A growing body of evidence suggests that, as more investors get comfortable with the concept of impact investing — deploying capital with the intention of producing social benefits alongside financial returns — 2014 will be the year "impact investing" ceases to be a buzzword and becomes a real option for financial firms, pension funds, and endowed institutions. Indeed, research by JPMorgan Chase projects that impact investments worldwide will approach $1 trillion by 2020, while a 2013 survey by the World Economic Forum suggests that nearly two-thirds of U.S.-based pension funds expect to make an impact investment in the future. Meanwhile, major Wall Street firms such as Goldman Sachs and Morgan Stanley have already assembled teams dedicated to impact investing. What does all this mean for foundations, and what role should and can they play in the fast-growing impact investing field?
The term impact investing was coined in 2007, but activities of this kind have been around for much longer. Since 1969, when program-related investments (PRIs) were created under the U.S. tax code, private foundations have provided more than $4 billion in unconventional financing for enterprises and activities that further their charitable purposes in areas such as poverty alleviation and education. In recent decades, socially responsible and sustainability-oriented investments have expanded in the public markets and in private equity.
In the last few years, attention has largely been focused on building the supply side of the impact investing field. The Global Impact Investing Network (GIIN) has convened a group of more than sixty investors representing $11 trillion in assets under management, including $60 billion in impact investments; the White House has used its bully pulpit to activate investors; and in 2013 the G8 created the Global Social Impact Investment Task Force. All this activity is promising, but it isn't enough to unleash the true potential of impact investing in terms of delivering game-changing social, economic, and environmental gains.
Unfortunately, too little attention has been paid to the demand side of the impact investing equation. Where are the investment opportunities to put capital to work for social impact and financial returns, whether at market or below-market rates? The last thing those of us working to build the field want to see is a whole lot of capital piled up with no place to go. In such a scenario, we know it wouldn't be long before that untapped capital fled for greener pastures. Even worse, we don’t want to see impact capital invested in enterprises that are not ready to deploy it or where “greenwashing” and excessive profiteering undermine the very social and environmental purposes that motivate our work. Recent challenges and setbacks in the microenterprise field send a strong warning signal: a run of failures on either the financial or impact front will set the field back a generation. We must avoid that outcome.
Foundations have at least three critical roles to play in meeting this challenge. First, many potentially investable impact enterprises are too small and/or require a substantially longer investment horizon than investors (especially those looking for market-rate returns) are willing to commit. These enterprises need to be nurtured, and foundations are in an ideal position to provide the kind of patient, growth-oriented, and risk-tolerant equity and debt financing that enable such enterprises to take root and flourish. Foundations also can provide expertise and access to prospective investors, either directly or through partnerships with programs and organizations whose mission is to build high-impact enterprises. Pacific Community Ventures' Business Advising program is one such partner, among many others. Over time, many of these enterprises and perhaps entire new sectors may become viable for impact investments with more conventional financing terms, or even "plain vanilla" market-rate debt and equity. But absent early-stage, catalytic capital from foundations, neither the social impact nor the financial return is likely to be realized. By sharing successes, these investments can also provide the additional benefit of “signaling” the market, both in terms of attracting like-minded investors to specific deals and new investors to the impact investing field itself.
Second, in some markets, conventional financing will never work due to the underlying economics, population served, regulatory constraints, and/or political risk. Real estate developers, for example, can't generate market-rate returns while providing housing for a senior citizen living on a fixed income of, say, $10,000. While public subsidies can help make the math work, they often create obstacles of other kinds. As Debra Schwartz, director of program-related investments at the John D. and Catherine T. MacArthur Foundation puts it, "In hard-to-finance markets, large-scale impact investments are made, not found." Foundations can play a role in these markets by providing patient, flexible financial support to mission-driven intermediaries such as the Nonprofit Finance Fund, Root Capital, and others. Foundations also can provide the first-loss reserves, guarantees, and subordinated investments needed to create innovative, structured finance vehicles like the New York City Housing Acquisition Fund, which offers "tranches" tailored to different kinds of impact investors, including those requiring market-rate returns.
Impact investing is not meant to eclipse traditional grants; both are necessary. The point is to use impact investing dollars where appropriate and to free up more grant dollars for where grants are truly required. As Amy Klement of Omidyar Network says, "Problem first. Tool second. You really need to understand the problem and the need before you decide the best way to address it (grant, equity, debt, etc.)."
A third way foundations can support the impact investing field is to use traditional grants to fund learning and policy activities, along with enterprise development and financial innovation. For example, Omidyar Network, along with the Rockefeller, MacArthur, Ford, and Surdna foundations, is funding case studies and other research to inform impact investing policy and practice in the U.S. and abroad. These efforts are also supported by a number of government agencies and are critical to the long-term development of the field.
As noted above, 2014 will be a critical year for impact investing. Today's biggest challenges are helping the demand side tap into a growing supply of capital and building the field itself. Foundations have a long history of developing and implementing innovations to address social problems. Building the field of impact investing should be added to that list.
Beth Sirull is president of Pacific Community Ventures, which, in partnership with ImpactAssets and Duke University's Center for the Advancement of Social Entrepreneurship, recently published the report Impact Investing 2.0: Insights: The Way Forward — Insight From 12 Outstanding Funds.