Editor’s Note: Drawing from the recently released book New Frontiers of Philanthropy: A Guide to the New Actors and Tools Reshaping Global Philanthropy and Social Investing edited by Lester M. Salamon, William Burckart attempts to bring additional coherence to the field in part two of this three-part series. Part one can be found here.
As impact investing has grown, it has begun to reshape traditional approaches to financing socially focused initiatives – sometimes to the point where paradigms start to shift. Take bonds for instance. Traditionally, investors have used them to loan money to a business or government to finance various projects or activities for a set period of time and guaranteed rate of return. If you’ll indulge an ‘80s reference, they are like Brian Johnson – Anthony Michael Hall’s character in “The Breakfast Club” – safe and reliable.
But due to the influence of impact investing, bonds have begun developing a bit of an edge. To continue The Breakfast Club analogy, they are becoming more like Judd Nelson’s John Bender: rebellious and riling up the space of social change. For instance, the $416 million Unilever bond mentioned in the previous post is not only increasing the efficiency of new and retrofitted factories - it is actually spurring investors to finance triple-A rated sustainable growth. And “social impact bonds” are catalyzing developments in the public sector by letting investors and philanthropists assume the upfront risk for social programs, while government only pays back the investors for the programs that actually work.
These bonds, which offer a fixed period of time but not a fixed rate of return, have caught the imagination of government, philanthropy, and investors and over $100 million has thus far been mobilized globally in this way. But if you’re scratching your head and reasoning, “well that doesn’t sound like a bond,” you would be correct. (John Bender was an enigma too).
Overcoming a “Conspiracy of Caution” in Community Development Finance
Impact investing has sparked similar changes in community and economic development in the U.S., broadening the utility of regulations to go beyond housing to include a wider array of social, environmental and economic issues. From a health clinic in the San Francisco Bay Area, to a mixed-use plan in a run-down neighborhood in Dallas, these efforts are overcoming what one community development activist described as a “conspiracy of caution,” in which neither bankers nor regulators had actively sought out new ways to increase investment in communities.
Indeed, as detailed in Lester Salamon's recently released book New Frontiers of Philanthropy, the community development space has been pioneering many of the impact investment innovations now gaining so much attention, from the rise of capital aggregators that serve as the middlemen raising capital from investors and providing financing to a range of entities, to the tapping of secondary markets that acquire loans that are made by lending organizations (and the process of securitization that makes this possible).
The book also includes a compelling agenda of next steps for enabling the use of impact investing to broaden the reach and role of community and economic development, which I was able to build on through a state of the industry overview and acorresponding op-ed. In both pieces, I highlight the need for Community Reinvestment Act (CRA) regulators to signal clearly that expanding community and economic development efforts to include a broad range of social services—outside of real estate—will not jeopardize a bank’s CRA status. I also draw attention to a few of the emerging wholesale mechanisms necessary for efficiently leveraging government incentives, philanthropic resources and private sector deal flow that are attempting to solve the challenges of fragmentation and inability to achieve scale by serving as comprehensive industry utilities.
The Nonprofit Sector is Winning and Losing
Impact investing is also confounding the boundaries of the nonprofit world. Long the frontlines of social change, many of these organizations are contemplating the opportunities that impact investing seemingly represents – while also considering the challenges.
Over the course of producing the book, Salamon and I spoke with the leaders of InterAction – a membership organization of nearly 200 of the largest nonprofits in the world – about the intersection of nonprofits and impact investing. In our conversations, it soon became clear that the tools of impact investment had the potential to unleash enormous new energies and substantial resources within nonprofits, powering creative approaches for solving long-standing global problems. It also became apparent that these developments would contain trade-offs, as covered in Salamon’s introductory chapter of the book (which was also published as its own monograph, Leverage for Good). This is due in part to the fact that nonprofit organizations operate on an uneven playing field in terms of access to capital, since the prohibition on their distribution of profits effectively denies them access to the most attractive source of capital: namely, the equities market.
