Much of the impact investing field has been driven by public sector actors, which have an important role to play both in the way they deploy their capital and the work that they can do to build the industry.
The public sector has contributed about 50 percent of the money that has been channeled to impact investing vehicles, according to a recent report from JP Morgan and the Global Impact Investing Network. Even as everyone has become aware of the power of the private sector to become a driver of development as the impact investment movement has grown, agencies like the U.S. Overseas Private Investment Corp. have been making what could have been classified as impact investments since before the term was coined.
Last year, OPIC invested $3.9 billion on loans, guarantees, insurance and support for private equity. Of the total amount, $2.7 billion went to sectors generally associated with impact like health and education, but that don’t meet the agency’s strict definition of impact investing. About $222 million were classified as impact investments — investments that as part of their business model seek to solve a social or environmental problem.
Devex recently spoke to OPIC President and CEO Elizabeth Littlefield about impact investing, the agency’s role and how the development community can improve the field. Here are a few highlights from our conversation:
What do you think are the key challenges facing the impact investing field?
Looking at the growth of the impact investing sector, as someone who was deeply involved in microfinance from its earliest seed days all the way through to the creation of a vibrant financial sector, I think there are three big things that need to be done to help the impact investing sector advance.
First, is clarity around the expectations and what the definition of success looks like. I feel like the industry is being held back by disagreement around what constitutes success as a financial return, what constitutes success as a development return, and how do we measure those things. One of the most important things is that we need to acknowledge that there is a range of financial returns that should be acceptable and not be apologetic about a 2 or 3 or 4 or 5 percent return. The financial crisis should show us [that] a stable and sustainable return is far more valuable than an unstable and elevated return and so I feel like that’s the most important thing. Let’s get clarity around what financial success means and what development success means and that frankly low-to-mid single digit financial returns over time is absolutely laudable.
The second thing, I think, is addressing gaps in the market and realizing that the whole infrastructure of impact investing is not yet in place. We have gaps with respect to early-stage capital, we have gaps with respect to grant money from foundations, which is not yet available, we have gaps with respect to retail. I think there’s a huge amount of latent demand from retail investors for a product that is consistent with their values, but the financial advisers are not yet directing them to impact investment opportunities. So, there are a number of different gaps in the financing spectrum. I think we need to collaborate and come together, and combine instruments and funding tools to address those gaps.
The third and most important thing is cooling the hype. Too often we’re injecting the impact investing space with way too much hot air and too much expectation. We saw the same thing in the microfinance field — the sudden claims that this is a panacea for all ills is really, really doing a disservice to the genuine and laudable gains that field has made so far. So as I’ve often said anyone that thinks the progress has been slow or uneven or disappointing in the impact investing market does not fully get the fact that we’re talking about transforming the way the world thinks about aid and capital, capital flows. That’s a huge, huge transformation that we’re making excellent progress toward and it’s a long-term transformation and it’s going to take time. I think the best thing we can do is take a deep breath [and] not get ahead of ourselves and encourage the market to build in a slow and organic way as it’s a really big transformation we’re aiming for.
What do you see as OPIC’s role in impact investing?
As a public sector entity, we’re able to intervene in the impact investing space in two broad ways. One is around the volumes of capital that we are investing, and the second is around designing specific products that fill gaps in the market.
On the driving investment part of the agenda, I think its important to note that everything that OPIC does has development impact — we’re a development agency. We’re very proud of the fact that every deal we do is designed to have a positive impact.
We did this tagging exercise that we felt was important because there’s so much confusion around what’s in the club and what’s out of the club and to me there’s been a lot of heat loss in the impact investing community as people argue what’s in and what’s out. We wanted to actually come pretty clean and acknowledge the way we broke out what’s in and what’s out of the impact investing definition.
What kinds of products has OPIC designed to help fill impact investing market gaps?
One of things that I do feel is holding back the sector the most is the whole question about gaps. We have a real problem with early-stage startup capital. There is plenty of capital available for scale up, for growth capital, for the funding that comes after proof of concept, and there is plenty of money available for super early-stage pilot testing. But there is almost no funding available between the early-stage tiny grant money and then the bigger scale-up capital. This early stage, first-loss money, angel kind of money, is utterly absent right now in the impact investing space.
I believe we need to bring different providers of capital — be they grant providers, early-stage equity, later-stage equity, or debt providers — together and align themselves to kick in at the right stage to support a given undertaking. So far those alignments, or those bolting together of different sources of capital, have been very difficult to line up or when they’ve been lined up they’ve been lined up on a sort of deal-by-deal basis, which is time consuming and costly.
