Envisioning the future of impact investing
As we considered the prospects for impact investing, we were especially interested in understanding what a large, mainstream market ought to look like. Based on our investor interviews and our study of how other investment products evolved, we believe a fully-developed impact-investing industry will have the following four features.
Proven and self-sustaining economics. When the impact-investing industry has matured, investors will generate market-rate financial returns without tax breaks, subsidies, or other help from governments. Until then, governments can play an important role in nurturing impact-investing markets. The United Kingdom’s impact-investing market is more sophisticated than any other, in large part because of the government’s support. A decisive shift took place in 2012, when the government funded an entity called Big Society Capital with about £120 million from dormant bank accounts and a levy on the four main UK High Street banks (followed by another £210 million through June 2015). Since then, Big Society Capital has provided seed capital to new impact-investment managers and has served as a clearinghouse for knowledge of impact investing and social entrepreneurship.
The UK government also lent indirect but vital support to its impact-investing industry by going further than many governments in contracting public services, such as welfare-to-work programs, to nonprofits and companies. Some argue that this approach has not always fulfilled its promise to produce better social outcomes for less money. In any case, it has created reliable demand for social enterprises and impact-oriented businesses, which increases these organizations’ need for capital.<a “=”” class=”link-footnote” rel=”#footnote3″ role=”tooltip” tabindex=”0″ aria-label=”Open tooltip”>3
A clear, consistent way of describing products. “Impact investing” means different things to different people. Some see it as a strategy for beating financial benchmarks, because businesses that target unmet social or environmental needs can be profitable but easy for investors to overlook. Others are happy to accept lower financial returns for the sake of backing enterprises whose main interest is creating social benefits. The investors we spoke to believe impact-fund managers need to clarify their intentions as well as the trade-offs inherent in their approaches. In particular, managers should be more objective about the levels of risk and the expected returns, both financial and nonfinancial, of their funds. Just as a mature impact-investing market needs shared standards for measuring impact, it will also need a common language for profiling impact funds.
The family offices and large asset managers we spoke to in the United Kingdom are especially excited about investing in businesses that put profits first and see social impact as a coproduct of their work. One example is the Gym Group, a UK company offering affordable health clubs to low-income people whom the wider gym industry generally does not serve. With capital from the impact-investment firm Bridges Ventures, the gym expanded to more than 35 locations in under five years and returned more than 20 times its original investment.
A range of well-defined offerings. Another sign that the impact-investment industry has matured would be the availability of specialized products. Just as some mutual funds and exchange-traded funds concentrate on geographies, industries, and asset classes, so should impact investors come up with targeted offerings. Focusing on distinct social and environmental themes can help when it comes to setting goals for how much nonfinancial impact a fund will make. Thematic funds should also be easier for investors to compare. Impact investors have set up funds devoted to education, and healthcare is emerging as another focus area.
A high degree of professionalism. More capital will flow into impact funds when they consistently offer investors the same quality of service as other investment funds. Some impact funds have operated for more than five years and have established sound, disciplined processes. However, UK investors told us they have concerns about newer funds, pointing to shortcomings in areas like financial modeling, business-plan preparation, and the evaluation of management, which can be a major risk in impact-investment portfolios. Funds may also need to offer more competitive pay packages to attract top financial talent.
Further reading: https://www.mckinsey.com/business-functions/sustainability/our-insights/how-impact-investing-can-reach-the-mainstream