In late 2011, during Africa’s terrible drought which caused food prices to skyrocket across the continent, the U.S. Agency for International Development and JPMorgan Chase & Co. announced a $25 million African Agricultural Capital Fund to provide much needed capital to Africa’s agricultural sector.
“This transaction exemplifies an innovative approach to impact investing that we hope will be a model for the future,” said Peter Scher, executive vice president and head of corporate responsibility at JPMorgan Chase & Co.
While the size of this deal was somewhat extraordinary, similar arrangements are becoming increasingly common, raising the profile of what is known as “impact investing” and enticing new and diverse players into a discipline and industry that many are regarding as a wave of the future in global development.
Stated simply and broadly, impact investing is the act of investing in businesses intended to create positive social and environmental impact while at the same time generating financial return. The concept steps beyond socially responsible investing, which involves investment due diligence, “negative screening,” or the voluntary proscription of funding companies involved in sectors that, some perceive, incite negative social or environmental consequences. Instead, impact investors – which can be individuals, foundations, private funds, development finance institutions, and commercial banks – take into account the constructive social and environmental contributions of investment decisions.
The still fledgling but expanding industry received attention when the Monitor Institute published a report in 2009 called “Investing for Social and Environmental Impact.” That report coined the term “impact investing” and cited the industry’s potential to grow to 1 percent of total managed assets globally, which would represent about $500 billion. Some label impact investing as an emerging asset class of its own because there is a separate community rallying and forming behind it that will require distinct support skills, systems and networks.
Then in 2011, JPMorgan Chase & Co. and the Global Impact Investing Network, or GIIN – a forum created to support the impact investing industry – published a report titled “Insight into the Impact Investment Market” that presented the perspectives of 52 investors and their experience in 2,200 impact investments. The report described the emerging industry as “in its infancy and growing” and offered a positive outlook for future growth.
“Over the last couple of years it has also become increasingly clear that a major movement is taking place around impact investing,” said Nick O’Donohoe, global head of research for JPMorgan Chase & Co. in 2010. “As a large investment intermediary, it is good for our business if we participate in thought leadership and the long term the development of this industry,” asserted O’Donohoe in an interview with GIIN.
One helpful way to define impact investing is to juxtapose it with microfinance. Specifically, while microfinance generally involves smaller loans of approximately $50 to $1,000 to individuals, impact investing finances small and growing businesses (which have also been referred to as the “missing middle”) to the tune of roughly $2,000 to $5 million. The fundamental belief, rooted in socio-economic development theory, is that these small and growing businesses hold real potential to alleviate poverty and provide jobs if they can grow and expand their operations. The main beneficiaries of impact investing then are grassroots businesses and emerging market firms which are often too big to secure microcredit loans and too small to receive loans from banks.
The principles of scale and sustainability are embedded within these small and growing businesses. Some development practitioners and several official studies emphasize that by providing services to the poor and vulnerable, companies can make a true development impact while simultaneously making money and building a wider client base. Improving the communities in which these businesses operate allows for greater consumption and demand, which in turn induces continued scaling of the business. While the risks of investing in developing countries once turned away investors, stunted growth in developed countries today has caused individual and institutional investors to turn to high potential emerging markets.
Impact investors also finance social enterprises – another term being adopted by the global development community to describe organizations with the primary mission to address social, environmental, or otherwise development-related needs. For-profit social enterprises are becoming attractive to investors because they are run like businesses but also contribute to the public good. They often solve development problems through innovative measures. Investors provide the startup and operational capital required for these businesses to operate competitively and effectively with the underpinning notion that employing a business approach can produce better humanitarian or development results.
Both for-profit and nonprofit social enterprises differ from corporate philanthropy models where a company’s core business is not necessarily integrated with its social mission. They also differ from the traditional nonprofit or charitable model which relies on donor funding and can thus be susceptible to shifting donor priorities or even donor fatigue.
There are several key factors driving the growth of impact investing.
Development finance alternatives. Foreign aid players and paradigms are changing. Today, the global development community is in constant search of alternatives to finance projects which deviate from the typical public donor-beneficiary model and involve the private sector. Leading organizations like Root Capital manage impact investing funds and have provided $330 million in credit to 365 agricultural businesses in 30 countries. The Acumen Fund has made commitments of $300,000-$2.5 million in capital and extended services to promote the scaling of small and growing firms. The Aspen Network of Development Entrepreneurs is an important thought leader for networking, training and research pertaining to the small and growing business model. Lastly, but very importantly, instead of resisting changes borne from the impact investment model, bilateral governments, multilateral organizations, and philanthropic foundations are throwing their political, financial, and operational weight behind new ideas and concepts such as impact investing.
Technology. Progressive development practitioners have harnessed the power of technology and social networking to create a global buzz and community around impact investing and facilitate necessary financial transactions. Perhaps the most well-known example in a related field is the nonprofit organization Kiva which uses the convening power of the Internet to receive and channel microfinance loans to individuals in developing countries. Other important platforms such as the BID Network are attempting to bring entrepreneurs and impact investors together online.
Development localization. Significant global development trends such as aid effectiveness, sustainability, untied aid, and the use of country systems are localizing development activity from program design to procurement through implementation. Impact investing is riding along with these movements as social enterprises and similar organizations highlight a special capacity to provide direct, on-the-ground results with less overhead expense.
Social responsibility. Individuals and corporations are increasingly dedicated to socially responsible practices and behavior. High-net worth individuals want their money spent in smart, sustainable ways that produce observable results and make a contribution. There is also a willingness among some investors to accept more risk and lower returns if their money benefits the public good. Furthermore, major corporations operating across the developing world are now recognizing that social investment and responsibility are not just nice-to-haves but a required cost of doing business that can produce long-term reputational and operational benefits.
There are also tests ahead for the industry. A major one is the ability of prospective impact investors to identify, vet, and gain access to the right businesses. Other challenges are mostly associated with proper standards and information that would allow stakeholders to speak a common language. Studies conducted by the Asian Development Bank and JPMorgan Chase & Co. uncovered that there are critical information gaps that must be filled to properly support the industry, such as better metrics for assessing social and environmental impact. Microfinance, which has recently come under scrutiny because the industry’s aggregate achievement is inconclusive, serves as a cautionary notice for the impact investing industry.
This is where GIIN and other like-minded organizations play a critical role. The GIIN Impact Reporting and Investment Standard, for instance, provides tools for measuring social impact. There is also much more information exchange today than ever before. Over the course of the past several years, impact investing leaders have gathered at prominent forums such as the Harvard Social Enterprise, Social Enterprise Summit, or SE Alliance, Social Capital Markets, or SOCAP, the Skoll World Forum and Sankalp Forum in India to fill the networking gap and meet with potential businesses. There is also a movement for establishing a social stock exchange, such as Impact Investment Exchange Asia, to act as a formal trading platform between investors and companies that meet high standards for social and environmental impact.
Impact investing is establishing a more vibrant place in the global community as various actors are moving to cooperate and organize around its cause. While questions and challenges remain, the general consensus is that impact investing could serve as a sustainable and valuable complement to the development efforts of government and philanthropy, effectively challenging the idea that investment must be only for profit and introducing other bottom lines to the traditional business equation.
As director of global advisory and analysis, Pete manages all Devex research and analysis operations worldwide and monitors key trends in the global development business. Prior to joining Devex, Pete was a political and security risk consultant with a focus on Southeast Asia. He has also advised the U.S. government on foreign policy and led projects for the Asian Development Bank and International Finance Corp.