The Impact Investor

 Why should mainstream asset managers and investment advisers take note of this emerging market?  Perhaps because those who fail to do so may well “go the way of the dinosaurs,” as venture philanthropist Charly Kleissner maintains.   Indeed the Monitor Institute projects the market will grow from its current value of about $50 billion to $500 billion in the next ten years, as more and more foundations, family offices, high net worth individuals and for profit institutions seek out impact investing vehicles and advisement. 

 The sector is drawing such a high level of interest for a number of reasons. First is the almost universal acknowledgment that traditional philanthropy and government resources alone will be inadequate to address the magnitude of the social and environmental challenges facing the planet in the 21st century.  There appears to be no alternative but to mobilize the capital markets to fill the breach. Second is the accumulating evidence that many impact investments are uncorrelated with the broader market: microfinance lending and community development bond funds, for example, held up surprisingly well in the recent market downturn.   Additionally, as global capital migrates increasingly to commercial opportunities in the developing world, complementary social projects to improve infrastructure, education, and health services in those markets are also making sense to mainstream investors.  The trend toward greater regulation and rationing of carbon emissions and scarce natural resources also adds luster to pure plays on environmental solutions.  Finally, the extraordinary fortunes amassed by a group of socially conscious entrepreneurs has spawned a new generation of “social venture capitalists” who believe that funding a business rather than handing out a grant is often the more effective way to realize a desired social outcome.

The Rise of Mission Investing

The charge into impact investing is being led by a group of philanthropies that include the Rockefeller Foundation, the KL Felicitas Foundation, the Annie E. Casey Foundation, The F.B. Heron Foundation, Meyer Memorial Trust, the Skoll Foundation, and the Bill and Melinda Gates Foundation. These so-called “mission investors” believe that a much greater portion of endowment monies should be directed toward projects related to a foundation’s underlying mission rather than funneled, as is current practice, into mainstream investments.  

 A survey released in October 2009 by  “More for Mission,” a nonprofit organization that aims to coax $10 billion in new money into the mission investing market by 2012, found that a group of 39 foundations in the More for Mission network that responded to its survey, with collective assets of $27 billion at year end 2008, reported their intention to increase the percent of their endowments allocated to mission investing from the average of 4.7% at year-end 2008 to the projected average of 6.9% by year-end 2009.  (M4M is  hosted by The Initiative for Responsible Investment, which now operates within the Hauser Center for Nonprofit Organizations at Harvard University.)

 Although the core group of philanthropies that participate in the More for Mission leadership network are already allocating significant portions of their endowments to mission investing, there are a number of reasons why the broader foundation community has been slower to follow suit.    “Foundation boards may be characteristically averse to perceived risks,” says Lisa Hagerman, Director of More for Mission.   “They may say, ‘let’s use conventional investments to outperform the market and continue to make the impact through traditional grant making.’”  The fact that most foundation boards have yet to articulate formal mission investing policies presents an additional obstacle.   

 Nonetheless, reports David Wood, Director of the Hauser Center's Institute for Responsible Investment, while many foundations are still "digging out of the wreckage" of the market collapse, they have at the same time been taking a closer look at mission investing strategies that they might earlier have shunned because their advisers deemed  them too risky.  “Thanks to the crisis, people are less likely to agree when their investment adviser says,  ‘you can’t do this because modern portfolio theory says you can’t’,” says Wood.

 At most larger foundations endowment investing and programmatic grant making typically operate out of separate silos with minimal interaction, says Hagerman.   The endowment side and the program side need to work together, she notes, to structure mission investing strategies that meet both the institution’s social goals and its financial risk/return requirements. With many mission investing projects, some form of subsidy, including outright grants, technical assistance, low interest loans, or loan guarantees must be imbedded in order to provide market returns for the endowment side and/or for outside commercial partners. Happily, says Kevin Stephenson, Director of Mission Related Investing at Cambridge Associates, some foundations are moving to bridge the disconnect between investing and grant-making by creating new positions for Directors of Mission Related Investing.

