An introduction to impact investing



9th Nov 2021

An introduction to impact investing

An introduction to impact investing

An introduction to impact investing for philanthropists, grantmakers and social investors

In just over a decade, impact investing has grown from niche to mainstream, a trend that has caught the attention, if not the commitment, of foundations, grantmakers and philanthropists. Worldwide, investors of all types have poured billions into companies that seek both social impact and attractive financial returns.

Traditionally, grantmaking and endowment investing have functioned as separate activities, one championing social change and the other financial gain. “But the emerging field of impact investing invites a productive collaboration between these two disciplines,” impact investing advocate Jed Emerson wrote six years ago. Today, that potential for productive collaboration has led several foundations to reimagine themselves as asset managers for social good, not just grantmakers. It is a mindset shift that requires foundations to think holistically about how best to deploy their assets to effectively address the challenges of modern-day societies.

Foundations have compelling reasons consider impact investing. Impact investing expands the scale and scope of a foundations’ work beyond what is possible with grantmaking alone. Yet, to date, curiosity about impact investing in South Africa runs higher than application.

Traditionally, investing and philanthropy have served two separate purposes: (1) invest to make as much money as you can without regard for its social or environmental impact, so (2) you can dedicate more of the earnings and asset growth for philanthropy. Impact investing has disrupted this paradigm and provide philanthropists with new avenues for amplifying their charitable goals.

What is impact investment?

Put simply, impact investing is any type of investment intended to generate positive, measurable social and environmental impact alongside financial returns.

Among the possibilities, impact investing includes the following:

  • Investments in socially responsible mutual funds or Exchange-Traded Funds (ETFs), often in conjunction with shareholder activism
  • Investments in socially responsible fixed income products such as community/social and green bonds
  • Impact-oriented private equity or venture capital funds
  • Loans or equity investments in impact-oriented individual companies
  • Investments in Social Impact or Development Impact Bonds
  • Investments in impact-oriented real estate or other real assets such as water or renewable energy
  • Loans or guarantees to nonprofit organizations

The financial return for impact investing can be just as good as any traditional investment, or you can trade off financial return for deeper social impact. The investee can be a nonprofit or for-profit, an enterprise, or a fund. The source of capital can be your personal assets or trust, a donor-advised fund, or a foundation.

The value impact investment adds to philanthropy

Impact investing has the potential to enable every foundation, grantmaker, donor or corporate social investor - regardless of size - to pursue its philanthropic mission more effectively. It can help individual donors, families, foundations with few or no staff, and all sorts of giving entities put more and different types of capital to work for social good. Even better, it can deliver philanthropic impact alongside financial returns—which can enable reinvestment of those funds in pursuit of even more social good.

A toolbox for impact investing

Today, the scale of community and global needs outstrips the supply of available capital, and foundations, venture philanthropists and social investors are turning to impact investing to bridge the gap. Grantmakers are finding ways to maximize the impact of their assets in two ways:

  1. They are making program related investments (PRIs) with the expectation that the amount invested will be repaid. Once returned, these funds are recycled into other charitable purposes.
  2. Foundations are using a portion or even the whole of their endowments to invest in enterprises and funds that are aligned with their mission. For example, a foundation focused on sustainability might invest in the development of alternative sources of energy. A foundation working to improve health outcomes may support businesses developing new diagnostic technology. By making these kinds of mission-related investments (MRIs), foundations can achieve both tangible social benefits and financial returns sufficient to sustain or grow their assets.

In the table below we provide some guidance on different tools grantmakers, philanthropists and social investors can use within the impact investing space:[1]

Grants
Loans
Loan Guarantees
Equity Investments
What it is

Money given to non-profits where they are required to track results and report back periodically

Money given upfront to non-profits and small businesses to be paid back with interest

The foundation agrees to cover an investor’s losses (up to a certain amount / under agreed-upon conditions) if the borrower fails to make timely repayments

Purchasing an ownership stake in a mission driven company or social enterprise

Who it invests in

Non-profits (without future recurring revenue streams)

Non-profits (with sources of recurring revenue)

