Monday, February 4, 2013

What is "Impact Investment"?

Impact investment is investment that is intended to create positive impact beyond financial returns. That sounds good. But how does this differ from other investment, such as ordinary capital investment, socially responsible investment or ethical investment? Where and when did impact investment start? How much has been invested this way so far? Who is investing in what? What are the prospects? Let's take a look.

Most investment in the past has been for the purpose of generating financial returns, though a few famous philanthropists have gone further. In the early nineteenth century Robert Owen developed the New Lanark cotton mills into a highly profitable enterprise that also looked after its workforce, providing them with a clean working environment and improved housing. At the end of that century the Cadbury brothers built a new chocolate factory in Bournville where the workers enjoyed high wages, pensions, medical care and superb housing (still standing -- and much sought after). Both enterprises showed that it is possible to have your cake and eat it: they were both commercially successful and socially responsible. But these became famous because they were exceptional. Many factory and mine owners did not share Owen's utopian socialism or the Cadburys' quaker faith and strove solely to maximize profit. Hence the  poor labor standards chronicled in the factory inspectors' reports that provided the factual basis for the Factory Acts in Britain. The history of all developed countries shows the same disregard for social and environmental standards in the pursuit of profit in the early phase of industrialization.

In recent years corporations have sought to become more socially responsible in response to demands from governments, workers, consumers, shareholders, regulators and society as a whole. A plethora of corporate social responsibility (CSR) and sustainability standards have been established by governments, international organizations, independent standard-setting bodies, industry federations and individual corporations. Numerous non-governmental organizations (NGOs) have been set up to promote and monitor compliance with the resulting standards. Corporations now display their CSR/sustainability performance on their websites alongside their appeals to investors. To the extent that the promises on websites have been matched by organizational restructuring, the establishment of internal compliance mechanisms, and relevant training programs, many companies have succeeded in improving their social and environmental performance. In other cases, little has been done beyond engaging a PR firm to "greenwash" the company's activities.

Socially responsible investing (SRI) has developed alongside the development of CSR and sustainability standards, especially with the massive growth of institutional investment. Most people in industrialized economies now have a stake in the stock market via insurance funds, pension funds, trade union funds and investment funds. When most investing was done directly by individual investors in individual companies, ethical questions were relatively straightforward: if you didn't like the company, you didn't buy its shares. But with institutional investing it is not always clear that the investor, for example a worker who has invested in a pension fund, is acquiring an interest in companies that are doing things that he or she considers morally acceptable. Pacifists might not relish their money being placed in a weapons manufacturer. An opponent of lung cancer might object to investing in a cigarette company. A religious body may not wish to be seen investing in industries which appear to contravene its commandments. So the first aim of ethical investing is negative: to avoid harmful investment. SRI starts with, but goes beyond, this negative approach, seeking not just to filter out companies that do bad things but also to choose investments in firms that behave well, whatever goods or services they provide.

Impact investment goes a step further by investing in activities whose main aim is to make life better, for example by enabling communities to grow their own food or by financing university education for children who would otherwise not be able to afford it. Such programs could otherwise be paid for through charity, philanthropic donations or government aid. The difference is that impact investors expect a return for their money. They may be willing to forgo some of the return on their investment if they can see the benefit to others, but many impact investors have a fiduciary duty to ensure a return at least as high as that on other investments.

One advantage of impact investment over simple giving is that that investors are less fickle than givers if they see a good return for their investment. Charitable donations -- whether from individuals, corporations or governments -- depend on generosity, which may vary over the economic cycle, or with public perceptions and moods. 

Another benefit of impact investment is that the investor has a greater interest in seeing a project through to completion and is therefore likely to take an active role in its management at all stages. For example, while a student receiving a normal student loan may end up failing exams and still have to repay the loan, an impact investor can instead work with the student to ensure he or she gets a good degree and finds employment so that the investor can obtain a good return.

The term 'impact investing" originated in a meeting convened by the Rockefeller Foundation at its Bellagio Center in Italy in 2007 to consider how to build a worldwide industry to invest for social and environmental impact. In 2008 the Rockefeller Foundation allocated USD 38 million to promote this kind of investment.

Since then, impact investing has grown rapidly, but, as you might expect from a project still in its infancy, still has a lot more to achieve. The total invested in this way in 2011 is estimated to have been just over USD 3.7 billion worldwide, a trifle compared with the USD 1.5 trillion in global foreign direct investment (FDI) flows in that year. Global fixed capital investment, which also includes domestic investment, is of course far higher.

So far, the most dynamic actors appear to be rich people ("high net worth individuals"), who account for a disproportionately large share of impact investment. Institutional investors have been slower to move. While considerable sums have built up in impact investment funds, there probably are not yet enough viable projects to absorb these, or to do so in the form in which they are being offered. The main sources are in the developed countries of the northern hemisphere and recipients in the "South", which does not yet reflect the growing importance of emerging markets as international investors.

There is therefore plenty of room for further rebalancing and growth of impact investing worldwide. This is true whatever happens to the global economy. Those working in the financial sector who now feel threatened by looming regulatory stringency and by hostility from the rest of society stemming from the perceived responsibility of the sector for the economic crisis have an incentive to move into impact investing for long-term career security. If and when the global economy recovers, impact investment can help share the wealth so that more people can live healthy and productive lives.

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