 Kleissner, whose KL Felicitas Foundation nurtures sustainable social enterprises in rural communities worldwide and participates in impact investing infrastructure building initiatives is unhappy with the glacial pace at which many older foundations are approaching mission investing.  “I look at the big foundations on the East and West Coast which are no longer led by their original entrepreneurs,” he reports, “And I see their administrators moving so conservatively, saying they will invest 2 percent of their endowment in mission investments as though this is something significant. If their original founders were around today they would have taken the lead in this movement.” 

 However, it is the hope of Raul Pomares, an investment advisor at Guggenheim Partners and coauthor with Steven Godeke,  Albert Bruno, Pat Guerra, Charly Kleissner and Hersh Shefrin of the book “Solutions for Impact Investors: From Strategy to Implementation,” that foundations will eventually come to view impact investing as just another tool among many to achieve their programmatic goals.  “If the most effective way to execute your theory of change is through a grant then do it,” says Pomares. “But if you need to achieve an impact of greater magnitude, do it with an impact investment or find a commercial capital partner.”

MRIs and PRIs

“Mission” investments fall into two broad categories. Program related investment (PRIs) are those closely aligned with a foundation’s mission and are deliberately structured to realize below market rates of return for the foundation and a subsidy for the impact project. PRIs have particular appeal to foundations because they count along with grants toward the 5 percent annual endowment pay out required to preserve tax-exempt status. Mission investors also make market rate investments (MRIs) that are expected to generate competitive returns.   The F.B. Heron Foundation, for example, makes PRIs in the form of small business loans to Self-Help Ventures, which invests in low-income community businesses, and private equity investments in SBA sponsored New Markets Venture Capital Companies. Under the advisement of Weston, FL-based fixed income managers Community Capital Management, F.B. Heron has made MRIs in bonds that fund down payment assistant to low-income first time home buyers in Texas as well as in “blight bonds” issued by the City of Philadelphia.  To meet the often finely focused social impact goals of the mission investor, CCM structures portfolios that target specific geographic regions and/or social purpose, like job creation for low-income populations or environmental sustainability. 

Perhaps the easiest way a foundation can acquire experience in the impact investing market is by making an MRI through a cash account in a community development bank, credit union, or sustainable regional bank. Imprint Capital Advisors recently worked with the Kellogg Foundation when the latter established $22.8 million in cash deposits with a group of community banks and credit unions. “Cash is easy, you can customize it to what you care about in issue and geography,” says Imprint’s Goldstein.  “We calculate that Kellogg’s MRI deposit program will drive $13.7 million in new lending into vulnerable communities.”  Had an equivalent deposit been held in commercial banks, Goldstein reports, the foundation would have funneled only  $3.4 million into low-income communities and would have realized less than half the yield.  Furthermore, the deposit is fully insured beyond the usual $250,000 FDIC limit through the Certificate of Deposit Account Registry Service.

 The Commercial Sector Enters the Market

While foundations begin to get their feet wet in impact investing, the greatest potential for growth is actually expected to come from the commercial and pension investment sector. CalPERS, which has long played a leadership role as an investor in underserved markets, along with TIAA-CREF, which formed a new global social and community investment department in 2006, are trailblazers among pension funds in the impact investing market. Both have set an example for newer pension fund entrants.  Among financial services institutions Prudential Insurance and JP Morgan Chase have been high profile participants in the market and active in impact investing networks. 

 Like their philanthropic counterparts, commercial institutions are finding both opportunities and obstacles as they explore the market.  Scott Budde, Managing Director and head of TIAA-CREF's Social & Community Investment Department, says that his group has been able to achieve the twin goals of both reasonable financial returns relative to risk as well as identifiable social and environmental impacts. TIAA-CREF’s impact investments include $582 million in corporate social real estate (including affordable housing), $100 million in microfinance and $49 million in community development bank deposits. 

