The authors reach the interesting conclusion that in impact investing, there is no trade-off between financial gain and social impact. The authors, Uli Grabenwarter and Heinrich Leichtenstein, define impact investing as any profit-seeking investment activity that intentionally generates measurable benefits for society.
Interestingly, and similarly to the rise of private equity, family offices are playing an important role in the emergence of impact investment as a new investment class due to their longer term outlook, lower risk averseness, and institutional freedom. The key focus of the study is to understand the patterns of success and failure in impact investing.
Investment return expectations
About half of the investors in the study were surpassing their expected returns, and the other half were below expectations. Interestingly this result was not correlated with the initial return expectation nor with any implicit trade-offs between return and impact. Rather the performance of the investors was a result of their strategic investment approach. The most successful investors had:
- Identified an area of desired Impact: focused their investments in one or two sectors and developed a clear understanding of what represented outputs, outcomes and impact in the sector.
- Identified a set of business models in that sector that were capable of delivering both financial return and social impact and clearly understood how to recognize the drivers of value creation.
- Invested in developing capabilities in the chosen domains, often through the hiring of external experts, acquiring market intelligence, and developing internal capabilities. This allowed them to become knowledgeable in the sector and improved the quality of the deal flow.
- Implemented a portfolio approach in the chosen sector by investing in a number of companies so that they could spread the risk and promote learning synergies.
In contrast to the successful investors who adopted the above strategic behaviors, the least successful investors adopted a largely opportunistic approach. Although they were motivated to give back to society, they tended to select investments based on personal preferences, emotional ties, and relationships of the investees with family members. Also they did not adopt a purposeful portfolio approach within a particular domain of focus nor did they built sector specific capabilities.
Strategic investment strategies required
These investors tended to largely underperform the more strategic investors, except when the investments were deployed by individuals with an entrepreneurial background making smaller scale deals, who had access to expertise and deal flow due to their background and effectively acted as social business angels. The key take-away from the interviews is that impact investing requires the adoption of the type of professional and strategic investment strategies that makes private equity successful.
Yet, it also requires extra expertise as it involves one more variable to select for and monitor – impact. This requires a particular attitude and criteria at each stage of the investment value chain (sourcing, screening, contracting, coaching and monitoring, and exit).
The study also identified a few best practices for impact investors:
- Impact investors select business models that are scalable and exhibit a strong positive correlation between financial return and impact. For example, selling rechargeable lamps to replace querosene in a pay-per-charge scheme with small upfront cost increases both profits and impact because the increased usage of lamps leads to increased impact as well.
- Development of consistent key performance indicators (KPIs)for impact that are suited to the focused domain and allowed comparison across investments.
- Adoption of criteria at exit that guarantees the preservation of the social mission of the investee organizations independent of the new owners.
- Use of innovative investment instruments such as convertible loans instead of pure equity deals.
Overall, this is a very solid and interesting study that deserves to be read by any individual considering entering the impact investing space. It may help family investors identify the sectors with strong positive correlations between financial returns and impact, where impact investing can become a viable proposition achieving both profit and impact. Download the study at www.iese.edu (PDF 539 MB).
For more, download Profit and impact can go together in family office investment (PDF 70 KB).