In developed economies, impact investing can target a full range of sectors, from healthcare to education to resource conservation. Domestic-focused funds and Community Development Financial Institutions have also carved out investment niches close to home, providing capital to enterprises that create jobs locally or in areas underserved by traditional capital providers.
Decision Points for Impact Investors
Despite the myriad of organizations that have become involved in impact investing and the potential for growth that has been documented by multiple organizations, impact investing remains a novelty to many mainstream investors. In fact, a 2013 survey by the CFA Institute found that only 15% of 727 financial advisors had a clear understanding of the principles of impact investing.27 This section aims to illuminate the wide range of decisions that impact investors face. These same decision points also represent the many uncertainties facing investors, which limit their ability to bring comprehensive financial and social strategies to bear in the most high-impact way.
Choosing the Right Strategy to Create Social Impact
An investor’s approach to financial returns is likely the biggest decision in moving into the impact investing space. A range of financial return targets has been generally accepted throughout the impact investing industry: market-rate returns, concessionary returns, and capital preservation. The ability to match the impact-return expectations of investor capital with appropriate deals remains a difficulty for impact investors—it was the number one challenge to the growth of the impact investing industry cited by respondents in the JP Morgan/GIIN investor survey.
While the impact-first or finance-first framework need not apply to all investments made in the space, it can be useful when creating investment philosophy. It can also help lead investors to choose the social issues that they want to effect. For example, an investor that leans more toward social impact (which might be a foundation or high net worth individual) might be more willing to invest in a social enterprise providing business services to entrepreneurs in Latin America. On the other end of the spectrum, a mainstream investor with fiduciary duty to clients might find more appeal in a company that matches its sales of eyeglasses in developed countries with product donations in developing countries.
Direct or Indirect: Picking an Investment Form
The unique features of impact investing—which include more involved due diligence and tracking of impacts— have made investing through a fund the predominant mode of investment. This approach allows specialized funds to grow expertise in the area of impact investing, leaving providers of capital (e.g., mainstream financial institutions, pension funds, and foundations) with less effort in monitoring investments and an easier ability to diversify their investment base. However, there are advantages to making direct investments into social ventures, including having more control over the investment process and greater visibility to company operations and social impacts. Most impact investment decisions made by large institutional investors or small investment offices carry the same choice: either create expertise within the organization to make direct investments or undertake extensive due diligence on funds and fund managers.
Geographic Focus: Where to Invest
Many impact investment funds have a geographic focus—largely choosing to focus on social impact in developing countries or in developed ones. Impact investing is sometimes associated with enterprises that focus on bettering the lives of the “base of the pyramid” population—the approximately four billion people globally who live on less than $5 per day.28 Over half of all social enterprises operate in the developing world, which has more acute needs that create more opportunities for socially-minded enterprises to sustain financially-viable business models.29
JP Morgan and GIIN’s impact investor survey from 2015 found that 99% of the respondents measure the social and/or environmental performance of their investments. The willingness of the impact industry to measure investment outcomes does help provide clarity to a very diverse set of investments, but impact-tracking still spans a wide range of metrics that vary by social impact sector. Impacts can be business model specific—bringing benefits to customers through products and services—or process specific— accruing to workers, the surrounding community, or the environment. This bifurcation creates complexity in tracking social outcomes and in comparing them to other impact investment opportunities. The preceding table highlights the diversity of measurable social or environmental outcomes across geographic and sector specific impact strategies.
Exiting an Investment: Liquidity with LongTerm Mission Intact
Impact investing’s fairly short track record as an investment approach means that examples of successful exits of venture investments through acquisition or initial public offering is limited. The JP Morgan/GIIN survey of 146 impact investors shows only 76 exits—17 are in the microfinance sector, where impact investing made the greatest inroads years ago, starting with Grameen Bank.
To increase the probability of reaching an investment exit point, over 50% of impact investors employing private equity structure “tag along” or “drag along” clauses in their investment terms.30 These clauses give minority shareholders the right to join any deal in which the majority shareholder is selling its stake. Other impact investment deals have structured revenue-sharing agreements or demand dividends that offer investors small returns based on income earned in the absence of a liquidity event such as an initial public offering or acquisition.
With the majority of impact investment exits coming in the form of company sales to strategic or financial buyers, some impact investors also grapple with the risk of a company’s mission falling away after it has been acquired. While fund managers may be pressured to find liquidity for their investments to allow investors to realize returns, they can also work to ensure the preservation of portfolio companies’ missions. To accomplish this, many funds use an “embedded impact” strategy, which utilizes a pre-investment screening process that allows investments only in companies with inherently impactful core business models, thus making long-term impact integral to the long-term viability of the company even if ownership changes.