 A 2006 TIAA-CREF survey revealed that the top priority of 67% of its retirement asset holders was to see their personal values in relation to social and environmental impacts reflected in their investments.  In response to this growing client interest in socially responsible investing, TIAA-CREF’s Social & Community Investment Department recently announced that it hopes to start up a fourth impact investing program focused on green building technologies soon.   

 But so far few institutional investors have, like TIAA-CREF, allocated a significant portion of their portfolios to impact investing or created policies to do so.  “Pension asset managers of necessity are picking from investment product options that already exist and fit their boxes,” says DeBerry. “But the challenge is none of those boxes contain the mission innovation.” It may also take time for some of the newer sectors of the market to achieve sufficient scale and transparency to be viable investment vehicles for large commercial and institutional investors. TIAA-CREF, for example, is unable to invest in many  microfinance institutions operating in the developing world because they are either too small and/or do not meet its reporting standards.  Budde notes, however, that TIAA-CREF felt comfortable in taking a $43 million private equity stake in the German microfinance bank Procredit in 2006. Budde reports that Procredit provides some of the most rigorous financial reporting and disclosures among global institutions, including comprehensive annual reports, full shareholder structures, and executive compensation for all its subsidiaries, including full GAAP reporting for subsidiaries in emerging markets like the Congo and Nicaragua. 

Yin/Yang of "Layered" Investing Structures

Some of the most effective impact investing projects involve partnerships between nonprofit and commercial institutions. These so-called “Yin/Yang” or "layered" deals bring together what the Monitor Institute calls “Financial First” and “Impact First” investors. The former are looking to optimize financial returns but also require at least some base level of social impact..  The latter seek optimal social impacts and are willing to accept lower financial returns. 

 “Yin/yang” strategies can often produce deep social impacts when the philanthropic or public sector participant brings technical or geographic know-how to the table, effectively offsetting some of the perceived market risk for the commercial investment partner.  “Foundations may be able to use their internal capacity most effectively when they come in as co-investors with traditional investors,” says Wood. “They might take on a little more risk or mitigate it in their underwriting because they know the areas and people better.” In other cases, he reports, the foundation can participate with a below market rate investment, effectively subsidizing the market rate return required by the commercial lender, in exchange for a social return on investment. 

 Ideally these deals make for more focused, better executed and more disciplined impact projects, with something approaching an optimal balance struck between social outcomes and financial returns. However, as Pomares and Godeke note in “Solutions for Impact Investors: From Strategy to Implementation,” “In these structures, the impact first investors must be very clear as to how their subsidy of financial first investors is increasing the overall impact and capital of the project and not just de-risking the deal for the commercial investors.”

Market Infrastructure Building Initiatives

A number of initiatives to bring more coherence and standardization to the impact investing market are currently underway.  For example, The Global Impact Investing Network (GIIN) of foundations, commercial investors, financial services intermediaries and advisory organizations is building an Impact Investment Fund Database to demonstrate the breadth of investment opportunities in the space.   The GIIN, in partnership with The Rockefeller Foundation, Acumen Fund (a global venture fund focused on addressing global poverty), and the not-for-profit B Lab, is currently spearheading a project called the Impact Reporting and Investing Standards (IRIS) “It can now be a huge challenge for investors to reconcile social impact data,” across products, says Amit Bouri, GIIN’s director of strategy and development.   “With IRIS we are setting up a standard set of definitions to measure social and environmental impacts.”  An IRIS data aggregator, also under development, will be a web-based tool  allowing users to access aggregated data and create benchmarks across sectors, geographies, or specific IRIS performance metrics.  For example, investors will be able to accurately track and compare the job creation performance of IRIS-compatible impact investment projects.

