Impact investments: A new fad or another class of assets?

Last week I attended a very interesting seminar organized by the Financial Inclusion Forum of DC. The seminar was dedicated to impact investments. For those that aren’t familiar with the term, impact investors are those who invest not just to make financial return but also to create a large social impact by reaching the “bottom of the pyramid.” The impressive panel of seminar speakers included Eliza Erikson (Chief Lending Officer at the Calvert Foundation), Agnes Dasewicz (Chief Operating Officer at Grassroots Business Fund), and Stuart Yasgur (Managing Director of the Social Investment Entrepreneurs program at Ashoka). The discussion was moderated by Ambassador John Simon (Founding Partner at Total Impact Advisors).

Prior the seminar, I read last year's report published by J. P. Morgan on the subject of impact investments. The J. P. Morgan report suggested that impact investment is an emerging class of assets, and that when J. P. Morgan applied their methodology on "selected businesses within five sectors— housing, rural water delivery, maternal health, primary education and financial services — for the portion of the global population earning less than $3,000 a year," the findings showed that there is "potential over the next 10 years for invested capital of $400bn–$1 trillion and profit of $183–$667bn.” The seminar was thought-provoking because of the wide range of presenters’ perspectives on impact financing. Calvert Foundation mainly provides senior debt financing to less risky projects; its portfolio has a very low default rate. Meanwhile, Grassroots Business Fund spun off from IFC and the World Bank and extends riskier investments to growing and innovative enterprises. Ashoka, on the other side of the spectrum, is financed solely by philanthropic capital and invests in individuals or small enterprises. As demonstrated in the seminar, the definition of impact investing varies from organization to organization. It is currently a very good time for impact investors, Eliza Erikson noted, because following the most recent financial crisis, investors and public at large are less interested in risky and high return investments and are more concerned with preservation of capital and sustainable investments. This point is further highlighted in the recent podcast on BBC on the subject of "Benefit Corporations." According to the survey discussed in the podcast, the majority of Americans supports creation of so called benefit corporations. Supporting Erikson’s notion, on April 13, 2010 Maryland passed the "Benefit Corporation Law" and became the first state to legally create a new corporate form (benefit corporation) that lets social entrepreneurs codify their missions in their corporate charters. Moreover, on February 15, 2011 the Rockefeller Foundation announced creation of $400,000 "social impact bonds" as a new mechanism to finance social impact programs. There is clear momentum, and proponents of impact investments need to seize this opportunity before the public's attention shifts again.

The panel also drew interesting linkages between impact investments and microfinance. When providing impact investments, the speakers found it especially useful to pull from microfinance providers’ knowledge base on the importance of developing uniform lending standards, the use of smartly blend capital (grants and capital funds), as well as the use of subsidies to provide public goods. As a growing industry, impact investors should also learn from microfinance providers about the risks that can occur when a small organization grows too fast and tries to satisfy the need of too many borrowers. We have seen that such rapid growth and emphasis on making a profit can lead to predatory lending and lack of consumer protection. As Agnes Dasewicz discussed, Grassroots Business Fund is careful when encouraging clients to transition from grant-dependence to more sustainable funding mechanisms (like impact investments). Although there is a need for other forms of capital, Grassroots Business Fund encourages transitioning from total financial dependence to self-sustainability by first adopting blended model (where grants are combined with capital funding). Microfinance institutions can learn a lot from such an approach and it offers new opportunities for socially-minded investors. As the presenters explained, some of the challenges that impact investors are facing include difficulties in measuring impact due to attribution and self-reported data; in treating borrowers not as beneficiaries but as clients; and in mobilizing local investors in the countries where borrowers operate.

Finally, I would like to end with a call to arms from Eliza Erikson: "Financial inclusion needs to run both ways: it is important to exert equal attempts to include both borrowers and investors and this is something that impact investors need to explore more in the future."