There are three ways in which private resources can be harnessed for meeting societal needs:
- Through charitable giving and philanthropy
- Through corporate social responsibility programmes
- Through the latest arrival in the marketplace for doing good – impact investing.
Social finance is a rapidly growing industry – the number of social investors is fast multiplying while bi-lateral aid stagnates. The OECD estimates there is US$228bn of social impact investment under management. Many international NGOs are now exploring the possibility of moving down the social investment curve, away from traditional philanthropy and towards impact investment.
Large international NGOs are working with investment banks to develop social impact bonds for large-scale programmes which is another form of results-based financing.
In other cases, traditional philanthropists are finding ways to recycle their donations by offering repayable finance to social enterprises who can design viable business models or to smaller NGOs that require a boost to cashflow for a capital outlay.
A changing landscape
The space of venture philanthropy and social investment is changing, and impact investing is gaining attention.
- On the one hand, an increasing number of mainstream investors, attracted by the idea of doing good while achieving positive financial returns, are entering the impact investing market.
- On the other hand, traditional grant-making foundations are increasingly giving grants in a long-term and sustainable way and starting to look into how they can put their endowments at use.
- Between these two types of capital providers, a group of venture philanthropy and social investment funds are mixing the two approaches, adopting the so-called venture philanthropy approach, combining financial support with capacity-building and a focus on impact measurement and management. Making social impact mainstream is good, as it helps attract more resources to social purpose organisations, including social enterprises, non-profit organisations and hybrid social ventures.
Impact investing is hip, it’s cool, it’s innovative and it’s very, very understudied and misunderstood.
Impact investment is becoming a staple on the speaker circuit. It’s sparking much interest from a financial services industry following the lead of wealthy clients. It even has the likes of illustrious institutions such as Harvard University and the University of Oxford offering courses on how to develop ‘business solutions to the world’s biggest problems’.
But impact investing is also bringing some serious financial muscle to the table. There is some US$502 billion allocated to impact investment worldwide, according to the Global Impact Investing Network (GIIN). To put it into context, this is 11 times the foreign aid flowing to the 15 Asian economies covered by the inaugural Doing Good Index and a third of the cost of achieving the Sustainable Development Goals by 2030.
Impact investors and social investors have much in common. They seek the same outcome – a society left fairer, more inclusive, more resilient and more prosperous because of investment activities.
Impact investment’s popularity stems from how well it seems to straddle business and philanthropy.
By using financial investments as a vehicle for doing good, it comfortably embraces the double bottom line and embodies the concept of blended value. At a time of great wealth creation but also rising inequality and unmet socioeconomic needs, impact investment has the potential to help close the gap in unprecedented ways, potentially at an unprecedented scale.
To explain this better – we present a new and evolving continuum or paradigm of capital and investments that seems to be emerging.
Along the investment-return continuum, impact investment falls squarely to the left of traditional philanthropy which focuses on social impact with no expectation of financial return. It falls to the right of traditional commercial investment which focuses on maximising financial return, or sustainable/ environment, social and governance (ESG)/responsible investing which weave in varying degrees of purposive social impact or at least screen out negative social or environmental impact. Between these two ends of the spectrum, the boundaries of impact investment are less clear. In our conversations with social and impact investors there is a great desire to engage in impact investment, but indecision on what that implies for the balance between social return and financial return.
Separating social investment from impact investment
So, we have social investment, which aims to enable social sector organisations to access capital. And we have impact investment, aiming to deliver both impact and return - a movement to reform capitalism - by including social impact as a third investment dimension in mainstream capital markets, alongside the classic binary of risk and return.
Impact investors and social investors have much in common. They seek the same outcome – a society left fairer, more inclusive, more resilient and more prosperous because of investment activities. This matter, because the quantum of investment capital deployed for profit by the private sector and foundations dwarfs the quantum of capital deployed by governments, development/humanitarian aid agencies and foundations for social outcomes.
Some investments have the potential to deliver significant impact at the same time as targeting market rate risk-adjusted returns. Other social investments may require more flexible capital to deliver their intended impact, where target return targets are sub-market or unproved. While investing across the return continuum can help philanthropists better align their investments with their charitable objectives, they are particularly well positioned to make the riskier sub-set of social investments where financial return targets are either sub-market or unproven.
Philanthropists also recognise that social investment can help social enterprises and charities become more sustainable, and in turn deliver better social outcomes. What’s particularly compelling for donors making social impact investments, is the opportunity to reinvest their original donation once it’s been repaid. This has the effect of multiplying their original investment as well as the potential to deliver impact many times over, and of course the ability to serve many more constituencies.
The space of impact investing has been growing and maturing over the last decade, attracting the attention of an increasing number of people. The positive news is that the lively discourse around impact investing brings more resources and capital to the space. The challenge, however, is that the risk-return-impact discussion becomes more blurred, creating confusion amongst both investors and investees and sometimes even disillusions or frustrations due to wrong expectations and lack of clarity around the intentions.
