Impact investing grows up: from intentionality to additionality (Part 5/5)

Falko and Harald discuss the current state of impact investing: where we are, why we’re here, and where we need to go. They draw on recommendations that commentators made as far back as 2012, and introduce new frameworks that help investors who are looking for “additional impact” to identify the most effective tools. 

This is part five in a series of five articles. In part one Falko and Harald argue that a shift in focus is needed in impact investing: from the strong emphasis on intentionality and identity – which requires asking: “can this impact investment be attributed to me?” – to an emphasis on additionality and systems – which requires asking “how do we ensure adequate funding of needed solutions to global problems?” And: “how do we effect the system change that is often needed for this?” 

In part two they dig a little bit deeper into their CC2 concept: "Causing Change That Wouldn’t Otherwise Occur." This is not to coin a new phrase, but to explain why there might have been more attention to pinpointing the "change" element, than the elements "causality" and "additionality". They also discuss the implications for impact labels - can we develop labels that capture causality and additionality? - and for monetisation of impact - can we put dollar values on the generated impact?

In part three they attempt to answer the question “do impact and return go hand-in-hand?” For this they introduce the SDG Venn Diagram to argue why it can be interesting to look at the overlap between what companies do and what we need to achieve the SDGs, but that the overlap is not that large, and why it is much more interesting to think about how the overlap was created in the first place. They also explain why there is very little 'impact-generation' to be achieved in listed equity companies. They conclude that we should be skeptical about propositions promising both impact and return, and even more skeptical if they promise higher than market-rate returns, especially if propositions relate to secondary markets investments.

In part four they argue that there has been too much emphasis on the "intentionality" of the investor, and not enough on elements such as causality and additionality, and that this may be because impact investors are often “warm glow optimisers”. They further argue that this may be detrimental – because warm glow optimisers are more concerned with the question whether impact can be attributed to them, they overlook – more important – questions around which outcomes are achieved. 

For this series they lean heavily on a series of articles published by Stanford Social Innovation Review, that are referenced throughout the text, and four academic papers co-authored by Falko. These sources are also listed at the bottom of this article.

Part 5: Systems & subsidies

In a previous article in the series we discussed the SDG Venn diagram, illustrating the universes of impactful projects and of corporate activities, and how they overlap. And we argued that investing in what’s already happening offers little additionality, even if it may serve to demonstrate there’s intentionality: it’s impact-alignment rather than impact-generation.

We show another version of this diagram below and argue that the investor looking for CC2-like impact, who wants to shift emphasis from intentionality to additionality, will recognise that impact and return in fact often do not go hand in hand – there are many projects in the blue circle that do not (yet) offer market-rate returns but are still in need of financing – and so will be interested in exploring what tools we have to shift the circles: to bring impactful projects into, or at least closer to, the orange circle of profitable and investable activities.

What do the SSIR authors say about these tools? 

• Brest: “It is possible for concessionary impact investors to affect the outputs of portfolio firms through private market transactions by providing subsidies in the form of accepting financial returns below the level that socially-neutral investors would require.”

• Bannick/Goldman: “Impact investors cannot afford to ignore critical political considerations. Enlightened politicians and policymakers have the potential to dramatically speed up the rate at by which an industry can scale to responsibly serve hundreds of millions… Governments have numerous powerful levers at their disposal to accelerate new industries for impact. Among the most important policy imperatives are: ensuring fair and robust competition; establishing appropriate regulation; and promoting entrepreneurship… Ultimately, success is best achieved when supportive politicians and policies are married with entrepreneurs and a diverse set of investors who are deeply committed to innovation and sector level change. Getting this formula right can mean the difference between impacting hundreds and hundreds of millions of lives.” 

