It was an exhilarating day of discussions and sharing. If we think about Impact Investing as an industry in the making, we can summarize the broader insights from the conference around four themes:
- Allocating societal resources for increased impact;
- New industries need innovative business models;
- Scaling-up in a sustainable way; and
- Can the logic of impact investing become embedded in the fabric of society?
For the purposes of this article, we’ll deal with the first two…
The purpose of Impact Investing is allocating societal resources for increased impact
The critical problem at the origin of Impact Investing is that traditional financial markets are falling short of their fundamental role of allocating capital to areas where most value can be created. The financial crisis exposed this problem but, beyond the visible effects of the crisis, we have deeper underlying symptoms in three areas…
First, humankind is currently pursuing an unsustainable path of development that may end up destroying the planet through the intensity at which we’re exploring and consuming resources.
Second, there’s a market failure in many developing countries in the allocation of capital to promising growth ventures. This equity gap also exists in numerous developed countries, but a combination of public intervention and venture capital funding has helped to alleviate the situation. However, in many developing countries the gap is huge and not addressed by public or market forces.
Third, in a lot of developed countries, there is, at present, significant cut-backs in Public Sector spending, which means that the social economy is starved of capital.
Financial markets failing
The commonality in all these issues is that almost all financial markets are failing their resource allocation role. We need innovation in the form of Impact Investment – defined broadly as the application of capital to activities that can generate high societal return, and where traditional financial markets are failing to allocate enough capital.
Doing this capital re-allocation in a scalable and sustainable way is the promise of Impact Investing as a field. Many of the investors helping build the sector are entrepreneurs; opening up new markets and creating new investment models. It’s their collective insight and individual entrepreneurial instincts that should help make this field a vibrant arena for decentralized innovation.
New industries need innovative business models
In Impact Investing there appear to be innovations across different areas. Impact Investing can draw capital from three different sectors:
- The Philanthropy/Foundation sector;
- The Public and International Development Sectors; and
- The Private Commercial Sector.
All these sectors have sizable pools of funds and it would be a mistake to constrain Impact Investing to have to draw only from commercial funds. Yet, each pool of funds may need different innovative business models…
To tap into philanthropic funds, there is the rise of a model of Venture Philanthropy organizations that use the approach of venture capital to allocate philanthropic investments with higher effectiveness, either in the form of grants or based on money-back premises.
The public sector/development funds are being tapped through debt mechanisms in the form of social impact bonds and development impacts bonds as the ones pioneered by Social Finance UK, and now spreading throughout the world. In this new financial instrument, return is directly linked to the efficacy of interventions by social sector organizations; risk is borne by the private sector, and the public sector benefits from reduced costs and positive spillovers.
Private/commercial capital is converging to a model in which commercial capital is invested in the equity of fast growing startups in developing countries operating in particular domains (micro-finance, micro-insurance, health services, etc), where profit is highly correlated with impact – “Profit with Purpose”. Bamboo Finance and Leapfrog are two compelling examples presented at the conference.
Overall, the commonality of all these new models is an effort to improve the allocation of resources by linking it more directly with sustainable value creation. That’s the essence of impact investing.