Bouri also reports that IRIS metrics will allow investors to understand the tradeoffs between financial returns and social impacts. “Venture funds and foundation endowments may need to achieve market rate returns but there are some family offices and high net worth individuals that are willing to take a cut in financial returns to achieve deeper social impacts,” he notes. “Our goal is to create enough clarity for the right capital to find the right recipient.”

Christa Velasquez, director of social investments for the Annie E. Casey Foundation, which has set aside $100 million of its endowment for mission related investing, applauds these efforts and believes it will encourage market growth: “We fully support the work of developing standard metrics like IRIS,” she says. “With the increased interest in social investments, it’s important to ensure that proper measurement standards are followed to avoid the appearance of green-washing.”

Rating Impact Projects and Companies

Efforts are also under way to foster more market transparency and ease of entry through the creation of standard rating systems. “The idea is for investors who don’t want to go deep into the data to have a service that does that on their behalf to scale this industry and allow it to grow,” says Bouri.  B Lab, for example, has created the B Rating system to certify the social and environmental impact credentials of a growing list of social entrepreneurial ventures known as “B Corporations.” 

 B Lab constructs a composite score for rated companies between 1 and 200 based on earned points along environment, employee benefits, community, consumer and leadership dimensions. Companies that earn 80 points or more are eligible for certification.  Among the current list of over 200 B Corporations are San Francisco-based Alter Eco (composite score 121),  a fair trade and organic  foods company which pays 100 percent of its employees healthcare premiums and offsets 25 percent of its associated carbon output, and IceStone LLC a Brooklyn-based startup (score107.5) that manufactures kitchen top and other durable surfaces from 100 percent recycled glass.  (IceStone sets aside 10 percent of profits for employees and 75 percent of its employees work in low-income communities.) B Lab is also developing a Global Impact Investment Rating System (GIIRS) using IRIS data for an array of impact investment projects and funds. 

A Social Stock Exchange?

In another effort to open up impact investing to a broader base of investors, the Rockefeller Foundation recently extended a $500,000 grant to investigate the feasibility of establishing a social stock exchange in the UK.  Pradeep Jethi, a UK-based social entrepreneur and former New Product Development Manager at the London Stock Exchange, who directed the Rockefeller study reports, "the proof of concept work is complete now, and points in the direction that institutional and retail impact investors want a social stock exchange." He notes that the success of the online micro funder kiva.org suggests that the retail market in particular may be ready for a larger-scale and more formal exchange that would enable small investors to participate in social venture IPOs.  “There are a number of companies that are at scale and ready to do an IPO, in sectors like social housing, alternative transport, health, education, waste water management and ethical consumerism,” he reports. “But it is hard for them to get sufficient visibility on the traditional markets to attract investment capital.” 

The Role of Subsidies

There are many opportunities for “financial first” investors to do exceedingly well in the impact investing market. “The performance expectation for these investors should be the same risk adjusted rate of return of a similar investment without  impact considerations,” says Pomares.   He  reports that some "financial first" impact investors have actually achieved better than benchmark returns as a result of the quality of the management teams that have been drawn to the field, executing impact investment strategies.   

 But many more impact investments require more “patient” capital, notes Penelope Douglas, managing director of San Francisco-based Pacific Community Ventures.  She reports that she has had to work hard to educate investors who participate in PCV projects in underserved US markets to have realistic return expectations.  PCV invests in brick and mortar companies that generate jobs and revitalization but not  “hockey stick” returns, she says.  “Instead these are the engines of slow steady growth and it is important for investors to understand that.” 

 GIIN’s Bouri also cautions that not all sectors of the impact market can be expected to offer competitive returns without some subsidy.  While it may now be possible to obtain market rate returns in the microfinance market, he notes, the sector was heavily subsidized by grant money in the earlier stages of its development.  