• Starr: “Impact investing isn’t necessary unless there is some degree of market failure to overcome. Overcoming market failure is risky and expensive, requires innovation and R&D, and generally provides low returns on investment… Investing business-by-business in scattered geographies isn’t going to make much difference. We have to catalyse industries. It’s a useful exercise to ask, ‘Does this model have the potential to make a big difference for a million people and, if so, just how would that happen?’ Rarely does that happen with a single firm. What it will take is clustering businesses, building value chains, and spurring competitors. We’re going to have to be more clever.”

• Bildner: “The most common characteristic we saw in social finance or capital market investments targeted at these focus areas was the need for massive tax subsidies provided by governments or ‘loss reserve’ coverage most often coming from philanthropic sources. This, by definition, is not a market return, but a return made possible by philanthropic capital or government tax subsidies that artificially de-risks the investment and enhances returns based on external subsidies.”

• Brest, Gilson & Wolfson: “[In contrast to secondary markets:] in private markets… however, it is possible for concessionary impact investors to affect the outputs of firms in private market transactions by providing subsidies in the form of accepting financial returns below the level that socially-neutral investors would require.” 

From these comments we can distil the Venn-diagram-circle-shifting toolbox: 

• Concessional investments / subsidies

• Blended finance: market-rate private investments catalysed by public or philanthropic investors

• R&D

• Public policy / collaboration with governments / public-private partnerships 

• Innovation

These tools have in common that they take into account the bigger system, or sector, change that is necessary to solve the SDG-related problem at hand. The reader will understand from the above that deploying these tools is heavy lifting, which invites an interesting question about which investors have the resources, willingness to make concessional investments, and flexible investment mandates needed to contribute to this kind of impact investing.

To aid this discussion, we offer another visual – the CC2 matrix – that categorises different types of investors based on these parameters, and also provides an indication of how deep their pockets are; in other words: how essential is it that they are part of these activities?

What is immediately apparent is the relative unimportance of retail investors to this kind of impact investing – for all of the talk of ‘democratisation’ of impact, they score low on both dimensions, have relatively small amounts of capital to contribute, and invest mostly in secondary equity and bond markets where – as we discussed in earlier articles – very little CC2-like impact is to be found.

However, all other categories of investors – private wealth investors (including family offices), philanthropic foundations and institutional investors (such as pension funds and insurers) – score high on one or both dimensions, suggesting they can play a role. Also, they have deeper pockets and taking into account the considerable SDG investment gap we face we need them at the CC2 table – they must play a role. And while institutional investors need to take into account their fiduciary duty to beneficiaries and clients – which generally implies they cannot consider concessional investments – they bring relevant expertise and resources, and have institutional capacity to collaborate with governments and development banks, and to assess what it takes in terms of blended finance solutions to meet their investment requirements.

Private wealth does not generally bring institutional power to these discussions, but may be willing to make concessional investments, e.g. to fund the R&D and innovation needed to shift the Venn diagram circles and ultimately make impactful activity investable. Given the relatively large dollar amounts they can bring this can make a meaningful difference. Finally, philanthropic foundations offer the best of these worlds – the investment discretion, the institutional capabilities, and the deep pockets.

Conclusion

Returning to the teenager analogy we started this series of articles with: we hope we have persuasively argued that, nearly 18 years old, impact investment has a lot to offer the world and has a bright future in front of her.

But if she is to live up to her full potential of offering impact investments that cause change that wouldn’t otherwise occur (CC2) she needs to shift her focus from intentionality – with its emphasis on warm glow, identity and pointing to changes (that would have happened anyway) to suggest attribution – to additionality, where the goal is not scoring “impact points”, but the real funding of solutions to societal problems, and where there is more consideration for the theory of change, and the narrative that explains the causal link between investment and outcome. 

This shifting of focus should also allow her to see that often impact and return do not go hand-in-hand, and that therefore concessional investments, subsidies, collaboration on R&D and innovation, or public-private partnerships need to be brought into the equation.

We call on the entire investment community to support us in further counseling this promising 17-year old and look forward to marking her 18th and 21st birthdays by observing substantial progress on the journey towards achieving CC2-like impact.

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