We are at a very exciting and important time in history. Technology, the immense creation of wealth and the focus on philanthropy, has given us a realistic chance, probably for the first time, to tackle and overcome some of the most intractable problems faced by humanity. Education, energy, clean water, food and housing are things that every human being should be able to take for granted in the 21st century. However, today a few billion people around the world still struggle for these basic everyday needs and impact investing has a key role to play in disrupting global poverty.
There is a wide range of investments and concepts that are broadly clustered under impact investing. I will focus primarily on equity impact funds, although many of the challenges will be common to other types of products as well.
According to the recent GIIN 2016 Annual Impact Investor Survey, the total size of assets classified as “Impact Investments” was $77.4bn at the end of 2016.
So real progress seems to be taking place. However, I would submit that a significant amount are reclassified assets that have already been “doing good work”. The “real” appetite for high risk investing focused on the poor, defined as those earning less than $4/day, remains very small.
To understand the challenges of impact investing, first, we have to understand and agree on the problem we are trying to solve and the opportunity this presents. I believe the challenge, objective and indeed the opportunity for impact investing is, how do we change the future of 2bn people living in poverty?
This is what Acumen has been focused on since the beginning. We have seen how often government aid and charity creates dependence. At the same time private business capital has not been able to provide basic goods and services to the poor. So the real opportunity for impact investing lies in this area, where aid has fallen short and markets have failed. We can use the tools of philanthropy and investment to solve problems of poverty, and impact the most vulnerable, at scale. However, such impact funds face a number of unique and difficult challenges.
Based on our experience at Acumen of investing in social enterprises across 13 countries over the last 15 years, we have come across broadly six types of challenges. Many of them will be familiar but the nuance and the manner in which they need to be addressed is quite different from traditional investment funds.
These challenges include:
- Educate and be the bridge between the investee and investors.
- Repeatable and cost effective data collection and impact evaluation system.
- Keep the investors involved in the journey.
- Competition versus collaboration.
- Proximity and changing the narrative.
- You have to be a catalyst.
Educate and be the bridge between the investee and investors
Almost 95% of investors are focused on financial returns, using traditional investment paradigms. If they are to incorporate impact in their investment decisions then there is a real need to educate them about the risk, return and time period needed to achieve both impact and return. At the same time, most of the impact fund investee companies do not have experience dealing with investors. Indeed, an impact fund will generally be their first exposure to external investors so a successful impact fund needs to act as a bridge to educate both sides and manage expectations.
Repeatable and cost effective data collection and impact evaluation system
One of the most difficult aspects of investing in a social enterprise is measuring its impact on lives and communities which is resource heavy and expensive. However it is critical to put in the time and effort to collect and explain the data, once the impact matrices have been agreed.
A lot of time and effort is spent in agreeing the impact matrices and on what to measure but not how to measure it, in a cost effective and repeatable manner that drives value for both the investor and investee. This is not easy to achieve but is critical for the success of the sector.
We’ve created a new impact measurement tool and methodology called Lean Data, which is successfully attempting to do this. It is low cost, fast, and allows us to articulate the impact, and also helps us and our companies make informed decisions.
It is critical to keep the investors involved in the journey.
Impact investing is high risk and generally requires a long-term commitment. In our experience the investment time period is between 9 to 11 years. It truly is a journey with many ups and downs and is quite different from investing in traditional funds. Hence it is important to keep the investors engaged and updated. Often this requires the investors to be willing to take out the time and make the effort to go see the investments on the ground, meet with the entrepreneurs, read primary and specialist research, as these companies and sectors are generally not well covered in mainstream media.
Competition versus collaboration
Given the scarcity of capital and the high risk, it makes sense to collaborate with other funds and competitors. You need to share risk and have others willing to come in when follow on capital is needed. This requires much more openness and willingness to share information than is generally the case in the mainstream investment world.
Proximity and changing the narrative
It is very important to be physically near the investee companies and communities that your investing in and trying to impact. You need to be on the ground, both for pre-investment work, from developing the pipeline to due diligence, and for effective post-investment support and monitoring. A lot of primary research is required and a deep knowledge of the sector and country. This was one of our early lessons. To be truly impactful you have to help change the narrative and bring about systems change and this will involve sharing your experience with other players and governments in order to impact policy.
You have to be a catalyst
Your investment alone is not going to pull 2bn people out of poverty. If you are to make a broad and large-scale impact that is not just financial, then often you will have to act as a catalyst. The level of engagement, skill set, willingness to be open is quite different from purely making an investment and exiting at an opportune time.
If you handle these challenges well you can create large scale and outsize impact but this is just the start, there is an immense amount of work for all of us to do.
Ultimately the real challenge is how do we make all investments accountable for their impact and not just a small segment that we label impact investments?