Impact Investing: Microfinance with Macro Impact
WHY YOU SHOULD CARE
Because some of these socially conscious funds are starting to get impressive results.
What’s the real business of business? Is it to produce and exchange goods and services? Drive innovation? Or maybe just generate profits? It certainly depends on whom you ask. Millennials — the generation that has made us re-evaluate how we think about our careers — think that improving society ranks ahead of these more traditional considerations.
As a result, impact investing funds, firms that provide capital to companies with the expectation of both financial returns and positive social outcomes, have become more visible over the past decade. The concept got its first big wave of publicity in 2006, when economist Muhammad Yunus won the Nobel Peace Prize for his work with Grameen Bank, the microfinance organization he founded.
Small-scale loans to impoverished entrepreneurs can stimulate economic and community development while still maintaining low default rates.
Grameen Bank showed that small-scale loans to impoverished entrepreneurs can help stimulate economic and community development while maintaining low default rates. It helped launch a number of funds with different strategies but a similar mission: to improve society by creating economic opportunity in a way that is still financially attractive. Since then subsectors have emerged focusing specifically on green investments, urban and low-income communities, and socially responsible organizations (i.e., no alcohol, tobacco, weapons, etc.).
Investors such as Acumen and DBL Ventures may not be household names quite yet, but they have gained a higher profile in recent years. Unfortunately, this hasn’t really translated into more committed capital. Generous estimates place today’s impact investing market at about $25 billion, which is still paltry when you consider there’s more than $1 trillion under private equity management.
A major reason for investor skepticism is a lack of certainty about whether the model even works. There has been little published data around financial returns and limited consensus on how to measure the social impact. In a Deloitte survey of U.S.-based pension funds, only 9 percent of respondents even considered the approach a viable investment model. But recently published data on the sector’s outcomes suggests that investors may want to take a closer look, as the impact on their portfolios may be just as attractive as the good it does.
Subsectors have emerged focusing on green investments, urban and low-income communities, and socially responsible organizations.
How do the funds supporting impact investing think about financial returns? A recent survey of 176 impact investment funds by the World Economic Forum and Deloitte showed that the majority expect to beat the public market, which is projected to yield a long-term return of just over 6 percent. Thirty-five percent predicted returns above 20 percent, which is in line with traditional private equity. So it’s clear that supporters of impact investing have been anticipating some serious successes. But given the tendency of funds to keep their results private, it’s been difficult to know whether or not they’re actually meeting their goals.
At the 2013 World Economic Forum in New York, however, a group of organizations released the results of a year-long project that provides the first true look at the practices and outcomes of leading impact investment funds. The study — co-authored by Cathy Clark, director of Duke’s Center for the Advancement of Social Entrepreneurship, Jed Emerson of ImpactAssets, and Ben Thornley of Pacific Community Ventures — takes a detailed look at 13 funds and argues that real progress is being made within the sector as investors better understand and implement the practices that enable meaningful social impact. There is likely some self-selecting bias expected for a group of funds willing to make their results known, but nonetheless this provides a good look at how much impact these funds are really having.
Although these investors are a small, diverse group, making different types of investments with different expectations of returns, the results provide some impressive examples. For example, the expected five and ten-year returns in private equity are 8.22 percent and 14.12 percent, respectively. Elevar’s Unitus Equity Fund, which was launched seven years ago, beat these averages handily with a return of 21 percent. Similarly, Huntington Capital typically invests using mezzanine debt, a type of loan that is expected to have lower returns than private equity, but its 2008 fund still managed to beat the expected five-year private equity return by over 5.5 percentage points.
How about the social returns? Evaluating that has historically been the hard part, but significant progress is being made. The Global Impact Investing Rating System (GIIRS), which was launched in 2011, provides the first standardized assessment of social and environmental impact. The organization assigns a company or fund a rating on a 200-point scale based on a variety of social factors, including how workers are paid and treated, job creation for local communities, environmental responsibility, and so on. By developing a standardized system that considers a broad range of social outcomes, the GIIRS allows prospective investors to evaluate funds or companies on a comparable basis.
Despite some apparent progress, the reality is that there is still a lot we don’t know about whether impact investing really works. John Buley, professor at Duke University’s Fuqua School of Business and former head of impact investing at J.P. Morgan, notes that “one has to be really careful to think whether above market returns in impact investing are anything other than idiosyncratic.”
Microfinance criticism specifically has increased in the past few years. Insiders have made claims of corruption and suggest that organizations can end up pressuring borrowers without having a serious impact on poverty. But as transparency increases, it shouldn’t be long before we can let the data speak for itself.
We are at the beginning of the first wave of data from established funds, most formed in the mid-2000s, that will be reporting returns on both a financially and socially comparable basis. If these numbers can validate the impact investing model, it could potentially lead to the first major spike in capital commitments. Even if the industry grows by no more than 10 percent annually, that means by 2020 investors will be putting nearly $50 billion to work, more than the entire 2012 GDP of Costa Rica.
Even if there isn’t enough evidence just yet to turn mainstream money managers into impact investing converts, the industry is gaining its footing and beginning to set itself up for future success. Traditional investors, who at this point still don’t seem to give impact investing serious consideration, may do well to take note. If attractive impact investment opportunities continue to pass them by, a generation of socially minded do-gooders might just beat them at their own game.