Return Considerations for Impact Investors
While the definitions and thinking around impact investing have congealed since the term was coined in 2007, there continues to be much debate among industry participants about what types of investors and investments truly count under the definition of impact investments. The most hotly debated of these is the trade-off between financial return and social impact, or if there should be a trade-off at all. This section seeks to aggregate data on the returns achievable through an impact investing strategy, analyzing market-rate social investments made in the venture capital and private equity asset classes. These vehicles make up the largest portion of impact investment funds—as detailed in the following chart—and have been studied most extensively.
Benchmarking Returns to Impact Investments
Early research in the impact investment field pointed to two distinct groups of investors—those whose investment philosophy was “impact-first” and those that were “finance-first.”31 Impact-first investors seek to generate social or environmental returns, but are often willing to give up some financial return if needed— these investments are often said to yield concessionary returns. Finance-first investors are typically commercial investors who seek market-rate returns while achieving some social or environmental goals. These investors might look for commercial products that add social or environmental value (e.g., solar lanterns sold in developing countries) or they might respond to tax policies that provide subsidized returns for certain types of investments that generally provide below market-rate returns (e.g., for affordable housing in the U.S.).
However, this separation, while still useful in thinking about the range of investment options, does not necessarily mean there is or should be an impact-return trade-off in all impact investments. This segmenting of the market has made it difficult for mainstream institutional investors to fully comprehend the field— leaving them on the sideline rather than putting their money to work for impact.
Traditional investors view investment opportunities through the lens of risk-return trade-offs, meaning that taking more risk in an investment should yield potential for greater returns (and greater losses). This same type of relationship does not always apply to impact investing, where more impact does not have to be traded for lesser financial returns, nor must investors choose one objective over the other. Multiple recent analyses serve as the impact investing market’s first attempts to quantify the financial return of their investments:
Cambridge Associates and GIIN 2015 Impact Investing Benchmark
In 2015, Cambridge Associates and the Global Impact Investing Network launched the Impact Investing Benchmark. The benchmark contains 51 private investment funds, pursuing a range of social objectives, with vintage years between 1998 and 2010. These funds are private equity, venture capital, or mezzanine debt vehicles, as investing in these types of funds is a common vehicle for impact investors. Cambridge Associates’ mission-related database shows that of 579 private funds tracked, 392 are private equity or venture capital focused.
While not all impact investing funds aim to garner market-rate returns, the impact investing benchmark restricts itself to only those funds targeting riskadjusted market-rate returns. This means the 51 funds in the benchmark all target an internal rate of return of 15% or higher, which is in line with most traditional funds of the same nature.
The 51 funds included in the benchmark have assets under management of $6.4 billion. They tend to be fairly small in size and relatively new: 27 of the 51 funds raised less than $50 million, and 35 of the 51 funds began in 2005 or later. In the comparable universe of funds (made up of traditional profit-only investment funds), which totaled 705, 71% raised over $100 million and nearly half were launched pre-2005.
Across all vintage years, the Impact Investing Benchmark yielded an internal rate of return of 6.9%, versus 8.1% for the funds in the traditional comparable universe. Performance varies significantly by vintage year, as displayed in the chart below. Older impact investing funds, many of which have been fully realized and are now closed, have significantly outperformed the peer group, while newer funds have not achieved the same type of financial success. These findings show that, for the funds included in the benchmark, financial returns do not necessarily have to be sacrificed in order to yield social impact, though exits may take longer to materialize when compared to traditional venture capital.
Wharton Social Impact Initiative
A recent survey of 53 impact investing private equity funds conducted by the Wharton Social Impact Initiative sought to enumerate the extent to which fund managers will sacrifice mission in exchange for financial returns. To do this, the Wharton Social Impact Initiative asked a set of questions that were specific to investment liquidity events—the point in time when financial returns are realized by investors. One of these questions collected data on the performance of realized investments (those in which a pay-out had occurred through acquisition or other means).
Wharton also collected data on firm characteristics, and found similar results to Cambridge Associates and GIIN. Venture capital and private equity comprised nearly two-thirds of capital commitments and 70% of the number of funds. Respondents’ fund size was relatively small, with 41 of 53 funds having assets under management below $50 million. Additionally, 60% of 53 respondents (32 funds) reported themselves as seeking market-rate returns.
Within the 53 impact investing private equity funds surveyed, the analysis produced return data for 170 individual investments in impact companies. These investments yielded approximately a 13% return (both realized and unrealized) between 2000 and 2014. This rate of return is nearly identical to the two benchmark indices used—the Russell Microcap/Russell 2000 index and the S&P 500. The study also found that mission-aligned exits, where investors believed the social or environmental mission of the company persisted after the investment exit, yielded returns that were on par with non-mission-aligned exits.