I keep on bumping into the same parallel conversations around the future of the impact investing sector.
With those in the trenches, what I hear continuously is that it is a long, hard slog. That companies take a long time to build, that the costs of getting things right are high, that grants and really forward-looking and patient risk capital is key, and that there’s not a straight path from here to there.
And yet the reports that keep on coming out and the sectoral conversations continue to cheerlead about all the capital that is coming into the space – prevailing estimates for total potential market size by 2020 are in the $500 billion (Monitor Group) to $1 trillion (JP Morgan) range – and to get there, we’re told, impact investing has to become an “asset class.” Part of getting from here to there, it’s implied, might mean sweeping under the rug the significant segments of impact investing where the economics don’t seem to fully work and where the financial risks are too big relative to the expected financial returns.
An investor I recently met at a roundtable on understanding and quantifying impact put it simply to me: “anyone who is looking at less than a ‘market’ rate of return is mispricing risk.”
(Whereas I think the big problem in the world is that we’re mispricing returns by equating returns with what we can see in a discounted cash flow analysis, thereby demoting “impact” to a fuzzy, non-quantifiable something for which it’s not worth taking actual, real risk.)
Without getting dragged into what is clearly a definitional conversation – namely, until we agree on what we mean by “impact” we can never have a serious conversation about the economics of “impact investing” – I have an observation that keeps on nagging at me: increasingly across sectors I meet more and more people who acknowledge that most of the most important (dare I say the most “impactful”?) work they do has crummy economics. Getting these projects/endeavors/businesses to happen requires the dogged determination to get many different stripes and flavors of capital to come together, lots of irregular stakeholders to develop a shared vision of the future, and, usually, a healthy dose of subsidy or public funding because there’s a clear public good being created when you succeed.
And yet in the impact investing sector we often hear that if investors aren’t fully financially compensated for the risks they take, capital will never flow in any serious way.
If that’s right, how do we explain away the fact that we have managed to create trillions of dollars’ worth of parks or mixed-use developments or hospitals or museums or great schools, most of which don’t make full economic sense but all of which are integral to a vital, vibrant society? The truth is that markets don’t fully work all the time, and yet huge amounts of capital are regularly mobilized to create things that are worth creating.
What I’m struggling to do is to better explain, by looking outside our sector, my feeling that the conversation we’re having in the impact investing sector is far too narrow and binary. When I identify the underpinnings of what makes vibrant, successful societies – you know, all those things that disappeared for a little while when Hurricane Sandy hit – and if I think about all of the incredible pure market plays that have been built on top of the existing infrastructure that was provided by the public sector….well it becomes clear that the “markets” / “not markets” conversation we’re having is far too simple.
And yet I don’t know specifically which data to look for to help tell this story. I need more examples across sectors and history, more evidence that helps explain clearly and succinctly what I know to be true: that solving big, intractable problems for disadvantaged communities by and large doesn’t pay (nor should it pay) handsome financial rewards. And the fact that it doesn’t isn’t some sort of failure of a prevailing orthodoxy, it is in fact a vindication of a rich history of bringing public, private and third sector players together – to bring the best of what each has to offer, including skills and preferences and the right kind of capital – to solve big problems.
I’ll be talking about some of these questions next month at the Global Philanthropy Forum, and I’d love your great ideas on how to prepare for this talk.
So, help, please! What are the best examples out there from other sectors (housing, roads, infrastructure, parks, museums, schools, biotechnology, the Internet, telecommunications…) that will bust open this “market return” mindset that is hobbling our thinking about how to create real and lasting change through impact investing?
I don’t know if I can provide examples, but perhaps some insight into the issue may help. I think you’re still operating under the same frame which informs this “market return” mindset. Even though you’re arguing against the idea that good impact investing requires a worthwhile ROI for the investors, you are still promoting the idea that impact investing mostly likely (and shouldn’t) provide a worthwhile ROI for investors, ignoring while at the same time addressing the fact that worthwhile ROI is precisely what these “impact investors” want!
