The next wave in the social investing space is to create a market of socially-oriented investment funds that are neither purely philanthropic nor purely market-based in their return expectations.
Put more simply – there’s a belief and an assertion that somewhere between pure philanthropy and pure investing, there’s a class of capital that’s willing to get a lower expected economic return for a higher expected social return. The most common term for this is “impact investing” and it’s applied quite loosely – but it implies a level of proactive care for social impact that’s a generation beyond the screened investment funds of the 1990s that invested in various flavors of “vice-free” stocks.
There’s no doubt that there’s a middle ground here, that it’s important that we find it, describe it, and understand it, because by doing so we will, over time, find much more capital and much more savvy investors willing to occupy that space.
That said, it’s not as easy as it sounds. There’s a pervasive myth out there that there are enormous piles of investor money poised to be “unlocked” if we create the right product and investment opportunity.
Having raised both philanthropic and sub-market return capital, I would describe the mental model people hold of how this will work as:
That is, people typically expect the holders of capital to look at a spectrum of expected financial return and implicitly find every opportunity further to the right (closer to a positive return) more attractive than every opportunity further to the left.
The reality, I’ve found, is different, with a picture that looks like this (yes, those are pockets).
Namely, the potential individual philanthropist / investor has two pockets, two types of capital that they’re used to deploying. The first pocket is for their investing, and it’s where most of their money goes and where they think about financial return. The second pocket is for philanthropy, which is also a defined practice with its own decision-making process – whatever that process may be.
Asking someone to make an impact investment isn’t a move along a rational economic scale, with each step proving marginally more attractive. It’s asking someone to do two things instead of one:
- Create a new pocket
- Invest out of that pocket with us
There’s nothing wrong or right about this, it’s just two sales you have to make instead of one; two decisions instead of one – at least if you’re talking to anyone who hasn’t developed that pocket on their own.
Doing this is important – it is, in fact, how markets are created, and the more that this becomes accepted practice (written about, talked about, understood and supported by financial advisers and investment professional, etc), the more that third pocket gets created for everyone, not just for the pioneering impact investors.
It’s important work, but it’s hard work, and until we understand it as such people will continue to throw around numbers blithely, implying that trillions of dollars are waiting on the sidelines, ready to be deployed in pursuit of social change.
Not yet. At least not until we all, together, create that third pocket.
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or, we show that there is a bridge between philanthropy and full return investing and that the two worlds are linked to each other and not separate pockets. it isn’t either/or. there isn’t a bright line difference. I have found donors to get really excited by the idea of bridging the two worlds with the “third pocket”
Jeff, I love the idea of bridging – and am encouraged to hear that you’ve found people to be excited about it. That’s exactly what we need to see!
I love the pockets.
And I agree: I’ve talked about how people view what they have in two ways: Stuff as Capital and Stuff as Gifts. The first is used to generate wealth, and the second used to generate goodwill. (I’m focusing on how it’s hard to get money from one pocket to the other, specifically capital to gift).
It will be interesting to see if an impact investing pocket arises.
I do think there is a pocket between 0% and market returns now, though, in socially responsible investing, i.e. capital investments in for-profit business that pledge social goodness. And it is distinctly separate from regular investing. I know of endowment funds where a portion of investment funds is set aside for the social investing. And when it comes to totaling the annual returns, the two sets of investments are judged separately; the return on the regular market is mentally held separately than the socially responsible market. Agrees with your theory of pockets rather than a spectrum.
I’m not entirely sure there are two separate “pockets” that need to ‘created’ and ‘pitched’. There is a wide variety of donors out there, all with different motivations and expectations. I believe your continuum should say “grantmaking” instead of “philanthropy” on the left-side – its the area of grantmaking that donors will not expect any financial return – the idea is to provide the sort of financing that enables a non-profit to achieve something and is not stuck in a cycle of repayment. The term impact investing or mission-related investing indicates how the ‘endowment’ or corpus of a foundation is applied – the endowment could be invested in a way that it furthers a foundation’s mission, e.g., a foundation focused on healthcare would not be furthering its mission if any part of its corpus were invested in tobacco. The middle ground that you talk about that intersects philanthropy and investment is actively being explored by a range of foundations and philanthropists – within the past few years there’s been a dramatic acceleration – there are already a bunch of high-quality intermediaries, and deal-flow is also better – and promises to only get better. I’m sure you’ve looked at FSG, the McKinsey study, Felicitas, Rockefeller etc. The “third pocket” as your post calls it, has already been created, and is in the process of becoming deeper.
Sunny, thank you for your comment. I’m definitely aware of the FSG, McKinsey, Felicitas, Rockefeller, etc. studies. My point is somewhat different – namely that “we” (the organizations that create the products and write the studies) don’t create the third pocket. It needs to be created in the mind of each individual decision-maker, something that is immensely helped along by the development of the practice of investing in this way and the development of the impact investing market. Just because we write the report doesn’t mean the philanthropist buys into the mindset (and I should say I’m talking more about individuals here though it applies to foundation officers as well).
Hi Sasha,
I completely agree with your thesis, IF we are talking about the kind of investor that is wealthy and financially educated enough to put his money in some kind of closed fund (i.e. private equity, venture capital).
I currently work with these kind of individuals, and even if I am not a great fan of generalizations, I have to say that according to my experience most of these people do generally really have two separate pockets, one for philantrophy – money lost – and one for investing – returns expected.
There may be the chance to create a third pocket for these kind of individuals – and here I think a fair big amount of advocacy is needed – but my opinion is that the big challenge (and the big money) is to attract “normal people” to put some of the money they usually dedicated to charity (money lost) in these kind of “get your money back” open funds.
Don’t you think that part of Kiva success is related to this particular side of the story?
Thanks,
Stefano