Report by Clark, Emerson and Thornley, October 2012, Pacific Community Ventures, Impact Assets and Duke University’s Fuqua School of Business: USA.
This article helps us understand what makes social impact investment unique and distinctive. The authors begin with the proposition that globally we have passed the initial proof of concept, and a social impact investment market is now taking shape. They record a cumulative list of 380 international funds, managing in excess of $40 billion, and 240 different firms with impact investing experience.
The distinctiveness of the social impact investment market is captured by six market dynamics:
1. The Relationship between Active Investors and Funds
Social impact investors, be they individuals, foundations, institutions or government, play a far more active role than traditional investors. As a result of their desire for social outcomes, they may put capital at risk, enable the creation of a fund, identify other investment partners and be involved in due diligence. However, the level of risk, particularly for the first investors, is much higher as the investment may well need to be committed prior to the fund itself being established. So active investors will need clarity of purpose, capital that is risk tolerant, time to invest, a strong network to like minded investors in order to catalyse the establishment of a fund or a platform where social impact investment can take place.
2. Funds and Fund Managers as Pioneers
The authors cite many examples where funds are playing a dual role of managing the fund as well as nurturing the pipeline for the fund in a way more akin to a foundation or an entrepreneur. This is another element that separates social impact investing from other more traditional and mature markets. Funds are also constantly balancing the social and environmental impact with the sustainability of the business model and its ability to pay dividends and have liquidity. And when investments are created or located, the fund is also required to work shoulder to shoulder with the entrepreneur to help create an industry ecosystem where that business can thrive. Finding the right people to play this hybrid role of fund manager is critical to the market being sustained.
3. Financial Innovation
The traditional approach to capital structuring is the jumping off point for social impact investment funds so real innovation is required. However, funds need to hold a tension in this regard so that the products and structuring aren’t so complex that they fail to attract sufficient mainstream investors. As a result, many funds use workarounds to limit the variations, flexing in such areas as:
• expanding the time horizons of the fund, as many social programs take 10 years or more to create impact and change
• managing return expectations both in terms of financial and social returns
• overcoming fund managers’ limited expertise, given the newness of the market
• capital stacking, blending multiple sources of capital and risk appetites together
• integrating debt and guarantees to reduce risk
4. The Growth of New Distribution Platforms
New platforms for social impact investing could help move much larger amounts of capital to the market as well as reducing transaction costs. However, gate keepers such as advisors will need to be convinced of the demand and also feel confident to discuss opportunities with their clients. Intermediaries have an important education role to play for both advisors and the general public who access investment opportunities through existing retail platforms.
5. The Performance Problem
Funds not only have the dilemma of how to report on financial and social returns when many funds are still in the early years of their maturity, they also need to differentiate the relative priority of financial and social goals and how they relate to the definition of success. In many instances, the definition of success can vary from one investor to another. Some funds refer to the amount of capital raised and the balance of its impact and ‘non-impact’ sources as a measure of success, in the absence of exits. We are also seeing an increase in the use of standardised impact reporting such as IRIS and GIIRIS but there is still a need for a language that will allow for the tracking, rating and comparing of outcomes and impact.
6. Aligning Purposes
The authors believe that if the purposes of investors, investees and funds are not able to be reconciled, then impact investing will not likely succeed. The challenge is to clarify and communicate these disparate purposes, both individually and collectively.
Applying this in Australia
Whilst we only have a handful of funds and products here in Australia, the dynamics of the social impact investing ecosystem still apply. We appear to have many people willing to play the fund manager role, however, there are both fewer active investors able to help create the funds and fewer entrepreneurs whose businesses are investment ready. Government, in the form of DEEWR and some state governments, have been and are preparing to play the role of active investors and a few of the large NFP’s and foundations are doing the same, but it may be that a smaller number of active investors than are seen in the US is partially slowing down the emergence of the market here.
It is clear that if we are seeking to create a local social marketplace, we’ll need the interplay of all three stakeholder groups to create the appropriate platforms and the role of intermediation. The role of active investors funding of this work will be critical.