Further, the benefits of invested capital are not always allocated evenly, as Michael Edwards, author of Just Another Emperor?: The Myths and Realities of Philanthrocapitalism, points out in the chapter on “Who Wins, Who Loses? Distributional Impacts” in New Frontiers of Philanthropy: “…the assumption that the objectives of philanthropy overlap extensively with the objectives of private investors is largely unfounded, and therefore is unlikely to deliver the benefits that are claimed for it. The use of the market-oriented mechanisms may even damage the health and strength of civil society and thereby reduce the long-term social and political impact of voluntary citizen action...”
Supply-side vs. Demand-side
The debate over impact investing for nonprofits relies on incomplete evidence, though, because most of the attention in fashioning this new system has focused on the “supply side” of the social-capital market, i.e., encouraging financial institutions, investment managers, family offices, and high-net-worth individuals to see the impact investment arena as a viable new “asset class” that could deliver solid financial returns while generating significant social and environmental impacts.
The assumption was that the demand side would somehow take care of itself. Unfortunately, however, this assumption has proven to be far from the mark. This has occasioned serious concerns about the investment-readiness of potential investees and pushed “the shortage of quality investment opportunities” to the first or second spot among challenges cited by potential impact investors. Indeed, many of those who see impact investing as a way to reform capitalism in the aftermath of the 2008 global financial crisis consider the lack of investment-ready deals to be the real challenge to building a robust social capital market, a point Salamon emphasizes in his introduction.
Foundations Are Trying to Get off their Assets
Nowhere are the opportunities and challenges of impact investing on more prominent display than in the world of private philanthropy. The casual flirtation that the philanthropic industrial complex of private and community foundations, donor-advised funds, and other charitable vehicles has had with impact investing since the 1960s (mostly in the guise of program-related investing) has evolved a bit in the past decade or so. While not yet a love affair, a deepening courtship seems to be in process.
As Salamon and I cover in Chapter 5 of New Frontiers of Philanthropy, charitable foundations are even beginning to operate as "philanthropic banks," using substantial portions of their assets in creative ways to advance their missions, and opening a variety of “windows” through which to dispense financial assistance beyond just the old stand-by of grants. These windows (each of which is covered in a separate chapters in the book) include loans and credit enhancements, private equity, insurance, broadened uses of socially responsible investing and purchasing, and even grants.
To be sure, this is not an entirely new development. The Ford Foundation planted the very seeds of impact investing when itpioneered the first Program-Related Investment back in 1968. But while government regulators subsequently approved this form of investing by foundations with the Tax Reform Act of 1969, it is an idea that has never gotten much traction. Consider, for instance, the size of the universe of foundations currently functioning as philanthropic banks. The number of PRI makers peaked at 133 in 2004 and dropped back to 120 by 2007, the latest year for which data are available. This latter figure represented considerably less than 2/10ths of 1 percent of the 75,187 foundations in existence as of that year. And foundations that turn to impact investing continue to struggle with making the shift. Clara Miller, the president of The F.B. Heron Foundation, recently identified some of the barriers they face in the Stanford Social Innovation Review: regulatory complexity, a perceived risk-return mismatch, limited expertise among traditional investment advisors, difficulties measuring impact performance, and a limited view of fiduciary responsibility.
A complex set of contributing variables unique to the world of philanthropy include: legal complications, skill requirements, tensions between program and investment staff, and an inadequate supply of qualified ventures. The net of these blockers and variables is that the embrace of impact investing by foundations appears to be limited if not downright weak.
Yet this may change as impact investing approaches gain wider currency. And with all the ferment that these approaches have already caused in the philanthropic, public and nonprofit worlds, it seems likely that innovators in each sector will find ways to better use them to their advantage.
In the final post in this series, I’ll explore the growing movement toward transparency, as impact investors strive to measure the nonfinancial performance of their investments and even compare investments by the social good they achieve.