Hype or Promise

For the past 100 years, especially in the West, we have organized our resources around two basic assumptions: first, that the only way for private citizens to address social problems is by providing donations to charities; and second, that the only purpose of investing and business is to make money.

We have built layers of systems to support a bifurcated worldview that separates charitable giving and investment. Our legal and educational systems, our philanthropies and our capital markets all support activity aimed at either generating financial return through investment or pursuing social ends through charity.

Within this world and its operating structures, for-profit investors and philanthropists can retreat into safe corners where separate regulation supports their independent activities.

However, over recent decades, growing numbers of people have come to reject this bifurcated world. These people, like many of those highlighted in this issue, see the world differently and have come to be called (from the enterprise perspective) “social entrepreneurs” or (from the capital perspective) “impact investors.”

They believe both that business can make an effective and morally legitimate contribution to solving social challenges, and that investors can actively target social and environmental value creation in their for-profit investments.

We believe these are not mutually exclusive.

Examples of impact investing that targets social challenges and works with governments and donors to forge more just and stable societies are now widespread in the Americas.

• In Mexico, Finestrella has used investments from the impact investing fund IGNIA to make mobile phones affordable and provide credit histories to thousands of customers previously locked out of both the mobile revolution and formal credit markets.
• Across the coffee belt of Central America, coffee farmers are using loans from Root Capital to enable them to serve more lucrative specialty export markets.
• In Honduras, a village has access to electricity, thanks to an investment in a mini-hydro power plant by impact investor E+Co.

But the rise of impact investing is not inevitable. What makes these pioneers inspiring is exactly what limits their power: they are iconoclastic individuals and institutions operating in a still-skeptical world. Most resources and most investors—whether trustees controlling large assets or individuals with smaller personal accounts—remain locked in a traditional approach that limits the social engagement of market forces and business. At the same time, established policies and regulations, educational opportunities, career paths, capital markets, and language all fail to support their aspirations and practices.

In fact, most of the time they get in the way.

Realizing the full potential of impact investing requires moving beyond the aggregation of a few inspiring anecdotes to build the new systems that can support impact-investing aspirations more broadly.

As we explain in our new book, Impact Investing: Transforming How We Make Money While Making a Difference, it means answering six fundamental questions.

How will we regulate impact investment?

In the bifurcated world, laws and regulations clearly define and protect traditional entrepreneurs, investors and philanthropists. But they are ill-suited to understand—let alone guide—enterprises and investors seeking to maximize blended value, the integration of economic, social and environmental performance that impact investing strives to create.

In the world of blended value, governments will need to determine how to harness impact investment to complement public resources in capitalizing the solutions to society’s most pressing challenges.

Because impact investing demands transformation in multiple systems—financial regulatory frameworks, corporate and nonprofit legal regulations, etc.—policymakers will play an especially important role. Policy shapes and enables markets. No major innovation in either investment practice or social change has ultimately achieved scale without a supportive policy framework. Creating effective policies and regulations will be crucial to impact investing’s potential future success.

In most places, our broad philosophy regarding the roles of nonprofit and for-profit capital management, as well as the specific systems developed around the world, have not yet caught up to the reality that the twin assumptions underpinning current regulation of philanthropy and investment are increasingly anachronistic. A patchwork quilt of innovation in specific subsectors points to potential components of this holistic approach.

But regulation by exemption is inefficient. These innovations must be woven into an overarching framework for regulating impact investing that can cover the full range of activities where impact investors are addressing social challenges and the many new areas they will move into in the future.

How will we measure value?

In the bifurcated world, we know how to measure the value of financial investments and are getting better at describing the social impact of charity.

In the world of blended value, we will have to create common language and measurement systems that ensure we steer our capital and attention to enterprises most adept at creating profit together with social value.

Only when enterprises can convey their social impact with the same credibility and comparability that they convey financial performance will impact investing become viable for those wealth advisors and institutional investors who remain skeptically on the sidelines.

Better impact measurement is also necessary to enable investors to allocate their marginal investment dollar to the best problem-solvers rather than the best storytellers. Interpreting “what is happening” in communities and telling the broad story of development will remain an important communications tool. If we are to move significant amounts of new capital into the impact investing arena, we will need to augment those stories with quantitative analysis that demonstrates both levels of capital performance and social/environmental impact.

How will we cultivate transformational leadership?

In the bifurcated world, leadership development systems and support services create clear pathways for talented people to navigate separate careers in charity or business.

The world of blended value will need new approaches to identify and train professionals who can apply business savvy to creating wealth and tackling social and environmental challenges together.

