A guide for impact investors. Impact investing, which promises both financial returns and intentional, measurable impact, is attracting more and more attention - most of it from private investors. And although foundations, social investors, venture philanthropists, donors and grantmakers are hard-wired for social purpose and would seem to be natural candidates for impact investing, so far in Africa, they are behind the curve.
Across Africa, the bulk of impact investment has been made by private investment fund managers from the US and Europe as well as development finance institutions (DFIs), which together have put up more than 80 percent of the money flowing into impact investing across the continent.
For years, philanthropy and investing have been treated as separate disciplines—one championing social change, the other financial gain. The idea that the two approaches could be integrated in the same deals once struck most philanthropists and investors as far-fetched. Not anymore. For the first time there is a lot of interest to explore impact investing as a new way to increase impact but also make the capital of Foundations more sustainable.
What is impact investing?
In short, impact investing refers to investments made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return.
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 social and green bonds.
- Impact-oriented private equity or venture capital funds.
- Loans or equity investments in impact-oriented individual (listed and unlisted) companies.
- Investments in impact-oriented real estate or other assets such as infrastructure (i.e. water, renewable energy, etc.).
- 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.
How can impact investing increase the impact of philanthropic grants or donations?
- It allows greater deployment of more resources to social change.
Instead of making donations or grants that are a small percentage of assets (foundations typically grant just 5% of their philanthropic assets), you may invest some or all of the remaining assets for social benefit. Moreover, these funds can be recycled and reused as the financial capital is returned.
It allows for the expansion of development portfolios and tools for social good.
While philanthropy can be an effective way to pilot a program or innovation, philanthropy on its own is not big or powerful enough to solve most social problems alone. Impact investing uses the power of the marketplace to achieve scale, and more financially sustainable solutions.
- It allows for partnerships and leverage.
Philanthropic donations or concessionary capital may help an enterprise build capacity and/or de-risk the investment so that it is attractive to the enormous reservoir of market-based capital. “Blended investments” are those that are underwritten by a range of capital, including philanthropic, concessionary, and market rate.
- It can bring alignment, integrity and credibility to investments.
You can have the satisfaction that comes from aligning your investments with your values and social goals as well as ensuring they do not undermine them.
Impact investing may not be for everyone
Impact investing may not be right for every situation and can pose challenges for even the most intrepid foundation, social investor, grantmaker or philanthropist.
While the rhetoric on the benefits and potential of impact investing rises, the reality is the following:
- The infrastructure to support impact investing is immature. There are not enough intermediary organizations or specialized advisors to readily generate and support a robust, vetted, high quality “deal flow” of investing opportunities, funds or platforms. This is especially true in African focused impact investing.
- Most non-profit organizations do not have the capacity – skills or experience – to execute (i.e. they are not “investment ready”) and there are insufficient resources to develop that capacity. Small for-profit organizations such as social/impact enterprises are often in a similar position. For other for-profit and non-profit organizations, taking on impact investments may not add any benefit.
- The track record for impact investing in Africa is still emerging and there are few benchmarks to help investors understand appropriate risk/reward pricing. If an investment is yielding both a financial and social return – and the metrics for measuring social/environmental impact are limited, even in philanthropy – how much extra risk is acceptable? Finally, with a limited track record, investors have less confidence that they can “exit” an investment opportunity easily.
- Most philanthropic funders do not have the expertise to analyze, monitor and support investment success while most investment and development professionals lack the expertise in impact management and measurement. It is a multidisciplinary investment class and requires new ways of thinking and behaving that takes many donors out of their comfort zone.
Does it work and who is doing it?
The Rockefeller Foundation is one of the leading forces of the impact investing sector.
Some of the lessons they have learnt along the way include:
1. Impact investing is incredibly diverse.
While all impact investing is united by a dual intent to generate both financial and social returns, the opportunities within the umbrella are vast. They include microfinance, affordable housing development, conservation and renewable energy finance and social impact bonds, to name just a few, and it varies by asset class, the investor’s risk tolerance and expectation of return, sector and geographical scope.
Impact investments can take the form of equity, debt, cash deposits or another hybrid form. Investors are as diverse as impact investing itself—ranging from private bankers, institutional investors, board members of nonprofits, or the smaller-scale crowdfunders who represent an array of goals, appetite for risk, amount of capital to spare and time horizon. There is something for everyone.
2. Impact enterprises are at the heart of impact investing.
Impact enterprises—more traditionally referred to as social enterprises—combine passion with good ideas. They are creating jobs, providing critical goods and services, and creating social and environmental benefits. Without these enterprises and other, non-enterprise destinations for capital—such community facilities and sustainably managed natural resources - impact investors could not translate their dollars into their desired impacts. More work is needed to build a robust pipeline of impact enterprises to absorb the incoming capital.
