Photo: iStockphoto.
Photo: iStockphoto.

Opinion | Move beyond mere trade-offs in impact investing

Some viable investment profiles do not involve a choice between impact and financial return

Across the world, we are seeing a proliferation of entrepreneurs with a vision to create social impact at scale. In South Africa, a network of low-cost independent schools uses a blended learning model with technology to deliver world-class education to low- and middle-income students. In India, the next half billion people who will come online via mobile phones will have access to everything from financial services to healthcare on their phones.

Investors are also recognizing the potential of impact investing. The Global Impact Investors Network’s (GIIN) most recent investor survey reports an asset base of more than $228 billion managed by 226 leading impact investors, a 4x increase since 2014.

We’ve seen a remarkable increase in the diversity of impact investors, each with different impact goals and investment strategies. But we’ve also seen an increasingly polarized debate about whether impact investing requires a trade-off between financial return and social impact.

One perspective claims that there is always a trade-off between financial return and impact, and therefore all true impact investing involves concessionary, or sub-commercial, returns. Others believe there is no trade-off between return and impact, and therefore all smart impact investments should achieve fully commercial returns. These competing claims can scare off potential investors. The reality is far more nuanced. There is a broad range of viable investment profiles. Some of them involve a choice between impact and financial return and others do not.

In 2017, based on more than a decade of experience, Omidyar Network first described our investment approach in our paper Across The Returns Continuum. We’ve learned that an investment can have both a direct impact on its customers or beneficiaries, and a market-level impact that goes beyond its direct beneficiaries to often drive sector-level change. In every investment we make, we seek to drive strong direct impact. However, whether we accept sub-commercial returns depends on our assessment of the investee’s potential to create market-level impact. By market-level impact, we mean pioneering a new business model which has potential for replication, creating sector-level infrastructure or enabling policy reform.

This was based on our own experience as an early-stage investor with flexibility to deploy capital across equity investments and grants. However, our peers have different profiles and capital pools, and focus on different asset classes and stages of investing. To learn more, we asked several exemplary impact investors across the world to share their approaches and explain how they balance risk, return, and impact in their own investing. This is what we heard.

Message 1: it’s clear that many savvy investors have already moved beyond the trade-off debate to develop sophisticated approaches that deploy capital at multiple points along the returns continuum. Prudential Financial leverages three different pools of capital with different return expectations to pursue the widest array of impact opportunities possible. Indian investment firm Lok Capital have found that it’s possible to achieve competitive returns in sectors like microfinance and financial inclusion. But their forthcoming High Impact Fund will leverage a mix of more patient, sub-commercial capital to achieve impact in higher risk sectors such as healthcare and education exclusively for the underserved.

Message 2: under certain circumstances, it’s possible to achieve risk-adjusted, market-rate returns with substantial social impact. For example, Elevar Equity has played an active role supporting companies in an undersupplied capital market while still achieving competitive rates of return. Their early success in scaling businesses serving low-income customers in India and Latin America has led to follow-on funds by both Elevar and others with similar investment theses. The Rise Fund—a growth stage fund—has developed a rigorous impact underwriting process and works with portfolio firms to ensure impact scales alongside financial returns.

Message 3: we also saw that some types of impact that aren’t conducive to market-rate returns—highlighting the need for rigour in making decisions about when and how to deploy sub-commercial capital. The most common rationale for sub-commercial returns is to target high-risk, high-impact opportunities where a lack of track record or comparable models makes it difficult to estimate expected financial outcomes. Blue Haven Initiative participated in a blended finance facility to help PowerGen Renewable Energy increase access to electricity via mini-grids—if it works, this could prove the economic viability of a new business model. The Bill and Melinda Gates Foundation uses volume guarantees to guarantee demand for drugs and vaccines, which has helped “make a market". This enables manufacturers to profitably expand to the developing world, significantly expanding access to life-saving drugs. Sub-commercial capital—with a range of returns from capital preservation to near market-rate returns—can play a unique role to fill the wide gap between market-rate finance and grants.

Finally, even the most sophisticated impact investors are still on a learning journey. What is clear is that the relationship between risk, return, and impact is complex and needs deep understanding. And as this understanding develops, we can better match each type of capital with the investment opportunity it is best suited to fund.

Roopa Kudva is MD at Omidyar Network India, an investment firm focussed on social impact

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