Interest in impact investing has taken off in the last year, reaching a whole new level. Among all this good news, however, are we losing sight of the full range of impact investing tools available?
Consider 2 recent examples: UBS is raising a $100-250 million impact investing fund among its high-net-worth non-US clients to invest in SMEs in developing countries. The Fund will report back to investors – and reward fund managers – based on social impacts as well as financial returns. UBS anticipates that every dollar invested will generate $13 in multiplier effects that benefit local communities.
The other example is a $25 million African Agricultural Capital Fund launched by the Gates, Rockefeller and Gatsby foundations, together with JP Morgan and USAID. Both of these funds demonstrate the progress that impact investing has made with the world-class caliber of investors involved, the pro-active focus on measurable social impact, and the increasingly sophisticated structure and scale of investment.
Many foundations may still be making low interest loans to their grantees, or parking funds in Community Development Finance Institutions — all worthy uses of capital — yet those simple traditional types of impact investing no longer define the field the way they did even three years ago. Today, it is investments like the UBS and African Agricultural funds that typify the impact investing movement: investing in small enterprises that provide some new solution to a social problem — such as access to clean water or low-income housing – or simply reduce poverty by providing employment and income in developing countries.
This type of impact investing does indeed deliver social impact, yet it also depends on finding, negotiating with, scaling up, and monitoring many small enterprises often headed by untrained entrepreneurs in remote regions where audited financial statements and easy exit strategies simply don’t exist. Impactful as these investments may be, the high transaction costs, limited liquidity, and scarcity of good managers sets a ceiling on their ultimate scale of impact.
It is important, therefore, to supplement this type of SME impact investing with other approaches that are more often overlooked, but offer even greater opportunities for scale, such as creating new financial instruments.
We may never forgive whoever invented the Collateralized Debt Obligations that still threaten to undermine the world’s economies, but that doesn’t mean that inventing new financial instruments must always be a bad thing.
Consider the $3.5 billion in vaccine bonds issued by the International Finance Facility for Immunisation to convert long-term government commitments to fund the development and distribution of vaccines into immediately available cash. The sooner vaccines are given, the greater health benefit they provide – and by converting a multi-year foreign aid commitment to immediate cash through these bonds, the social impact was dramatically increased. Launched in 2006, these were the first aid-financing bonds ever issued, turning unpredictable (and often unfunded) government commitments into predictable and reliable funding that can support better planned immunization programs. The market to turn long-term foreign aid commitments into immediately usable cash must be a substantial market indeed. But who is out syndicating such bonds?
Or consider the Ygrene Energy Fund which, together with the Carbon War Room, a nonprofit founded by Sir Richard Branson, and a business consortium that includes Lockheed Martin and Barclays bank, plans to invest as much as $650 million over the next few years to slash the energy consumption of buildings in Miami and Sacramento. The group plans to exploit a new tax arrangement that allows property owners to upgrade their buildings at no upfront cost, typically cutting their energy use and their utility bills by a third. The building owners would pay for the upgrades over five to 20 years through surcharges on their property-tax bills that will repay the investor’s capital but would still be less than the energy savings. In the last three years, half of the US states have passed legislation permitting energy retrofits to be financed by property tax surcharges creating hundreds of billions of dollars of financing opportunities that would immediately reduce carbon emissions and – equally important in today’s economy – create jobs. When will these funds be assembled?
A more speculative example is the development of social impact bonds, first launched last year in the UK, now being explored in the US by Social Finance. Also known as pay-for-success bonds, they depend on philanthropic investors to launch social programs that can save the government money by delivering better outcomes – such as reducing chronic homelessness. Once the savings are documented, the government is obligated to repay the investors with interest. Several states and the federal government are already exploring the issuance of several hundred million dollars of these bonds. More philanthropic subsidy is needed to develop this promising concept into a reality.
These financing structures represent an entirely different kind of impact investing – ones that start at large scale and engage governments and major commercial enterprises. They don’t depend on the participation of individual investors and foundations that can invest $50,000 to $1 million in a specific impact investment, but they certainly require philanthropic subsidy to cover the upfront cost of researching, developing and structuring these deals. Any sizable foundation could play a transformative role in stimulating billions of dollars in impact investment by focusing on designing and developing new financial instruments that target specific social problems. We just need to redirect a small slice of Wall Street’s immense creativity toward social, rather than personal, gain.
Of course, these complex financial instruments do not carry the personal satisfaction that an individual investor – or foundation trustee – may feel in knowing that his or her investment has helped grow a small business that provides clean water to a village or raised a farmer’s income. Yet if the scale of impact is what matters, it seems like too much of the impact investment community’s attention is directed toward these small social enterprises rather than toward the enormous potential of new financial instruments that could finance large scale social progress.
Perhaps an analogy is appropriate: As funders become more sophisticated they tend to move from subsidizing direct services to funding research and policy change, trading off the satisfaction of tangible impact for the benefits of large scale influence. Maybe the same thing will occur in impact investing; as the field matures, funders will realize that innovative financing structures, rather than individual social enterprises, offer the greatest chance for large-scale leverage.