to the not-for-profit organizations is mostly limited to grants and charity and is directed at specific projects with little investments into creating operational scale.

Investing for impact or more commonly known as “Social Impact Investing” is a way to tap into large amounts of capital, innovation and entrepreneurship to solve some of the greatest social and environmental problems of the world.

Social Impact Investing intentionally targets specific social objectives along with a financial return and measures the achievement of both. Consider the example of SKS Microfinance bank in India which started in 2000 as a non-profit organization. In 2006, it converted from non-profit to for-profit. In the six years prior to converting to for-profit, SKS had a customer base of 200,000 customers only, but in four years from the point it became for-profit to when it went public, the customer base grew from 200,000 to 7,000,000 customers! The impact dramatically increased from a few hundred thousand benefiting households to millions of households in a shorter period of time.

Let’s take another example where the UK government established an independent impact investment company, Big Society Capital (BSC) and funded its equity capital of 400M pounds from unclaimed bank assets and 200M pounds from large retail banks. Since its inception in 2012, the BSC has been very successful in creating a significant progress in mainstreaming impact investment in the UK by committing 150M pounds to 31 social impact investment managers and a social bank which together deploy unsecured debt, secured debt and equity to social entrepreneurs and social impact bonds. It has also attracted an equal amount of matching investment from third parties. This example also helps demonstrate the increasing interest among governments and capital providers to invest in impact. According to the impact investing report from Monitor Institute, this is due to a number of reasons, summarized below:

  1. Increasing numbers of very wealthy investors at a younger age who want their investments to make a financial return but also “make a difference”.
  2. Consumers becoming more “value driven” in their approach to buying and investing creating a “demand” for social investing
  3. Mammoth social and environmental issues such as inequality and poverty increasing in urgency and visibility inducing a greater need to find innovative solutions to address them
  4. A plethora of talent especially graduating millennials highly interested in joining institutes where they can contribute towards social causes

Another incentive for investors is diversification of assets. Since impact investing is an alternate asset class, it will be much less prone to the ill-effects of a financial crash. This consideration has become even more important after the financial crisis of 2008.

So what are the challenges today with Impact Investing becoming mainstream?

One of the biggest challenge is the non-availability of enough risk-free capital to propel these social impact ventures forward in their infancy. Microfinance banks needed about $2 Billion of grants and charity money to get to the scale at which they could be profitable. One way to minimize this challenge is to choose opportunities or creatively design businesses where risk is minimal but this may limit opportunities. Investors should be mindful that with any start-up there is risk, and should be aware of cognitive biases that might make the risk in a social impact venture appear more magnified. However, on the flip side, whereas traditional businesses may have proven investable business models, social businesses do not have the rich track record of success in comparison.

Another idea to address this challenge could be the Yin-Yang approach of investing. This approach recommends that impact first organizations and financial first organizations can work together through appropriate intermediaries to create propositions and products to serve the needs of both kinds of investors. For example, the impact first organizations can provide risk insurance and subsidies so the financial first organizations can pump money to provide scale and still expect market rate returns. Yet another idea involves the support of grants and government funds to build capability into the social sector organizations to allow them to attain scale. This will allow impact investment organizations to build administrative capability for day to day operations, early customer acquisitions (where appropriate) and attraction of good talent.

Another challenge is that the intermediaries for impact investing are few and far apart. This creates a whole raft of problems that prevents the industry from becoming mainstream. Some of these problems are summarized below:

  1. Uncoordinated, haphazard efforts that are not optimized
  2. High search and transaction costs
  3. Fragmented demand and supply
  4. Underdeveloped Networks
  5. Complex deals
  6. Lack of consultancy/ advise
  7. Lack of transparency and comparability
  8. Lack of provision of flexibility and diversification
  9. High illiquidity
  10. Lack of flexible payment mechanisms

“It takes consistency in language to create a business. The biggest challenge is to have a coherent set of terms and phrases that are clearly defined and have clear meaning”. Preston Pinkett, Director of Prudential Social Investment. This brings us to our third challenge which is the lack of enabling infrastructure. At this moment, there is a lack of models, theories, standards, protocols, policies and established language. The market environment and infrastructure such as regulatory, legal and tax systems are highly structured around conventional mechanisms of investing which take financial returns and risk into consideration. Unless and until, impact can be adequately measured and quantified with the same level of fervor and reliability as the conventional investing systems and there is a level of standardization achieved, the inclusion of impact as a significant consideration in investment decisions will be limited.

Lastly, I would suggest that impact investing organizations as well as independent governance bodies should actively seek reviews from the communities the organization impacts. This is to make sure that there is actual impact being created as opposed to money being made off the poor as was the perception in India where Microfinance suffered a huge backlash in 2010, when they commonly started being called ‘loan sharks’.

In conclusion, in my opinion, social impact investing promises an unprecedented level of success simply because it addresses more human needs on the Maslow’s hierarchy of needs than any other form of investing – it addresses the lower level needs that are satisfied with financial returns and its addresses the higher-level needs of belonging, achievement and a sense of purpose that are satisfied through social impact returns – all at the same time. After the global financial crisis in 2008, there is general realization that traditional capitalistic markets contributed to the problem and are just not enough. The challenge is to remove the barriers and include impact as a significant consideration alongside financial return and risk in the markets of tomorrow.