Bridging and linking philanthropy and investment impact
Social investors and philanthropists aim to create positive social, socio economic, and environmental impact whilst impact investors aim to create positive social, environmental and economic impact alongside financial returns, thereby creating blended value.
Impact investments differ from earlier forms of socially aligned or socially responsible investments in that the intention behind the impact investment is to have a positive impact as opposed to merely avoiding negative impact.
The impact investment market covers a broad range of sectors, with the greatest share of impact investing capital allocated to financial services, energy, microfinance, housing, food & agriculture, infrastructure and healthcare. Assessing the intended impact and actual value created (in the form of return on investment) is an important part of impact investing.
There is often confusion over the distinction between impact investing and philanthropy.
The diagram below – also referred to as the capital spectrum - indicates a continuum of donating to investing, based on the activities and objectives of the investor type:
Table: Rockefeller Foundation (2016): Situating the Next Generation of Impact Measurement and Evaluation for Impact Investing
As a specialized impact advisory firm (Next Generation Consultants) we are seeing a substantial uptick in the number of our clients exploring and pursuing all the tools in the philanthropic toolbox in service of their charitable mission. And through our specialized impact methodology and technology platform (the Investment Impact Index) we are seeing the increased impact resulting from the combination of philanthropic and impact investment capital.
Corporate social investors, venture philanthropists as well as high-net-worth individuals are beginning to see the value of using some of their capital, their financial investments and endowment funds, as another way to address the issues they care about most.
They are taking a stand for change by putting their capital to work in service of their mission. Whether they are making direct investments in social enterprises; choosing environmental, social and environmental investing; or making investments aligned with the sustainable development goals, they are seeking an expanded investment approach to reaching their social and mission-related objectives.
They are also finding themselves acting as shareholder activists and advocates in proxy voting, provide program-related investments or participating in community development banks. Each of these strategies, despite their differences, is helping the philanthropic investor effect change at a greater scale.
The idea of linking a range of financial investments and instruments with charitable investments is not new. More than a decade ago, the Rockefeller Foundation wrote a book entitled ‘The Power of Impact Investing: Putting Markets to Work for Profit and Global Good’.
The book addressed the ways in which investments could jump-start the mission and focus of foundations and the different ways to interpret impact investing. In fact, the Rockefeller Foundation coined and popularized the term “impact investing.”
Key Characteristics of Impact Investing
The following characteristics distinguish impact investors from mainstream or traditional investors:
- Impact investors are self-identified: They aim to have a positive environmental or social impact and impact investments are made with the explicit intention to help address economic, social and environmental issues like climate change, hunger, poverty, homelessness, and the HIV/AIDS epidemics.
- Delivers a financial return on capital: Impact investors do not only focus on positive impact, but see impact investment as a business activity and, therefore, they also have expectations of financial return on capital or at least to break-even.
- Consider a broad range of financial instruments and sectors: Impact investors employ a variety of financial instruments, all with different risk-return profiles, from direct investments for private equity, to loans and micro-finance to the renewable energy sector.
- Assesses economic/social/environmental impact regularly: Impact investors require regular assessment and reporting of the social and environmental performance of their investments to ensure transparency and accountability as well as inform their future investment decisions.
Mutually beneficial relationship
As the world evolves and the quest for capital to ensure a more sustainable, inclusive and equitable future intensifies, it is clear that all types of capital will be required if we are to reach the global objectives of the sustainable development goals by 2030. Neither philanthropic donations, nor impact investing by itself will solve all the world’s problems.
According to GINN, impact investing still faces challenges. These include:
- A lack of appropriate capital across the risk / return spectrum.
- A lack of suitable exit options.
- Limited sophistication of impact measurement and management practice.
- A lack of high-quality investment opportunities with track records.
In support of the challenges above, philanthropic capital can be utilized to:
- Increase capital leverage, i.e. by extending the reach of limited development finance and impact investing to facilitate larger volumes of private capital that can be channeled to investments with the highest development impact.
- Enhancing impact: By combining the skill sets, knowledge and resources of public and private investors to increase the scope, range, and effectiveness of development-related investments.
- Delivering risk-adjusted returns: Risks can be managed by guaranteeing first loss capital or risk underwriting to fully or partially protect investors by ensuring/guaranteeing returns in line with market expectations.
- Funding additional technical assistance: To supplement the capacity of investees and lower transaction costs.
- Providing market incentives: Guaranteed payments contingent on performance of future pricing and/or payment in exchange for upfront investment in new or distressed markets.
- Unblocking institutional constraints: Including the limits of an organization’s mandate and the regulations of investment authorities that can restrict some types of instruments used (e.g. equity or direct debt investments).
The powerful combination of impact investment and philanthropic resources can therefore assist in:
- Preparing, and reducing commissioning uncertainty and ‘first-mover disadvantage’.
- Pioneering, helping high-risk enterprises or projects to experiment with, test, and pilot new business approaches.
- Facilitating, offering investments at more generous terms than the market to encourage investments with a high expected development impact.
- Anchoring, seeking to ‘crowd in’ private capital on equal terms to achieve ‘first close’ or demonstrate viability.
- Transitioning, providing a pipeline of mature and sizeable investments cultivated by development funders that attracts scalable investments through exits to commercial players.
Whilst impact investing is not ideal for every charitable project stage or investment opportunity, philanthropic assistance may be the best tool for offering technical assistance or preparation for an impact investment, or for spearheading a project when risks are unknown or too high for market investors. In these cases, stakeholders may choose to harness blended finance, which allows philanthropists and impact investors to work together.
To combat persistent economic inequality, chronic homelessness and other social injustices the time has come for a combined effort between grantmakers, corporate, social and venture philanthropists and impact investors to create a new more sustainable future.
Perhaps the biggest opportunity lies in enhancing and extracting additional social value from impact investments. For example:
- Sustainability: Once a philanthropic venture is shown to be commercially viable, impact investment is better suited to sustain it.
- Replication: A success in the social sector naturally leads to imitation by others who also want to earn a profit, producing replication (at scale) with diminishing levels of further philanthropic support.
- Leverage: Impact investment and private capital can be catalyzed to support social objectives, thereby minimizing the use of scarce philanthropic funds.
- Innovation: Engagement with impact investors provides direct access to new technologies and business models that can meet social objectives more effectively.
- Efficiency: Working directly with impact investors offers access to the latest management techniques and systems while also benefiting from the focus on efficient operations demanded by the market.