Small businesses

Social enterprises

Mission driven projects and enterprises

Mission driven companies

Why it is useful

Helps non-profits provide essential services

Helps cover upfront costs

Meet unexpected costs not covered by grants

Complements place-based work

Encourages conventional investors to support community development projects

Can extend to projects with regional/national scopes

Advances philanthropic work while expending no money up front

Gives foundations a seat at the governance table

Results in financial and social dividends if the enterprise prospers

Helps facilitate scaling of a solution to a social or environmental problem

[1] Source: Bridgespan Group

How to move from pure grantmaking into impact investing

  1. Board engagement is a critical next step for implementing an impact investing strategy. In most cases, board approval is required for a foundation to engage in impact investing, and that often requires ongoing, high-touch engagement from impact investing champions—whether staff or fellow board members. Boards will also want to understand their options and they can do this by reviewing the practice of peer institutions to see how impact investing operates; understanding literature on impact investing performance; identifying examples of impact investment policies, and investment vehicles, that illustrate impact investing’s potential
  2. Developing your strategy - A clear, considered strategy is vital to the success of your impact investments. By articulating your goals before you start investing, you will be able to choose the best approach to assess opportunities, plan how best to use your resources, build efficient staffing structures and internal processes, and establish how you will measure the impact of your investments.
  3. The first step in developing a strategy is to establish your impact investment focus. The issues or geographies (or both) you would like to target and how they might align with your foundation’s mission, vision, and values. One way to get started is to examine your existing grantee portfolio and look for investable opportunities within those organizations that complement your grant making. For example, you may have given grant funding to a nonprofit focused on affordable schooling or medical care. That nonprofit may also have an existing investment fund or need financing to build facilities, buy land, or launch a revenue-generating enterprise.
  4. The next step is to determine what investment vehicles do you want to use. The first consideration in determining the type of vehicles to employ is identifying your risk tolerance. There are impact investing opportunities along the entire risk spectrum. While you can make higher-risk private equity investments, many lower-risk, fixed-income investments are also available.
  5. Making impact investments. There are essentially two ways to make impact investments – directly or indirectly. Direct investments are made directly to organizations, companies, and nonprofits. Indirect, or fund investments, are made into funds that pool capital and then deploy that capital into organizations, companies, and nonprofits. These funds can be intermediaries, fund managers, or other asset managers. Deciding between direct or indirect investments is an important part of your overall strategy and has implications for your foundation’s capacity and time. When deciding whether to make direct or indirect investments, you should determine how involved you want to be in any given opportunity. For example, when making a direct investment you may be offered opportunities to take board or committee positions to help guide the enterprise, which is a significant time commitment. An alternative is to invest in an established fund, which would require less involvement.
  6. Finally, you can decide what kind of portfolio you are going to invest in: Renewable energy, education, health care, - the opportunities are endless.

For those funders and grantmakers, philanthropists and corporate foundations considering a move into impact investing, we conclude with the following advice:

  1. Choose the right tool: Match investments to the problems you are looking to address
  2. Use all your assets: Consider ways in which you can use all the assets to your disposal – not just funding – such as technical support, networks, procurement, etc.
  3. Place racial and gender equity at the center: Make equality the centerpiece of how you think about investing for impact
  4. Match your strategic ambition to your capabilities: Consider working with outside fund managers if you do not have the inhouse competencies, skills and resources
  5. Build expertise over time: When building an investment team, hire experienced impact investing professionals to work with your team over time to ensure investments align with your impact ambitions and objectives
  6. Collaborate with peers: Given the complexity of effectively deploying impact investing to achieve meaningful change, consider opportunities to collaborate particularly with those with significant experience of harnessing impact investing
  7. Make the mind shift from grantmaker to asset manager: The shift means taking a holistic approach to identifying the proper financial tool for the problem at hand.

Making impact investing part of foundation strategy can be a challenging journey with uncomfortable twists and turns as existing ways of thinking and working collide with new ideas. Impact investing gives foundations, grantmakers, venture philanthropists and corporate social investors tools to achieve social, economic and environmental benefits that grants alone could never duplicate.  Impact investing also provide foundations a new way of thinking and working that is more suitable to a post Covid world.

Reana Rossouw is a management consultant that work with social and impact investors to develop strategies for enhanced impact and return on investment.  She has assisted numerous corporate social investors moving from traditional grantmaking to impact investing.  Her expertise in impact management and measurement has ensured a successful transition to a new environment for her clients that has led to increased opportunities to create shared value for all stakeholders.

More information about the work of Next Generation in the social investment sector can be found at www.nextgeneration.co.za and information about the work of Next Generation in the impact investment sector can be found at www.investmentimpactindex.org.