3. Of all the support mechanisms needed for successful impact investing, impact rating and measurement systems are among the most critical.
These systems not only help mission-focused investors and fund managers assess the social and environmental performance of their investments, but also enable impact enterprises to measure and improve their operations and services.
The industry has seen evolution and growth in its standards, the volume and diversity of investments, and the standardization of its reporting and metrics. It is also now seeing less fragmentation and increased coordination at the international level through efforts such as the Impact Management Project.
Looking ahead, building a robust evidence base of the true outcomes and impacts of impact investing is the next frontier for this rapidly growing sector.
4. Data on investments that fail are as valuable as positive track records.
Many investments—even mainstream investments—have the potential to fail, and often do. Understandably, investors are often hesitant to share this kind of data. But the open sharing of information and lessons learned will help to grow both the sector and its appetite for impact investing.
5. Governments play a critical role in the decisions of impact investors.
It might not be immediately obvious to the average investor, but governments can make their lives easier or harder, depending on the kind of environment they create for impact investing.
Some of the ways that governments can enable impact investing include introducing benefit corporation legislation, providing lower corporate income taxes for high-impact businesses, funding incubators, and making equity investments. This will be critical in the African context to ensure the growth and take up of impact investing.
6. If impact investing becomes “business as usual,” the future will be a much different place.
As far as impact investing has come in the last ten years, there is still more to do to make it the norm and give everyday investors access to a range of investment products.
Aspirational estimates suggest that impact investments could one day represent 1 percent of professionally managed global assets, channeling up to hundreds of billions of dollars towards solutions that can address some of our biggest problems, from poor health to climate change.
Whether your foundation or enterprise decide to move forward slowly with one or two deals or go “all in” on impact investing, you will want to articulate your goals, define your strategy, and make sure you’ve got the skills and capacity to execute and assess progress.
These steps include:
Develop an investment policy:
The policy will typically include: a goals statement, percentage of your portfolio dedicated to impact investing, asset allocation targets/ranges and performance benchmarks. The goals statement will address such areas as: desired income generation, principal growth, liquidity needs, volatility and risk parameters, investing time horizon and social impact goals, including “impact themes” or areas where you would like to make a difference.
This will help make impact investing work for your needs. Your impact investment policy can be separate from or integrated into an overarching investment policy.
Define your strategy:
Building off your investment policy, develop some indicators of success for your financial and social/environmental goals. Determine the primary strategies and approaches you will use, including which tools/investment products as well as how you will source and assess investments and how you will align investments with your philanthropic strategies.
Develop a budget, timeline, and action plan. Be sure to build in plenty of time and resources for learning, building your capacity to execute and assessment.
Build your capacity to execute:
The expression “execution trumps strategy” rings true for impact investing. Most traditional philanthropists and foundations will not have the capacity in-house to jump into impact investing. Impact investing requires not only program expertise, but ability to do credit analysis, financial and organizational due diligence, legal skills, and new systems for monitoring and tracking payments.
You may elect to train existing staff, hire new staff, use consultants or work with intermediaries such as banks or DFIs who can execute. Co-investing with experienced impact investors is another way to execute.
Assess your progress:
Finally, you will want to build in systems and milestones for assessing your progress. This begins with making sure your own goals are clear and developing good systems for investee reporting.
The Global Impact Investing Network (www.giin.org) is the most valuable resource of information in this regard. To track and compare the progress of your investees you can also draw upon the vast array of benchmarking and performance indicators on IRIS+ (Impact Reporting and Investment Standards), a catalog of generally accepted performance metrics that leading impact investors use to measure social, environmental, and financial success of their investments.
We hope that you are intrigued about the potential role of impact investing in your foundation investment and/or philanthropic portfolios. The opportunity to both bring new tools and dramatically expand the pool of capital directed to positive social change is enormously exciting for all of us who care about making a dent on what seem like intractable problems.
We also hope that you recognize that this type of investing requires a complex set of skills and expertise to add to your traditional program repertoire – a true multi-disciplinary approach.
Most important of all, we hope that you are feeling better equipped to begin navigating the territory and explore whether it makes sense for you to get involved, and if so, how.
Next Generation are experienced impact practitioners who have assisted numerous social and impact investors developing impact strategies, creating impact management and measurement processes and systems and have developed the Impact Investment Index that is our technology platform focused on impact assessment, verification and reporting.
You can also read more about our impact management and measurement methodology by clicking here.