Impact Investing is here to stay. Here is why.
Impact investing[*] is a phenomena that should be reckoned with. A field not as young as one might think – arguably its history begins with the social unrest of the 1960s – impact investing came to prominence only a couple of years ago. Nevertheless, this newcomer at the intersection of financial and social sectors already has success stories under its belt. Take for example, Blue Orchard, a financial institution successfully investing solely into the microfinance organizations or Acumen Fund that has invested $83 million dollars in social enterprises across multiple countries around the world, or Omidyar Network that has committed $611 million to both for-profit and nonprofit companies since its inception in 2004. But there are more drivers contributing to the success of impact investing besides a few financial figures and well-known nonprofit brands.
Much more important are the broad social changes that the world has been experiencing for a past decade or two. Today not only we are faced with ever increasing environmental, humanitarian, and social problems, but today we actually can do something about it. Technology, widespread and almost instantaneous access to information as well as rising incomes across the board (so called “flattening”of the world, the term coined by Thomas Freidman) turned many silent observers into philanthropists, volunteers, social entrepreneurs, ever demanding and conscious consumers.
Business as usual rarely works now. You can attribute these changes to Generation Y-ers and their particular outlook on life, unprecedented numbers of young people single-handedly creating fortunes from scratch, or to the relative political stability the world has experienced since the breakup of Soviet Union. There are pragmatic reasons for the rising popularity of impact investing as well: the global financial crisis has showed just how ineffective and destructive traditional financial instruments could be. The subsequent need for minimizing risks made investors look outside the box. As it turns out researchers at NYU have found evidence that investing in microfinance institutions can help portfolio diversification. No matter what the reasons are, the point is that the world now has time and resources to effectively solve global problems and impact investing is one of the most useful and promising tools to do so.
2) Impact Investing is Data & Performance Driven, at least much more so than the nonprofit sector. As the formal definition of the sector is still in the works, practice remains extremely diverse, with some funds positioning themselves along their traditional financial-sector counterparts and others self-identifying as inherently pro-social. An intermediary between financial and social sectors, impact investment funds have to produce both financial and social returns. It’s easier said than done, however. “For the most part, evidence does not always look like that of conventional investing.” Yet the large portion of the market still expects equity-style returns. (A Market Emerges: The Six Dynamics of Impact Investing.) In fact, majority of impact investment funds rated by GIIRS target 11-25% rate of financial return. Are these expected return rates realistic? We just have to wait and see.
3) Impact Assessment is based on Social Impact Metrics. IRIS (stands for Impact Reporting and Assessment Standards) social and financial metrics seem to be the most widely used ones, some are industry-, some are company-specific, all can be implemented and tracked by nonprofit, for-profits, and social enterprises alike. Nevertheless, there is no industry-wide acceptance of any single standard.
4) Main challenge: aligning risk and returns (both financial and social). You thought you had it bad in the financial sector. Add a third unknown into the already complicated equation and you have a good picture of the impact investing field. So far we have talked only about the providers of the financial instruments, but what about the people and companies on the ground that put the money to work? It turns out that social entrepreneurs and nonprofits have the most difficulty raising funds from impact investors at the seed-level. There are simply too much risks involved. Time-horizons of potential investment returns are too long. There is so much more uncertainty in building a business in a developing country, much more so in a poor, underserved community! That is why the work of an impact investor never ends with writing a check, it is a much more involved, intricate process, like Acumen Fund’s patient capital, for example. An excellent article from Stanford Social Innovation Review, Closing the Pioneer Gap, discusses this issue in much depth and is a read I highly recommend.
As you can see, there is a great deal to be done to make impact investing a long-term success. Yet, despite its young age, the sector has already disrupted both financial and nonprofit industries and challenged the status quo. Is it not a good enough reason to watch the industry closer, join the discussion, and maybe even help shape a financially-sustainable and powerful tool for social change?
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