So what we’ve sought to do is create those kinds of aligned capital facilities in an ex-ante rather than ex-post structure, where you’re putting together the capital beforehand and inviting the projects to come forth. We’ve put together a thing called the innovative financial intermediaries program, which is a two-year $500 million pilot program, which will enable OPIC to be much more responsive to proposals coming in from small-scale collective investment vehicles like hybrid funds or tiny equity funds or debt facilities that need financing but haven’t normally fit into our existing processes. The idea is to really stimulate some of the more innovative collective investment vehicles that are coming along that we haven’t been able to support so far.
And we’ve developed the ability to do working capital financing which is really very new for us because OPIC has traditionally been a project finance house. We’ve really only done cash flow-based lending, so for us to do inventory finance or working capital finance is a new thing. But we felt it was necessary to really address the needs of a lot of the excellent consumer goods-based companies that are focusing on the bottom of the pyramid.
The third new product is a thing called “portfolio for impact,” another pilot to finance small-scale, early-stage projects in the impact investing space that might not meet our normal underwriting guidelines and procedures.
What is the growth potential of impact investing?
There’s been far too many overblown expectations about the field. I feel like the world has been divided into what I’ve often called the breathless maximizers that claim that the field is going to be a trillion dollars or $500 billion and the sort of derisive minimizers who scoff and say no matter how big the impact investing market is, it’s never going to be anything compared to the $15 trillion global financial markets. For me, the truth is really somewhere in the middle. What we should really be benchmarking ourselves against is the extremely paltry total size of foreign aid. If we can get impact investments to cannibalize a big chunk of the foreign aid budget by doing the things aid is doing today, but doing so in a way that is financially sustainable, that’s a really powerful thing.
What is the development community’s role in impact investing? What can it do to further the field?
One is more sharing of experience around track records such as the experience of the International Finance Corp. and what OPIC and other public sector investors who have been in the market for many many years. What exactly has our experience been in investing in things that aim to have a social impact and a sustainable financial return? Offering up our track record is one very important thing we can do.
Another very important thing we can do is frankly put institutional egos and agendas aside and come together to combine our instruments — whether they be grants or debt or equity — upfront so each individual enterprise doesn’t need to struggle to go from its startup phase to its early-stage phase to its growth phase by going to different institutions. We can help meet those needs by bringing our capital, aligning it all together in a way that makes it easier for enterprises to access multiple sources of capital from from one entry point.
I think the third thing is we can be careful about understanding the magnitude of what we’re trying to accomplish here and not letting expectations run ahead of what we’re really able to deliver on the ground.
Where do you think the impact investing field is headed? What are your longer-term predictions?
If we had to take that moonshot and think forward as to where the industry will be if we’re having this same conversation in sort of five or six years from now. First of all, clearly the role of the private sector in development will be understood and it will be private sector, and tools to stimulate the private sector, that will be a much bigger part of the conversation around development and foreign aid than they are today. Right now the conversation around development tends to be very foreign-aid-dominated and I think that is going to change.
See more on impact investing:
▪ Impact investing: What’s in it for your nonprofit?
▪ 10 tips to boost impact investing
▪ De-risking impact investing critical for more capital
▪ New private equity fund targets microfinance institutions for women
▪ How to win funding from impact investors
▪ What's next for impact investing: Definitions, measurement and rising expectations
Secondly, I think all of the retail investors out there will have their 401ks with an impact investing option. It seems the spectrum between socially responsible investments on one hand and impact investments will blur. Right now you have socially responsible SRI funds that have the negative screens embedded in their investment thesis but they're not necessarily investing in things that have an intent to do social good. On the other hand of the spectrum you have impact investments, which may not have embedded in them the basic environment, social and government risk-mitigants that SRI funds have at their core. I think the spectrum between SRI and impact investing will blur as the one takes up the positive screen and other takes up the negative screen.
And lastly, I would say I think the “[global] south” will drive the innovation here. A lot of the hype is coming from the “[global] north”; a lot of the talk, a lot of the conferences, a lot of the speeches, a lot of the publications, but in the end of the day I think the dynamism and the innovation is going to be coming from Africa and Asia and the Middle East and not the U.S. and Europe.
One of the things I’m most excited about is that I think retail investment is going to drive this over time and that retail investors are going to be more attracted to the notion of a financially viable competitive instrument that has a great story with it than the notion of a charity that has a financial return. So I think the way we position impact investment with retail investors and family offices is extremely important. I think once we get retail investment involved and they see that steady, sustainable financial returns can be gained, you’ll have repeat business from those retail investors that will start kicking in and I think that’s really going to be the tipping point towards sufficient capital driving the sector. I would say the gatekeepers to retail investors, which are the financial advisers, are going to be pivotal in making sure that the opportunities are understood by retail investors.
We’re really talking about a very deep and fundamental change in the way people think about capital and the way it flows and its purpose and the decisions people make about how they deploy their capital and that goes to the very core of the human notions of saving and investment. What we’re trying to do is very, very big, and we should be patient and gentle with the progress that we’re making toward that enormous transformation.
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