Redefining Returns: The Impact of an Emerging Investment Model
Impact investing offers a way to make targeted investments in ventures with a social or environmental mission. This emerging set of assets represents a new subset of socially responsible investing (SRI), which seeks to proactively create, monitor and assess social and environmental impact as part of the investment objectives in addition to a financial return.
The notion underlying impact investing is that the creation of economic value and social value are not mutually exclusive and that a market-based approach can be used to develop sustainable solutions to social and environmental issues. According to Amy Bell, head of principal investments for J.P. Morgan Social Finance, "There is an increasing number of emerging business models where the pursuit of social or environmental impact is a mutually reinforcing goal alongside financial return. These are the types of business models that impact investors actively target."
One of the underpinning theses behind the emergence of impact investments is the potential to expand the monies available to address social and environmental issues beyond the limited capital available through philanthropy and aid alone. In addition, the draw of impact investing for investors is often the higher level of accountability an investment offers versus traditional philanthropic and aid-oriented methods of creating social and environmental change. By uniting philanthropic players, public sector actors and private sector investors, impact investing offers the potential for more scalable, effective solutions to these challenges.
"Where it is possible to identify for-profit business models or market-based solutions that also address a social or environmental issue, why not invest capital to address that challenge and expect a return?"
Market growth trajectory
The global market for SRI, or those investments that incorporate environmental, social and governance concerns, is at least US$13.6 trillion1in professionally managed assets. Of those assets, impact and community investments total US$89 billion.2 A survey by J.P. Morgan and the Global Impact Investing Network (GIIN), a not-for-profit organization dedicated to increasing the scale and effectiveness of impact investing, found that 99 impact investors had committed US$8billion to impact investments in 2012 and planned to commit US$9 billion in 2013.3 Respondents in the prior year's survey also expected impact investments to constitute 5 percent to 10 percent of portfolios in 10 years.4
These reports found momentum toward market growth despite the challenge of defining a market with varying levels of expectations for returns and differing areas of focus for intervention. A number of leading market participants are actively collaborating and sharing experiences through GIIN in order to bring an increased level of professionalism to the market.
Organizations with social or environmental objectives can integrate impact investments into their portfolios to further both financial and corporate responsibility goals. Today a variety of investors are participating—including development finance institutions, foundations, private wealth managers, commercial banks, pension fund managers, boutique investment funds and high net worth individuals. Investors have deployed capital across multiple business sectors, including agriculture, water, housing, education, health, energy and financial services. Their impact objectives can range from mitigating climate change to increasing incomes and assets for poor and underserved populations.
Serving and Growing the Market for Impact Investments
J.P. Morgan launched the Social Finance business in 2007 to service the growing market for impact investments. Social Finance is dedicated to servicing and growing this nascent market through:
Principal investing—invests J.P. Morgan capital in impact investment funds with the dual objective of achieving improved livelihoods for underserved populations and financial return.
Client advisory—serves investor and issuer clients through structuring and placement of impact investment products to clients and client coverage of leading impact-oriented organizations.
Research—delivers thought leadership to the impact investment market and serves as an informational and educational resource for our clients.
Our proprietary impact investment portfolio holds a number of fund managers who seek to fulfill our impact mandate "to improve livelihoods for low-income and underserved populations:"
African Agricultural Capital Fund—invests in agribusiness to support the development of small holder farmers and rural economies in East Africa and aims to improve the quality of life for at least 250,000 small holder households over the life of the fund.
Bridges Social Entrepreneurs Fund—provides growth capital to support high-impact, scalable and financially sustainable social enterprises in the UK.
IGNIA—supports the founding and expansion of high-growth social enterprises serving low-income populations in Mexico, including healthcare, housing, water, technology and food/agriculture businesses.
LeapFrog Financial Inclusion Fund—invests in businesses that provide insurance and related financial services to low-income and financially excluded people in Africa and Asia; aims to reach 25 million low-income and vulnerable people, providing them with a springboard to escape poverty.
MicroVest II—seeks sustainable solutions to poverty by facilitating the flow of capital to finance institutions serving low-income individuals in emerging markets such as Latin America, Asia and Eastern Europe.
