The success of an investment is increasingly defined not just by risk and return but also its impact on society. Silvia Pavoni talks to the investors that demand purpose along with profit, and that are bringing about a revolution in the process.

Discussions on how to mitigate climate change and alleviate poverty have moved from wholehearted but small activist groups to mainstream circles. And private sector capital is increasingly flocking to the causes – not just as a charitable move, as profits are deemed to be important.

Last December, in an unprecedented deal, 195 governments reached an agreement on global warming during the Conference of Parties in Paris; meanwhile the value of green bonds globally has reached a record $70bn and rising. Talk is being increasingly followed by investment in other areas too. The most optimistic estimate, by the Global Sustainable Investment Alliance’s 2014 review, has the total of funds invested in social and environmental ventures around the world in 2014 to be $21,400bn – about 27% of global gross domestic product that year.

The theme has been picked up by specialist investors, as well as by wealthy individuals, large fund managers and banks. Regulators are paving the way for long-term investors, such as pension funds, to include social and environmental concerns in their allocation choices. And, perhaps more importantly, today’s youth is highly sensitive to these issues. Doing well financially is not enough – there is increasing pressure on an investment to do 'good' too. This is impact investing: allocating capital to a project or organisation with the intention of solving society’s problems, measuring results and gaining a financial return.

Backing the underdog

Most people familiar with impact investing would know of Ronald Cohen. He set up one of the earliest impact funds, Bridges Ventures, in 2002 to invest in the poorest 25% of the population of the UK. The fund now manages about £600m ($909m) and has been able to deliver a 15% net internal rate of return to investors. Before being referred to as the father of impact investing – his many ventures include social investment institution Big Society Capital and the chairmanship of the G8’s Social Impact Investment Taskforce and its successor, the Global Social Impact Investment Steering Group – Mr Cohen was known in finance cycles for his highly successful venture capital firm Apax Partners. 

In a speech at Harvard Business School in 2014, he said: “When you bring in impact you bring in the invisible heart of markets on top of its invisible hand,” while noting that economist Adam Smith was prouder of his book covering themes of empathy, The Theory of Moral Sentiments, than he was about The Wealth of Nations. This is what makes impact investing revolutionary.

A lack of metrics to assess social impact has traditionally compressed the potential scale of philanthropic efforts, while budget constraints restricted government welfare programmes. But the creation of tools that measure social improvement and connect it to a financial return means that capital can be allocated to the most deserving ventures – amplifying their chances of success.

Mr Cohen says: “We are on the brink of a revolution in the way we tackle social issues, including environmental issues. Just as the tech revolution came from venture capitalists backing tech businesses, this revolution will come from impact investment backing innovative social entrepreneurs and organisations.”

Big name support

Other big names are throwing their weight behind the impact investment movement. In 2015, Goldman Sachs acquired specialist consultancy Imprint Capital, BlackRock, the world’s largest fund house, head-hunted the Robin Hood Foundation boss Deborah Winshel to run an impact division, and private equity giant Bain Capital hired former Massachusetts governor Deval Patrick to found a business that will focus on delivering attractive financial returns by investing in projects with significant measurable social impact. Meanwhile, risks such as climate change are now on financial regulators’ agendas, as Mark Carney, chair of the Financial Stability Board and governor of the Bank of England, recently discussed in a speech delivered to the insurers of Lloyd’s of London.

In late 2015, the US government issued new guidance on the Employee Retirement Income Security Act, which will allow private pension funds to consider environmental, social and governance factors, in addition to financial returns, when making investment decisions. Governments have also begun to take practical actions, such as tax breaks introduced in the UK in 2014 that allow individual investors to get 30% upfront tax relief on the money they commit on social enterprises. UBS was the first bank to take advantage of the initiative in 2015, when it offered wealth management clients a £5m fund run by impact investment specialist Resonance.

And in the US, the Overseas Private Investment Corporation, the government agency that mobilises private capital towards developmental causes, will invest up to $200m in specialist investor LeapFrog, in what is considered the largest single commitment to any impact fund manager to date and which brings LeapFrog’s total commitments to $1bn – a step towards the creation of a community of large impact fund managers.

Social impact bonds

Deploying for-profit capital for social causes can be very powerful. The ability to gain a financial return brings scale, being able to measure a social return makes the activity sustainable, and creating innovative investment products means that such results can be achieved at seemingly no cost to taxpayers.