Namrita Kapur, Vice President of Strategic Partnerships at Root Capital, a “hybrid” social investment fund that provides credit and financial management training to rural businesses in developing countries, reports that impact investors need also to be reminded that public subsidies play a critical role even in mature markets—for example small businesses in the United States continue to receive subsidies through the Small Business Administration. She reports that considerable pressure has been placed on hybrid institutions like Root Capital to both scale up operations and provide market returns, sometimes without sufficient recognition that an important part of this process requires both philanthropic and submarket rate capital.   Kapur warns of the unintended consequences of focusing exclusively on commercial returns: “We forget that there are aspects of functioning markets that require an investment in public goods.  For example, without our grant funded financial management training services, some of these businesses might never have the skills to access credit from local financial institutions let alone from a social investment fund like Root Capital.   We see this same dynamic across industries.”

In spite of the difficult markets in which it operates, Root Capital has thus far realized a 99 percent repayment rate on over $150 million in credit extended to 255 small businesses in 30 countries. In some instances it has partnered with other social finance organizations like RSF Social Finance, Calvert Social Investment Foundation and Conservation International. Root Capital also partners with industry leaders to mitigate risk within their loan portfolio. For example, it recently provided a $225,000 loan to a group of Tanzanian coffee farmers to purchase coffee washing stations and secured the loan with purchase contracts from Starbucks. At the same time Root Capital extended critical financial management education and training that will ensure that the farmers acquire the skills they need to manage their business over the longer term.  

Root Capital also functions as an “uber catalyst,” says Kapur, encouraging local banks to enter the impact investing space.  Peruvian banks, for example, increasingly participate side by side with Root Capital in deals, and in a few cases, Kapur reports, local banks have taken over loans to companies that Root Capital has nurtured into going concerns with stable track records.  And in underdeveloped capital and lending markets focused on rural businesses, like in Africa, Root Capital is aspiring to work directly with local banks on prudent risk mitigation and due diligence practices.   

Preserving the Creative Tension As The Market Grows

There is some debate among stakeholders in the impact investing market about the possible downsides of bringing it “to scale” as well as about how it can be made to grow without sacrificing what makes it most unique and innovative.  “To blithely talk about scale as though it will solve all the problems of the world is not always desirable,” says John Goldstein, cofounder of Imprint Capital, a San-Francisco-based advisor to mission investors. “The hard thing for this industry will be to turn this drive for scale versus the love of small is beautiful into something constructive.”

 Wood says “we do need more rigorous metrics and a more consistent vocabulary but they need to be flexible enough to accommodate the particularities that are growing out of this dynamic market.”  A formal rating system that compares social impacts across a broad range of mission categories isn’t necessarily the way to go, Wood reports, citing the example of Root Capital:  “From my perspective Root has done great work on metrics, and this will help investors feel confident in their social return, but there’s something beyond the metrics, encompassed in their story, that is also fundamentally attractive to investors. Conversations about metrics and ratings can sometimes overemphasize the quantifiable and underemphasize the compelling ‘story’.”

 Don Shaffer is the president and CEO of RSF Social Finance, whose mission since 1984 has been “to transform the way the world works with money” through investing, lending, and giving in the areas of food and agriculture, education and the arts, and ecological stewardship. Although he supports efforts to improve social metrics and construct impact rating systems he also maintains that the market should be careful to strike a balance between over-fragmentation and overstandardization.  “It is a very good thing to have a more cohesive capital market so that more well intentioned people will feel comfortable coming into it,” he says. But Shaffer is concerned that in an overly centralized marketplace  “the bigger players will figure out how to game the system to their advantage.” Although it is hard to imagine such an eventuality at this early stage of the market, he says, “it would be sad if everything was dependent on gigantic ratings organizations and if the impact capital market evolved into what we see on Wall Street.”

Goldstein, who calls himself an eternal optimist, believes the future of impact investing lies with finding creative ways to scale up the financing side and share information more productively, while continuing to move forward with the labor intensive, hands on work that is so often required to affect deep social change. “I am pragmatic about how hard it will be to do these things,” he says. “But the real breakthroughs come through just these sorts of tensions.”