How the development of a full shelf of financial instruments and products can help maximize market potential.
By Dr. Maximilian Martin & William Burckart
Greater awareness about impact investment has come with deeper scrutiny of the investors and investment products populating the market. From products that provide market rate and below-market rate returns to investors that are characterized as either “impact” first or “financial” first, or some combination of the two—the range of expectations and motivations driving the growth of the market is diverse.
Making Impact Investible and its companion Primer that was commissioned by the U.K. government for the G8 Social Impact Investment Forum, both authored by Dr. Maximilian Martin of Impact Economy, offer a number of insights making sense of the factors influencing the development of impact investing and market building. These reports argue that the full engagement of different investor groups – from philanthropic investors to angel and venture stage investors, private and institutional investors, and financial services institutions – can enable the market to provide the capital needed for an effective response to the megatrends reshaping our world.
When Dr. Martin and Arthur Wood invented the contingent returns model in 2005 – linking a social metric to a financial return for the first time and providing the conceptual basis of what was later called the Social Impact Bond (although it is a structured product) – their arguments sounded revolutionary (see Market Based Solutions for Financing Philanthropy).
Today, that discussion lies behind us as consensus grows that the structuring expertise available in finance needs to be applied to funding social problems if we ever want to solve them.
Beware of Overburdening a Promising Instrument
Impact investors should build an impact capital market that is not dwarfed by the magnitude of the challenges. To achieve that, we will need a full shelf of financial products. This gap is one of the major contributing factors holding back a comprehensive and balanced development of the market.
Given the attention that impact investing has received recently and the proliferation of social impact bonds (SIBs), identifying growth constraints might be viewed as unnecessary alarmism. So let’s be specific.
Take, for example, the first SIB that was designed for distribution to retail investors in the U.K.: the Allia’s Future Children Bond. From Europe to the U.S., and a whole host of other countries, investors are experimenting with SIBs or pay-for-success schemes. The SIB model raises capital to fund social interventions with clear success metrics from private investors. If successful in terms of social outcomes, the investors make a return from public sector savings. If not, they also lose the principal.
The Bond referenced above seemed like a promising opportunity to expand the use of one of the flagship instruments of impact investment but due to a lack of interest by retail investors, it failed to raise enough funds to launch. A host of other factors — including poor marketing, bad timing and the very features of the particular SIB – were captured in an independent evaluation and are worth exploring.
But the conclusion is clear: it would be unwise to overburden the SIB model with expectations to anchor market growth. To achieve that, we need other kinds of products as well, otherwise, opportunities available to investors for the market to grow will simply be insufficient.
Maximizing the “Investibility” of Impact: Key Findings
Making Impact Investible also provides a number of key findings related to addressing the disconnect between the function certain investor groups can play in the market and what they need in order to be able to fulfill such roles, including:
1. The financial product shelf needs to be developed.
Consider the financial instruments you know of and ask how they can be applied to social issues. SIBs are an outstanding innovation but we need other solutions as well. Doing so will achieve the dual purpose of unlocking more opportunities for different groups of investors to engage in impact investment and avoiding the risk of the market being too closely linked to the success of one type of investment product.
2. The cost of conducting an impact investment needs to decrease.
Transaction costs are still too high but the entry of more players and improvements in the systems and tools that measure the social and environmental dimensions of transactions will start to help at some point. Moreover, tactics that, say, the government in the U.S. used to foster the growth of the venture capital industry — such as the U.S. Small Business Investment Company (SBIC) and Small Business Innovation Research (SBIR) programs — could be replicated in countries that have deep financial markets and are known to originate trendsetting financial products.
3. De-risking of investments should be expanded.
Investors are motivated as much by returns as they are by the presence of risk. Governments around the world routinely engage in such de-risking when they provide export guarantees or underwrite infrastructure projects.
For instance, Arsago Affordable Housing (a client of Impact Economy) invests in housing in Brazil, aligning a segment of its transactions with the government-subsidized “Minha Casa Minha Vida” (MCMV) housing program, which provides incentives for first time home buyers emanating from Brazil’s emerging middle class. The MCMV program has also been replicated in Chile and Colombia.
The present opportunity is to proactively connect this underwriting activity with impact investment market building.
With financial innovation, lowering of transaction costs and risk underwriting where appropriate, we can turn global megatrends into opportunities for society – maximizing the impact of impact investment by building a healthy capital market. We can build this market; we simply need more construction sites in order to do so.
Its potential can be far greater than even the greatest boosters can dare to dream.
While this post represents the close of this series on CSRwire, the discussion will continue over at Impact Economy. Stay tuned!
Part III: Making Impact Investible: Enabling New Sustainable Businesses
Part II: Measuring the "Impact" of Impact Investment
Part I: Making Impact Investible: Cutting Through the Hype of Impact Investing