UP FOR DEBATE: Impact Investing
Response to "When Can Impact Investing Create Real Impact?"
Impact investors should not be burdened with proving social impact.
The article by Paul Brest and Kelly Born perpetuates the idea that financial returns and social impact are a zero-sum game and that you cannot maximize both. This perspective has done a tremendous disservice to the impact investing field. If the world had adopted it two decades ago, poverty would not have been reduced by 50 percent.
Not all human and environmental challenges can be tackled with commercial approaches, and many terms denote the noncommercial initiatives that address these challenges, including philanthropy, nonprofit, public sector, and corporate social responsibility. A new term is justified only if it is not old wine in a new bottle. That is why at IGNIA we believe that impact investing should be reserved for a commercial approach, lest we confuse more than we clarify.
The authors ask, When can investors expect both to receive risk-adjusted market-rate returns on their investments and have real social impact? The answer is, When an intervention of high social value is mounted on a sturdy business platform. We proved that this was possible with commercial microfinance. At IGNIA, we seek to extend this approach to affordable housing, digital access for the daily needs of people at the base of the pyramid (BOP), access to health care, high-nutrition products, and other basic needs.
If we succeed and achieve extraordinary financial returns, this will attract a flock of market entrants. With their entry we will create an industry, and only then can we guarantee achieving a lasting and large enough impact to move the needle. In this way financial returns can be the main driver for social impact. Accordingly, there is no question that intentionality is a key element of impact investing and the intention should create an industry. How else can we stand a chance of tackling the enormous challenges we face?
Brest and Born’s perspective—that in order to achieve impact you need capital willing to accept concessionary returns—is based on the view that reaching clients depends on a single dimension: price. But the value proposition to a client is much more complex than price. For example, Mexico provides free public health care, but after factoring in travel time, waiting time, multiple visits to the doctor, and quality of care, people at the BOP would consider that the total transaction cost is actually large. Seeking a better value, people at the BOP are often willing to dig deep into their shallow pockets to opt for a commercial health-care alternative. The market economy has taught us this lesson, but in the socialimpact world we refuse to accept it.
Brest and Born’s view that “an ordinary market investor, who seeks market-rate returns, would not provide the capital on as favorable terms” perpetuates two false views: first, that investments with impact cannot achieve extraordinary returns, and second, that the impact world sets the bar too low and continues to fund mediocre business plans for which no source other than concessionary funding is possible. If the first view were accurate, few of the great innovations that have improved the quality of life
of humankind over the past 100 years would have flourished. The second leads to the view that impact investing is an industry devoted to funding the well-intentioned “walking dead” (to use the venture capital industry’s term).
By focusing on financial returns, Brest and Born miss the point that what distinguishes impact investors from traditional investors is that they have a higher tolerance for risk.
Brest and Born also call for more attention to measuring outcomes. But we have spent too much time and too many resources discussing impact measurement and trying to measure outcomes. Is an individual who needs eyeglasses better off if she has access to them? If you are wearing a pair while reading this article, you know the answer. There are myriad basic products and services such as eyeglasses to which the majority of the world’s population does not have access and which, if they did, would allow them to live significantly improved lives. So let’s move on and not overburden those initiatives focused on underserved communities with academic questions. They already face plenty of challenges trying to deliver what they promise.
There is no question that there is a role for philanthropic capital in impact investing. Philanthropy, as in the biotech and the cleantech industries, can provide the very early stage R&D capital that carries such high risk that it would never attract any return-seeking investor. In this well-worn model, philanthropy, often through universities, helps give birth to new ideas and enables their development into working concepts, at which point the risk level is in the range where venture capital can enter and bet on building an effective business model. Instead of playing this role in impact investing and supporting disruptive business concepts on their hard road to viability (or not), philanthropy too often funds no risk and therefore no innovation, as when it gives free houses to the homeless or waits in line to provide growth capital to already-proven social enterprises.
One last thought. Venture capitalists understand that their industry is based on the portfolio approach to returns. In impact investing we seem to have missed this lesson. With a “concessionary returns” approach, the end result is a portfolio characterized by very low risk/low returns projects that, by definition, are neither transformative nor very innovative. Instead we should adopt the portfolio approach, knowing that most projects that swing for the bleachers will fail but those that succeed will achieve such high impact and financial returns that they will more than compensate for the failures.