Authored Article: It’s Time to Cut Through the Hype of Impact Investing

By William Burckart

In a time of skyrocketing deficits, uncertain financial markets, and staggering need, many government, business, and nonprofit leaders are eagerly looking for help from impact investments—deals that achieve a measurable social and environmental impact alongside a financial return.

But impact investment is not well understood outside of a relatively small group of early adopters, and even this band of innovators harbors multiple, sometimes-incompatible interpretations of the concept.

The result of this fragmentation is that government is struggling to build an environment that encourages impact investing while investors and foundations try to figure out what kinds of returns are reasonable to expect. In the meantime, hype is outpacing reality, and all the excitement could fizzle into very little unless we get serious about figuring out ways to move forward.

To help sort out what is real, Impact Economy—an impact-investment and strategy-advisory firm—has just issued a paper, Making Impact Investible, written by our founder, Maximilian Martin, so that foundation and nonprofit officials as well as people in government and business can help figure out next steps. A primer based on this document was released at the June Social Impact Investment Forum held by the Group of 8 leaders.

That meeting was a sign of the growing interest in the approach and the need to continue to drive momentum and further strengthen the industry—not only for the financial advisers and institutional players focused on the “investment” side of the equation, but also for the foundations and nonprofit organizations focused on the “impact” that these investments are meant to produce.

Although impact investing is a new buzzword, the seeds of the idea have been around for a long time. The Ford Foundation in 1968 pioneered the first version of this idea when it made what it called a program-related investment.

This form of foundation investing has long been approved by government regulators, but it is an idea that has never gotten much traction. As a matter of fact, far less than 1 percent of foundation assets go to such investments (and only five one-hundredths of this 1 percent has actually gone to equity).

Foundations that have used the approach can do a lot of good now by talking about the steps they took to measure social and financial returns and to find the right organizations and projects to support.

But a more important step would be for foundations to see themselves in the way Lester Salamon, a nonprofit scholar at Johns Hopkins, has proposed: They should become philanthropic banks.

The F.B. Heron Foundation has been making this shift for nearly two decades and has recently signaled that it will move all of its assets (both endowment and grants) into investments that produce both social and financial returns, as The Chroniclenoted in a cover article this spring.

Other grant makers, including W.K. Kellogg, K.L. Felicitas, and Mary Reynolds Babcock, are also taking important steps in putting more of their endowment—and not just their grant-making resources—into investments that support their philanthropic goals.

Granted, aligning investment policy and mission is accomplished more easily if your mission is community development than if it is, say, human rights. But a growing number of foundations are determined to use their endowments to absorb risks that stymie private investors from putting their money into ideas that benefit society.

For nonprofits, the path to getting involved in impact investing is far trickier. They are encouraged to experiment with ideas like creating benefit corporations—businesses that are designed specifically to achieve social returns, not just profits—or pay-for-success programs (also known as “social-impact bonds”), where private donors put up money and government pays them back if a project achieves intended results that not only benefit society but save taxpayers money.

Lost in this message is that not every group can benefit from such approaches, and an equal number are simply not yet equipped to handle investment dollars. For one, it’s hard to measure results in many types of nonprofit work or even to define the social and environmental impact of a project.

Yet even if not all nonprofits can get a direct financial benefit from impact investing, many of them would gain indirectly if the idea spreads. The growth of such investments could reduce competition if some groups could take advantage of impact investments and limit their reliance on grants from foundations, corporations, and wealthy donors as well as from government sources. What’s more, the experimentation with new ways to finance social causes will eventually lead to new ideas that benefit a far wider range of organizations than we can imagine today.

Thus the opportunity for traditional nonprofit organizations is less about reconfiguring the fundamentals of their financing as it is about rethinking how they fit into the impact-investment market. Nonprofits can work with businesses to consider a twist on impact investing that helps them not only aid society—but actually to “prime the pump” for the impact-investment market, as two top officials of the Omidyar Network, a pioneer in this area, put it in a blog post last year in the Stanford Social Innovation Review.

To do this, they can look for help in an unexpected corner. Corporations increasingly engage in what Impact Economy’s Mr. Martin has dubbed “impact venturing.” They now also finance start-ups and spin-offs with combined social and financial objectives. The most famous example is perhaps Danone Communities, the social business incubator of Danone, the global dairy and nutrition group.

In addition to investment capital, social businesses also need access to expertise, and some corporations are reorienting their corporate philanthropy in this direction.

Among the examples: Coca-Cola’s 5by20 plan, which is working with foundations, nonprofits, and other organizations to give women the skills and resources they need to become entrepreneurs involved in each aspect of the company’s production chain, from providing agricultural products to running bottling plants and convenience stores.

Social inequality and unrest, regional health issues, and global resource and commodity shortages are all factors that ultimately affect the ability of a company like Coca-Cola to expand its products and services to reach the world’s poorest and most vulnerable.

That’s why nonprofits will have an increasingly important role in business innovation. Both foundations and nonprofits will need to play increasingly new and sometimes surprising roles to help enable a fully functioning ecosystem of impact investment.

Government, in turn, needs to practice smarter policy making that focuses as much on developing new tools as it does on adopting policies that encourage growth of impact investing. And everyone, from the social entrepreneur to the impact investor, needs to strive for increased transparency and ways to measure social-impact investment according to common benchmarks.

Impact investing is at an inflection point: For all its progress, impact investment risks becoming another satellite activity on the margins of social finance, rather than transforming mainstream capital markets and investments.

It has been an intense six years as impact investment went from a new concept in 2007 to a promising market in 2013. However, the journey forward will be even more extreme, as will the scrutiny. And hype will no longer count as progress.