What is social impact investing? is it a lost cause?

What is social impact investing?

Social impact investing is something that is pretty much as old as the hills, yet brand new. In essence it is a way to use money that is not really “normal investing” and neither is it charity – giving money away. Social impact investment is the provision and use of capital with the aim of generating social as well as financial returns. Social investment carries and expectation of repayment of some or all of the finance. It can cover loans, equity, bonds and is sometimes used alongside other instruments, such as guarantees or underwriting. As with any other investments, whether the investee business performs well, returns generated may be principally reinvested in the business, as well as offered to investors.

Good guys finish second don’t they?

Social impact investment is a venture that is designed to improve society. This might be investing in a mechanism to reduce homelessness or the re-offending rates of prisoners. Often there will be a fixed lock-in period (typically 5-8 years) as the project concerned is usually long-lasting. A rate of return is offered, which is normally fairly modest and should the project fail you may not get your money back.

Reaching the reformist in you

My statement that social impact investing is as old as the hills is right in the sense that landowners and industrialists have often invested into community projects. However as we have become ever more reliant upon a State system that appears no longer able to cope, it has returned to discussions. As the money is not gifted, there is a fundamental assumption that the specific project is of significant interest to the investor, who is risking providing some of their capital to help (with an understanding that it should be repaid with a bit extra back, but may not be repaid at all if things don’t work as planned).

Want a better dinner party story?

I wonder if you would discuss this aspect of your portfolio more freely at a dinner party? “Part of my portfolio is helping to get young offenders back into employment and you’d never believe the massive difference it makes to the rate of re-offending. Do you realise that in the UK we spend the equivalent of an Olympics each year on the penal system.” Its certainly a lot more interesting than opinions about the Bond market. I imagine that Slavoj Zizek would have some thoughts to offer about this (which I would find interesting) as it can be construed unfairly as “social conscience investment” – securing the feeling of doing something good, arguably paying more (in opportunity cost terms of missed “normal” investment) or forgoing returns in exchange for a feel good factor. Zizek considers buying your ethical coffee from Starbucks and if you want to get your brain thoroughly overloaded try “A Perverts Guide to Ideology” a truly interesting documentary film. Anyway, however accurate (or not) this may be, it is certainly the case that the Welfare State is not coping and specific targeted projects are having a favourable impact.

Cause and Effect

There will be questions about the real benefits when the data is washed through carefully, but there is certainly a need and genuine attempt to help society. Naturally careful selection of the right project is vital and given the additional risks to capital, requires significant investor sophistication. The problem that advisers have is the knowledge about this sector in the first instance and then struggling to make it fit into a suitable investment strategy that the regulator will also understand. No easy feat, but then to achieve great things effort is always required and certainly no lost cause…

Dominic Thomas

Why social impact investing and regulation are good for each other…and you.

Here is a piece by Mitchell Kutney in the US. I’m reproducing it here with his permission. He has a thoughtful perspective on finance and philanthropy and an active interest in social impact investing. Here he argues why social impact investing needs good regulation so that it doesn’t get abused in the way that some micro finance initiatives have.

We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks… Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people. — Muhammad Yunus, founder of Microfinance.

In the 1990s, people assumed that the altruistic intentions inherent in microfinancing would be enough to prevent exploitation once introduced into mainstream markets. Perhaps impact investing is a similar enough financial innovation that we can learn from some of the growing pains of microfinancing to help prevent history from repeating itself.

Microfinance is a form of financial service for individuals and businesses lacking access to traditional banking and institutional credit. It differs from impact investing in that it focuses on opening capital to typically disadvantaged populations, whereas impact investing is more concerned with results-based outcomes that either improve society or the environment while still garnering economic returns. Also, occasionally impact investing is connected with donations and public dollars to account for various financial risks, or if there is government involvement (e.g., social impact bonds).

Regardless, both impact investing and microfinance are market-based solutions designed to address economic gaps within society. However, the notion of profiting from the poor is still a contentious debate at the cornerstone of these modern financial innovations, and impact investing is no exception with its primary target being emerging markets.

Accountability Structures

One way of possibly addressing this issue would be to embed third-party oversight into the very infrastructure of governance, such as regulation and accountability structures. This way, if any donations or public dollars are topping off an impact investment, we can be sure those dollars are being used appropriately, or if a company is leveraging an impact investment as a part of their social responsibility envelope, the public will be informed whether the investment is actually making a positive difference in the community.

If proponents for impact investing are serious about the introduction of new social and environmental markets, they need to equip these markets with the necessary tools to stand a fighting chance. Otherwise, once impact investing becomes commonplace, and more and more players enter the market, financial outcomes will again dominate, as witnessed in some cases of microfinancing, only with impact investing, it will be at the expense of social and environmental gains.

Avoiding Exploitation

The lack of regulation in microfinancing opened the door to exploitation and led to a number of negative consequences with the most egregious being a series of suicides that happened after a number of reckless microloans were made to local farmers in India. According to MFTransparency, the annual percentage rates of some microloans have been over 300 percent in countries like Zambia or Ghana. These high interest rates alone are not necessarily indicative of exploitation (since the smaller the loan, the higher the distribution cost), but they serve as sobering reminders of how market forces dictate costs despite any altruistic intentions. Clearly, the only way to ensure values are being upheld is by providing some type of oversight or monitoring.

Organizations like the IIPCollaborative have been making some notable efforts in this domain, such as their London Principles guidelines, but these recommendations represent drops of water in the ocean; more global institutional support is needed to help establish oversight, financial transparency, credibility and appropriate standardizations (especially for environmental and social metrics).

Swimming with Sharks

Since impact investing is searching for the sweet spot between high-net-worth individuals’ expectations for responsible investing and effective channels for catalyzing social change, we need to ensure that this financial instrument is not abused. Or else, just as microfinance was defenseless against the sharks, impact investing may find itself in deep waters.

Mitchell Kutney

Follow him on twitter: @MKutney