One of the most significant innovations created by this movement are social impact bonds (SIBs). These are financing mechanisms that seek private sector investment for social interventions. They typically address an issue that can be measured by its cost to the public. If the interventions are successful, the government of the country affected commits to repaying and rewarding investors. If they are not, investors forfeit any returns as well as the principal.

The Brookings Institution has listed a total of 38 social impact bonds around the world that were active as of March 2015 worth a combined $162m. They range from the first bond launched in the UK in 2010 to tackle prison recidivism to the most recent deal analysed by the think tank in January 2015 set up to reduce the rate of primary school grade repetition and drop-out in Portugal. Three other SIBs were launched in 2015: in Switzerland and Finland, to improve the integration of refugees in the local economies, and in Israel to reduce the drop-out rate and extend the studies of computer science students. Others are in the making.

The first social impact bond was the brainchild of Mr Cohen’s Social Finance. It committed £5m to fund a series of rehabilitative interventions for selected groups of male offenders sentenced to less than 12 months at Peterborough prison. The first phase of the scheme did not reduce the number of reconvictions sufficiently to trigger payments to investors – recidivism fell by 8.4% against the required 10%. However, investors will get their money back in 2016 if there is an average fall in reconviction events of at least 7.5% across the first and second groups.

Even if initially unsuccessful, SIBs have ignited a revolution in the way people think about such intervention. Goldman Sachs is also an investor in such instruments. Margaret Anadu, managing director in the urban investment group at the bank, recalls the experience of another prison recidivism bond for the juvenile detention centre at Riker's Island in New York, which Goldman funded alongside the Bloomberg Foundation. Due to a variety of factors, the programme did not create the desired impact and the financing was not repaid. But the biggest results came from the shift in mentality that the deal brought about, according to Ms Anadu. "We shifted the risk onto the private sector; New York City taxpayers did not have to fund the programme from their own pockets. We got everybody thinking about how the private sector can partner with the public sector to solve such challenges," she says.

Goldman started looking at impact investing in 2001 and now has $4.5bn of its capital invested in social and environmental ventures. “Up to the first social impact bond, we assumed that in the social area nothing could be measured,” says Mr Cohen. “The problem is that we mix everything up when we talk about measurement. We mixed up measuring the value of an improved life, but actually you don’t have to measure the full value of an improved life. It costs £22,000 for a prisoner to return to jail and if you rehabilitate 1000, it’s £22m. So you can measure that [improvement] very accurately.”

Breakthrough bonds

Thankfully, there are examples of fully successful social impact bonds too. In the UK, the £1.5m Triodos New Horizons SIB in Merseyside and the £800,000 T&T Innovation SIB in Greater Manchester are set to be the first in the world to repay their investors in full. Both intervention providers, Career Connect and Teens & Toddlers, respectively, have recently raised capital for two follow-on bonds, also designed to help vulnerable young people, and in which the Bridges Social Impact Bond Fund, managed by Bridges Ventures, has agreed to invest up to £1.35m.

Much ground has also been covered by specialist investors through private equity, debt or other structured solutions to support ventures in housing, education, healthcare, renewable energy, micro insurance and financing, among many others, and which have helped create projects as inspiring as they are profitable, say professionals.

LeapFrog, for example, has invested in a South African business, AllLife, that provides life and disability insurance to people who are HIV positive or diabetic. The company realised that, in both cases, if drugs are taken regularly, people can have a normal life expectancy. So it has tied its policy to the results of blood tests, which clients need to take and provide to the insurer regularly.

Bima, another of LeapFrog’s investments, provides life, accident or health insurance where the premium is covered by clients’ mobile operators depending on how often they top up the credit on their phones. It serves as a loyalty reward to the telecom provider, something that is particularly valuable in emerging markets where people switch easily between operators, and runs in 14 countries around the world, from Bangladesh to Ghana to Paraguay.

Insurers would typically say that a global business ought to look at growing by 1 million customers over 10 years. “On average, [Bima’s] product is growing at 700,000 new customers per month,” says LeapFrog’s co-founder Jim Roth. “More than 90% of their customers never had insurance before in their lives; they are getting a safety net.” Having life insurance often means easier access to the mortgage market, so both companies are opening up important opportunities to nascent middle classes.

