Impact Investing - A promising start

Welcome to GPEI’s Impact Investing thread. The intent of this area is to tease out questions of interest, curious and/or significant developments and proffer, now & then, insights and answers into this emerging investment space. There is no presumed monopoly on good ideas so if a forum for discussion emerges, so much the better.

To start, perhaps a tentative definition of how we at GPEI see the world of ‘Impact Investing’.  This is not intended to be prescriptive, but an attempt to at least frame the subject for discussion. Impact Investing: for some, Impact is the dominant partner in the pairing, to others, Investing is. Not surprisingly, we see Impact as the necessary condition and Investing as the active condition. Impact is the effect of an investment dollar on measurable, socially beneficial goals or metrics. Investing is the deployment of capital for an expected positive return. Hence together, ‘Impact Investing’ is an element or sector within the spectrum of socially responsible investing that seeks to deploy capital for an acceptable level of risk adjusted return while concurrently having benefits environmental and/or social terms. Clearly this is an attractive and potentially powerful concept. 

So far so good. However, within the world of Impact Investing, many debates are in progress. The main ones as far as I can see are:

·                     Is this truly a new area?

·                     Should there be a trade off between Impact and return?

·                     Is there a distinction between developed & emerging market approaches?

·                      Can the sector scale & grow?

We won’t try to answer all of these questions straight away, but as starting points (albeit open for discussion), some early thoughts:

·                     Is this a new area:  Not really. From renaissance patrons and guilds through to the present, there has long been an understanding that many good long term investments take into account the needs and priorities of stakeholders in addition to shareholders.  What appears to be changing is an effort to make the impact metrics more disciplined & quantitative – or ‘benchmark-able’ and a desire to attract professional discretionary capital to the sector.

·                     Should there be a trade-off between Return & Impact: An emphatic ‘no’. Our desire is to see this young sector scale & grow and become part of a sensible professional investor’s asset allocation decision. Any suggestion of systematic reduction in efficient investment return raises too many questions and is inherently unsustainable – defeating the objective of scale & impact.

·                     Developed & emerging market approaches: While both have active Impact practices where the allocation of private capital to address needs arising (most frequently) from public market failure, the operating environments are significantly different. We will choose to focus on the emerging markets (as that’s where the needs and opportunities are greatest) while learning from the developed markets.

·                     Can the sector scale and grow: We certainly hope so!  But to do so, it needs to mature, professionalise and attract genuinely dispassionate institutional capital (i.e., non DFI, Endowment and Family Office funding). 

Before we go on, a further definitional refinement is needed. I say above that Impact Investing sits in the spectrum of socially responsible investing. For professional investors that may be a confusing statement, so perhaps a useful clarification is to think of the activity using the labels and models applied in the private sector to fund and grow companies. Typically, the private sector sees a development spectrum that ranges from Angel investing, through Venture Capital to Growth, before entering into the territory of more mature activities involving listed equities and LBO’s. The divisions between the areas are approximate, but widely understood and follow the evolution of a company’s development. The nomenclature in the social space is different, but triaging activity by the stage of a company’s growth helps.  In the social investing world, Venture Philanthropy may substitute for Angel investing or early stage Venture Capital investing. It takes place at the earliest stage, backing a concept more than an established activity or organisation. The philanthropy part of the pairing suggests a flexibility of return expectations that may be helpful in getting off the ground. The private sector’s Venture and Growth areas are more akin to Impact Investing (although the boundaries are still fuzzy). They invest to scale and institutionalize a company that is in its early but not seminal stages. As such, Impact Investing delivers growth capital to extant organizations that appear both commercially viable and whose activities are measurably beneficial.

Notwithstanding the occasional discord on definitions (and the one above will likely land far short of unanimity), if we take as the universally accepted goal of the sector to ‘have an impact’, what has to happen? An educated estimate of the AUM devoted to emerging markets Impact funds stands at approximately $4-5 Billion. The larger Impact asset managers have in the order of $200-300 million AUM. Clearly, neither the total nor the individual pools are significant versus the opportunities or the pool of institutionally invested assets, measured in the trillions. Thus, to have an impact and to be significant, the sector has to develop a cohort of skilled intermediaries who can manage third party capital; achieve exits to demonstrate returns; and understand the structural and fiduciary needs of institutional investors.

It’s a promising start.  In future posts we hope to delve into some of the questions, issues and paths ahead in more detail.  Any comments are of course welcome as we try to ‘institutionalise’ this intriguing sector.