Expected market returns
Return expectations for this asset class vary by instrument type, investor perceptions and chosen benchmark. In recently published research, J.P. Morgan found that more than two-thirds of respondents are targeting market rates of return, while one-third of respondents view themselves as concessionary, or willing to slightly compromise their rate of financial return.5 In another study, 60 percent of respondents said they do not believe that a trade-off between impact and financial returns is necessary.6 Some areas have more of a track record on returns than others. For example, more data exists on investments in renewable energy, micro-finance, and support for small and medium enterprises in frontier countries, whereas less data exists on investments that support low-income and underserved populations in emerging markets or innovative business models to deliver healthcare and education. Impact investors and business owners are continuing to identify new models of intervention that can generate return and positive impact and deepen the track record with time.
A number of impact investors deploy capital through private equity funds; 83 percent of a select group of impact investors responded that they had used private equity funds in a recent survey. Respondents to the same survey also noted use of private debt (66 percent of respondents) and equity-like debt (44 percent of respondents), which typically offer more flexibility in liquidity and tenor.7 Longer-term, the availability of traditional financial structures will attract more investment capital and support further market growth.
Market participants are also innovating around financial structures to better deploy capital to issue areas. One of the most recent examples is the social impact bond—also known as a pay-for-success contract or outcomes-based finance. In concept this allows the government to outsource the provision of a social service to an intermediary and only pay for that service once a defined set of outcomes is delivered. Investors pay the up-front costs of the intermediary with the expectation that the government will pay back investors out of savings accrued from the program's success. Says Bell, "It's a compelling way to share risk, using standard financial concepts to bring together a unique set of participants such as public sector, private sector investors and the not-for-profits that typically deliver the services."
One challenge that institutional investors face is the ability to find high quality investment opportunities with a track record. With a lack of indices and exchanges and few intermediaries in the impact investment market, large investors are turning to banking partners or boutique advisors for help in navigating this space.
Impact measurement—developing a framework and methodology to rigorously and analytically evaluate the impact of an investment—is often another challenge for institutional investors. Bell says it is important that investors define their objectives with regard to financial and impact returns and look to hold investees accountable for both in making impact investments.
The impact mandate, or "theory of change" as it is sometimes called, is a key concept in establishing benchmarks, as it helps establish specific objectives and targets for the desired impact. A framework to evaluate investments against objectives may include, among other factors: how an investor defines its targeted population or issue, the approach or intervention model for improvement, and evidence of ongoing commitment to achieving the impact mandate.
An asset class garnering attention
Impact investing has garnered attention from the general public, governments and philanthropic organizations. This new class of investments cannot be ignored by institutional investors seeking to diversify their investment strategies and satisfy a broader range of investor demands. For a pool of capital with defined financial and impact objectives, there are interesting ways to test the market and gain experience as products in this asset class increasingly become available.
Theory of Change: A Methodology for Targeting Measurable Outcomes
A theory of change is a methodology for planning and evaluating social intervention.8 Just as Six Sigma starts with the end in mind, a theory of change starts with an intended goal and builds a pathway to it. It does so by using assumptions to build a hypothesis abou thow change will occur—based on an analysis of all the identifiable causes of change and their interconnections. The process is participatory—with stakeholders articulating a shared long-term vision—and outcomes-based, with each outcome tied to an intervention on the roadmap for change.9
For many impact investors, the value set of an individual or organization commonly drives an impact thesis and can reference a theory of change, often naming clear objectives such as access to clean water or affordable housing. It can reference a target population, business model or set of outcomes through which the investor intends to deliver the impact.10
1 Global Sustainable Investment Alliance, 2012 Global Sustainable Investment Review, January 27,2013, page 9, www.gsi-alliance.org.
2 Ibid, page 11.
3 J.P. Morgan and GIIN, Perspectiveson Progress: The Impact Investor Survey, January 7, 2013, page 3,www.thegiin.org.
4 J.P. Morgan and GIIN, Insight into the Impact Investment Market, December 14, 2011, page 5,www.thegiin.org.
5 Perspectives on Progress: The Impact Investor Survey, page 13.
6 Insight into the Impact Investment Market, page 9.
7 Perspectives on Progress: TheImpact Investor Survey, page 9.
10 Yasemin Saltuk, J.P. Morgan Global Social Finance Research, A Portfolio Approach to Impact Investment,October 1, 2012, page 4, www.jpmorganchase.com.