Feeling better

In healthcare, Bamboo Finance’s chief executive, Jean-Philippe de Schrevel, is proud of its investments across India, where a project to set up low-cost family doctor practices has served 35,000 people in just two years, and has provided private equity-style returns to investors. He is also proud of the partnership with Louis Dreyfus, the agricultural conglomerate, to set up a $50m impact investment fund focusing on small and medium-sized agribusiness enterprises in sub-Saharan Africa. Louis Dreyfus will invest $10m to seed the fund and provide expertise in the region, while Bamboo Finance will bring its private equity and impact measurement skills. The specialist currently manages $290m of impact assets.

Often demand generates its own supply and finding investible projects has not been difficult, according to investors. Helping to identify the appropriate investments are governance consultants such as Sustainalytics and start-ups such as B Labs, which are among those trying to build impact score sheets and certification systems. Furthermore, as intermediaries begin to pop up in emerging countries, investors’ search for good assets will become easier.

“There are now fund managers in Africa or Asia that lend and invest in organisations in their country [or region]. A lot more [local] fund managers have emerged over the past five years and that has accelerated the growth of investable projects,” says Jennifer Pryce, chief executive of the Calvert Foundation. One such fund is Mauritius-based GroFin, which provides financing to small businesses in Africa and the Middle East, and where Calvert has placed long-term capital.

Investing long term

But to give real scale to impact investing, more long-term investors are needed. For the past five years, the Global Impact Investing Network and JPMorgan have taken annual snapshots of the impact community. Their latest report, Eyes on the Horizon, released in May 2015, has analysed data on 146 impact investors that have a total $60bn of assets under management. Almost two-thirds of investors are fund managers. Long-term players such as pension funds or insurance companies account only for 2% of allocations. This is causing concern.

“[Some pension funds fear that impact investing] is untested; but I just say, look at what happened in the automotive sector [the Volkswagen scandal in November 2015] and the hit you’ve taken on the shares of those companies,” says Mr de Schrevel.

One pension fund that does invest in the field is the Fourth Swedish National Pension Fund, also known as AP4. Its chief executive, Mats Andersson, believes that there is a common misconception about the conflict between sustainability ventures and returns. “It’s actually the other way around – you can’t be long-term successful if you don’t put sustainability on the agenda," he says. "I personally don’t care if we have large fluctuations on assets we own; what is important is that we avoid real risk, permanent capital loss. Climate change is a real risk that we need to mitigate. We have gradually decarbonised our equity portfolio and at same time enhanced our returns. And I think it is our fiduciary duty to act like this.”

Difficulties for investors

Changes in regulation to encourage such investor participation will help add such responsibility on other pension funds’ fiduciary duties. But the field does present real difficulties for long-term investors. When French insurer Axa Group set up its €150m social impact fund in 2014, for example, it felt it needed to adjust to much smaller tickets than the ones it would usually invest in without becoming a majority owner of the assets.

Managers’ limited track record is also an issue. Other specialist investors recognise the problem. “I’m tired of funds by people who have an idea to save the world but have no idea on how to build a fund that institutional investors can actually consider,” says Gil Crawford, chief executive of MicroVest, a provider of private debt and equity capital to financial institutions that serve micro, small and medium-sized businesses.

It would also be useful to create products suitable to retail investors, as the Calvert Foundation in the US and Triodos Investment Management in the Netherlands already offer. The Resonance Social Investment Tax Relief Fund may well pave the way for smaller investors in the UK.

And as growing numbers of mainstream names look at the field and discover its profitability, fewer questions such as ‘how much money are you prepared to lose?’ will be asked by financial advisors to interested clients.

“To be honest, we went into this as a bit of an experiment in 2009,” says Amy Bell, head of principal investments in JPMorgan’s social finance business unit. “We weren’t sure what kind of assets we would have found. [But] there hasn’t been the rate of failure that we had expected coming into the market as early as we did and I think that some of the managers we invested with will exceed expectations.”

The potential of impact investing is such for governments, investors and, most importantly, society, that it is hard to imagine it not overcoming these initial challenges. After its first $350m fund invested in a variety of fields including agribusinesses, healthcare and renewable energy across emerging markets, Eytan Stibbe, the founding partner of Vital Capital, is now planning a second, larger fund of between $500m and $700m. Demand is so high that fundraising will be easy, he says. And he has no doubt about the way ahead, adding: “In the future, we won’t have to call it impact; all investments will be impact investments. You will have to single out the ones that are not.”

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