Mitigating the effects of climate change, bringing basic water and sanitation services to billions of people across the globe and creating jobs for the long-term unemployed are just some of the challenges that confront the world in the 21st century. Meeting them will require both money – lots of it – and ideas. Although the global capital markets hold tens of trillions of dollars, most of those funds are locked up in investment vehicles and structures that have nothing to do with positive social and environmental impacts. The question is, how can we release the capital that is essential for solving the world’s most pressing problems?
During the 20th century, philanthropic institutions funded many breakthroughs that greatly improved human wellbeing. These included the development and dissemination of life-saving vaccines and improved seeds for food crops, as well as the rise of social movements for civil rights around the world. Foundations commonly partnered with governments, civil society and each other to accomplish such goals but, in the 21st century, the combined resources of government and philanthropy seem to be proving insufficient for the increasing number of tasks ahead.
Fortunately, a growing subset of investors is putting investment dollars to work with the goal of creating social and environmental benefit as well as generating financial returns. Known as ‘impact investors’, they are pioneering a new industry that operates at the largely uncharted intersection of philanthropy and profit-maximising investment.
Impact investing is related to, and sometimes confused with, socially responsible investment, which screens out negative or harmful effects. However, impact investing goes further than this in that it involves the initial intent to proactively create positive social and/or environmental changes beyond financial return. The past few years have seen rapid growth in the supply of impact investing capital, and this has been mirrored by a growing demand for appropriate finance from innovative and increasingly sophisticated social entrepreneurs.
In between the investors and enterprises sit a small, but important and growing, number of intermediaries – ranging from dedicated fund managers to boutique investment bankers – who can facilitate the efficient and effective flows of capital. Servicing these market participants is a rapidly developing industry infrastructure – including social and environmental reporting standards, benchmarks, impact rating agencies and social stock exchanges. And policy and regulation are evolving to accelerate this type of investment, while holding it accountable for producing social and environmental effects.
Impact investments can vary dramatically by geography, sector, objective and level of financial return. Many people are familiar with micro-, clean tech or community development finance, which are among the most mature sectors of impact investing. However, it is proliferating much more widely, as the following examples show.
In Sub-Saharan Africa and Central America, Root Capital provides loans to agricultural cooperatives and other farmer organizations that sell their harvest to fair-trade buyers like Starbucks. The loans are backed by advance purchase agreements, which reduce the price risk for farmers as well as investors. Root increases famers’ incomes, promotes environmentally sustainable farming, and provides a reliable financial return to its investors.
In north-western America, Clean Energy Works Oregon provides up-front financing for home improvements that substantially increase energy efficiency. They are repaid over time through a deduction from residents’ utility bills. In addition to providing a financial return to its investors, the organisation reduces household energy costs for vulnerable consumers, produces environmental benefits and creates high-quality jobs for local contractors.
Impact investments are being used creatively to address an increasing variety of social and environmental problems. But it is important to note that private capital is not appropriate in all cases and that it should complement, rather than replace, philanthropy.
The impact investors themselves are nearly as diverse as the uses for their capital. American institutions like the Rockefeller Foundation have long made programme-related investments. Now, counterparts in the UK and elsewhere have begun to make impact investments from their endowments. Significant momentum is coming from a new generation of private wealth managers and family offices like New Island Capital in San Francisco and the Sainsbury family in the UK. They reject the premise that capital must be invested solely for financial return or given away as donations, and instead are seeking opportunities to invest money in pursuit of their values.
Development finance institutions (DFIs) like the International Finance Corporation also have an important role to play and can sustain themselves through earned income rather than government allocations. Large mainstream banks such as J. P. Morgan, Deutsche Bank and Citigroup have expanded their impact investing businesses beyond niche portfolios and minimum regulatory requirements. And finally, pension fund managers like TIAA-CREF are also responding to the demand for impact investments. Pension funds and other institutional investors generally face stricter regulatory requirements than foundations, DFIs or private wealth managers, but they have collectively committed billions of dollars to these forms of investments.
The advent of impact investing does not mean governments and traditional philanthropy can step back – they are more important than ever. Grants will always be needed to support activities that do not generate revenue, like advocacy and work in communities too poor to benefit from market-based interventions. Foundations are also critical to the continued support of infrastructure for the new social capital markets. For their part, governments must ensure that impact investing is neither too hard nor too easy. Public policy should aim to reduce barriers that are prohibitively onerous, while actively catalysing new areas of impact investment. Policy-makers can set and enforce a high bar for impacts and they can mitigate the risk of ‘green-washing’ by companies and investors.
Our 21st century challenges require 21st century approaches. Impact investing promises to be one approach for tackling problems that were previously considered insurmountable.