You don’t need more examples to prove your argument – you need a new, more honest frame for communicating it. One in which you make the clear distinction that financial investing is NOT philanthropy. Financial investing is what people do when they take a risk in order to get a return. Philanthropy, on the other hand, is based on the idea of donation, on giving material without the expectation of return. Sure, you can say some people “invest” in a spiritual sense, but the return is not capital and the investment is not capital. It’s spiritual.
Perhaps a better term to focus on, then, is not “impact investing,” but “impact philanthropy.” Stop looking to investors, and start looking to philanthropists. Indeed, your previous post on philanthropists highlights this well. I think, more than trying to find examples in other sectors, this is the mindset you should more be focusing on.
Good luck!
Sasha- Thanks for your post. A few thoughts:
1) To add to your idea about mis-pricing returns, the way things get measured now leaves out significant external costs. In effect, it encourages extractive, rather than regenerative, business models. If an individual or company can take something out of a system (ecosystem, community) without having to pay for it, they generally will, and will “over consume” compared to if it had a price. Impact investing seeks to redress this situation. RFK wrote about the shortcomings of measuring GDP in terms of how a society is doing, and Amory Lovins and others have pointed out the perverse incentives in industries like energy, where consumption rather than conservation is incentivized. Some of the returns in impact investing are “invisible” to the financial system, and will remain so until policies change incentives. An emergent example of where this is happening is in carbon markets. They aren’t perfect, but they are pricing an externality, which is allowing entrepreneurs in solar lighting and improved cook stoves to emerge.
2) For many years, economists, politicians and citizens understood that markets didn’t work for everything. And to over-generalize, the world was more local/national then, instead of global (in terms of flows of money, information, people, ideas). The trend in the last few decades has been a strong bias towards markets (with the fall of most communist systems seen as evidence of the strength of market based democracies). And in some cases, a philosophical (dogmatic?) belief in pure/free markets (which don’t really exist). I take a different view. I am encouraged by the questioning and exploring of the limits of markets and property rights. Social entrepreneurs, and those that invest in them (like Acumen Fund), have been an important part of this movement. “How can we use market/business approaches to solve these challenges?” As we work in this sector, we see (unsurprisingly) that markets aren’t always the answer. Or maybe, more precisely, that pure market approaches, are not the answer. As you point out, societies and communities have for decades provided services such as health care and education with hybrid approaches that involve philanthropy, government, and user fees.
3) To add to the examples you cite: i) National Parks and wilderness areas (not just in USA, but around the world); ii) Biotech- National Institutes of Health provides early stage funding for much (most?) of the early research that leads to new drugs and vaccines; iii) don’t forget the internet was funded by government research; iv) Charter Schools; v) Private (and public) universities; vi) Electricity (TVA or rural electrical cooperatives); vii) waste/garbage collection (sometimes public, sometimes private) and viii) housing (mortgage deduction subsidizes home ownership). Basically, there are all kinds of enterprises filling the space between truly public, and truly private, goods. All seem to be based on the idea of rather than precisely measuring who gets what of the societal value created, that it is just a good idea to create the value for a community with some getting something they didn’t “pay” for. Maybe we don’t need to carve up and collateralize every single thing to maximize financial returns? And, when we go to “help” a relatively disadvantaged community, it would be nice if we didn’t show up with a “here’s how to do it” solution that ignores the way these systems emerged in developed economies (e.g., often with direct or indirect subsidies from gov’t or philanthropy).
4) If you haven’t read the Dismal Science: How Thinking Like a Scientist Undermines Community by Stephen Marglin, I’d recommend you put it on your list. I have also found Owning Our Future by Margaret Kelly and Local Dollars, Local Sense by Michael Shuman to have interesting ideas on markets and businesses and our financial system.
Best,
Paul
Sasha, excellent post. I agree with you that as a field we need to get a lot smarter about the risk/social impact equation — this will make or break the field. I also agree with you that the path to scale here isn’t just about making this an asset class. Commercial markets are already incredibly good at allocating capital efficiently, including to businesses that generate positive impact and solid financial return. The risk is that by pumping up the industry in this way, there will be nothing incremental or new about investments labeled as impact investing.
I would ask you though to reconsider the use of the term ‘crummy’ economics. While the economics in many cases for impact investing are sometimes different than traditional investing, taking on additional and different types of risk doesn’t necessarily mean lowering financial returns.