The impact investing industry also needs to move beyond its tendency to deify charismatic individuals. It has too often overlooked the role that “regular” people need to play in a broader movement. As long as impact investing is accessible only to people whose temperament or personal circumstances enable them to make radical breaks from traditional roles, it will be too limited to make a real difference.

How will we unlock philanthropic capital?

In the bifurcated world, private individuals and families eager to contribute to social purpose have set aside pools of assets they invest in order to generate cash flow that they may donate to charitable organizations.

In the blended value world, these foundations will no longer be able to organize exclusively around the question, “How do we give well?” and instead need to consider the more fundamental question of “How can we use our total assets to address social and environmental challenges most effectively?”

This may sound simple. But it is profoundly disruptive to a philanthropic system that has embedded the bifurcated worldview into how it is governed (with separate board committees overseeing grant making and investing), organized (with separate teams or outside specialists handling investing and grant making responsibilities) and staffed (by leaders drawn typically from the social sector or academia with little comfort questioning the decisions of investment professionals).

Making good grants and sustaining financial performance has been hard enough. To realize the potential of impact investing forces foundations to figure out how to integrate grant-making and investment in order to achieve portfolios of asset allocation that maximize a blend of financial return and social impact.

How will we move the money?

In the bifurcated world, a vast array of institutions constitutes the capital markets that separately facilitate exchange between donor and charity, investor and business.

In the world of blended value, these capital markets will have to turn to the task of connecting impact investors and social entrepreneurs. Private banks, wealth advisors and institutional investors need to build the intermediaries that may connect people interested in impact investing to the enterprises that can take their capital and transform it into profit and social outcomes.

Development financial institutions will need to reassess what “additionality” (a term used by many impact investors to define the added value of their investment versus investments made by strictly market-rate investors) means when private investors are moving billions of dollars into the markets in which they traditionally operate.

And impact investing needs to become accessible to common people, not just to the ultra-rich. Work by financial intermediaries such as the nonprofit financial services firms ImpactAssets and Mission Markets (see the Charticle on pages 71–77 for a description of these groups) becomes an important part of creating the infrastructure needed to allow mainstream capital at both the individual and institutional levels to flow into impact investments.

What next?

The bifurcated world will certainly linger for a long time. For many people, separating investing and charity will no doubt continue to make sense.

But some established systems will need to adapt to the new aspirations of impact investors. Others will become increasingly isolated as they fail to adjust to the new conditions.

In the meantime, the impact investing industry is in a fragile, emergent state.

Industry actors understandably focus on the difficult task of helping enterprises, investors and funds succeed. Few have the time or mandate to step back from this day-to-day struggle to consider the collaborations necessary to build the new systems that will eventually make their work easier and the industry accessible to more people.

The disruptions to the microfinance industry in India in 2010 showed that everyone who cares about the future of impact investment has a stake in creating a more supportive operating environment to ensure its success.

In the Indian state of Andhra Pradesh, inattention to these questions by commercial microfinance practitioners led to a catastrophic run-in with politicians able to mobilize public anger against an industry that largely ignored the need to measure and communicate its social value and proactively develop supportive regulation.

Getting too complacent by operating under the radar or through work-arounds is not sustainable. Getting policy right will be crucial.

But it will not be easy. The examples of impact investing in this issue alone illustrate the challenging questions that traditional regulatory systems are hard-pressed to confront.

• If a microfinance loan to a Mexican fruit seller is a better way to lift her family out of poverty than a gift would be, should an investor receive a tax break to lend to her?
• How do regulators protect the interests of investors in a venture capital fund like IGNIA who want the fund managers to pursue both financial returns and social impact?
• Should Root Capital be allowed to maintain its nonprofit status, and the tax break that comes with it, if it raises commercial investment to fund its operations?
• Should government-created entities like OPIC subsidize microfinance companies like Compartamos when the latter may end up making millions of dollars in a public stock sale?

This agenda cannot be left to any one segment or institution. New systems to sustain impact investing will emerge from the engagement of investors, entrepreneurs, policymakers and customers as well.

What will result from the present and growing interest—some might say hype—surrounding impact investing? Will it undermine support for philanthropy and draw resources away from more productive investment? Will it bring the renewal and energy that enable us to tackle the seemingly impossible challenges we face? Or will it simply fade, as so many other development fads have in the past, before making much difference at all?

The answers rest on our ability to recognize impact investing as a systems-challenging movement that will require more than just great entrepreneurs creating interesting anecdotes about inspiring entrepreneurs.
 

Authors: Antony Bugg-Levine, CEO, Nonprofit Finance Fund; Jed Emerson, Executive Vice President, ImpactAssets