The European Venture Philanthropy Association (EVPA) issued a report in November 2018 which aims to provide guidance in the process of clearing the air around risk, return and impact. It describes in concrete terms the difference between two impact strategies: “investing for impact” and “investing with impact”.
- An investor for impact sees itself as a means to an end, hence it starts from the social challenge it wants to solve, the beneficiaries being front and centre. For an investor for impact, financial and non-financial support are both equal and indispensable instruments to get to the impact.
- Investors with impact, on the other hand, are primarily investors. The impact aspect is considered alongside the need to achieve stable financial returns, which remain their primary objective.
They provide the following guidance for the two types of investors:
To read more on the difference between the impact value chain of social investors vs impact investors, see page 7 of our short guide "Concepts, Definitions and Aspects Related to Measuring Impact" - download it here for free.
Overview of impact strategies
- Consider primarily the achievement of a positive social impact, with a range of intentions for or without financial returns
- Have the social challenge, social solution and beneficiaries as the starting point (solution focus)
- Articulate a theory of change
- Evaluate their own impact on the social purpose organisation (SPO) supported
- Give particular attention to the potential of the SPO to generate the desired impact, resulting in the centrality of the SPO’s impact model in the deal screening and due diligence phases
- Adopt a positive screening approach when selecting investees
- Adopt a more rigorous and management-oriented, bottom up approach to impact measurement including the use of customised indicators – often co-designed with SPOs, while trying not to burden investees with excessively demanding requests for evidence during the investment itself
- Focus on additionality instead of just intentionality
- Put particular emphasis on preserving the impact of the SPO when they exit
- Have impact as a secondary objective, subject to the achievement of a financial return
- Use social impact to mitigate the risks associated with the achievement of a financial return
- Screen investments primarily based on the potential financial return they can generate – and then on the potential impact
- Select investments mostly using standardised criteria (e.g. ESG, PRI, etc) or a negative screening approach, requiring a high detail of evidence that a specific model has achieved impact in the past
- Measure investee’s social impact performance based on standardised indicators (e.g. IRIS, GRI, etc.)
- Are very dispersed in terms of the financial return they target (from -100% to 0% +)
- Consider potential financial returns as a means to an end (i.e. the achievement of a social impact)
- Are willing to give up part of their financial return for the achievement of a higher social impact
- Generally expect positive returns in line with those of traditional investors
- Target primarily financial returns – wit the achievement of a social impact as a secondary goal
- Are not willing to give up part of their financial return for the achievement of a higher social impact
- Are willing to take higher operational risks if it means achieving a major social impact
- Perform an explicit social and financial risk assessment (e.g. also considering risks associated with not achieving the desired social impact)
- Take also into account the potential (and collateral) negative impact
- Develop ways to mitigate the risks
- Use impact evidence to reduce the risk associated with impact
- Start looking at risk from a financial perspective and focus on de-risking the financial component
- Do not always develop ways to assess and mitigate risks associated with social impact
- Look at the risk of generating a negative social impact only as a screening criterion (i.e. in the do no harm sense)
There is no doubt that to make the world more sustainable, we need all the resources available. Whether a social investor or an impact investor – it is in humanities’ best interest to develop solutions that contribute to sustainable development.
Already we are seeing new blended financial models that are working together to bring about change and impact at scale. The breadth of the resulting innovations has been profound. A new breed of change leaders are using blended financial models and market-based innovations to enable social entrepreneurs to break away from traditional funding models. Philanthropic and government funding are now complemented, and often replaced, by revenue-driven models that range from international license agreements to forward commodity contracts.
The rise of market-based solutions is focusing attention on new possibilities for investing in social change. These innovations are mobilizing new pools of capital and engaging a new set of stakeholders in social change. While market-based innovations create great opportunities, these innovations also introduce new degrees of complexity. The emergence of social finance has been characterized by real growing pains as this sector has witnessed almost as many missteps as achievements. There are many cautionary tales. For instance, there are social entrepreneurs that have become small business owners, social businesses that have abandoned their mission to pursue profit, and financial services organizations that have left their clients poorer and more indebted than when they began.
We have much to learn to successfully harness the power of markets to address social challenges at scale. Social entrepreneurs, investors, and other participants of social finance are adeptly recognizing historical mistakes and are building on the lessons of the past. But these are still the early days. As a sector, we need to move beyond ill-fitting comparisons with the private sector, deepen our understanding of how and when we can use the market to address social challenges, and develop the competencies to do so effectively.
Fortunately, the sector is evolving quickly, attracting new thinkers, innovations, and entrepreneurs. Social finance has grown from a few pioneers to a nascent industry at the intersection of commercial finance and social action. Blended finance is set to change the social sector and its stakeholders for ever.