Impact investing: grabbing a piece of the $650 billion market

Impact investing is a growing phenomenon but many mainstream investors are wary of it. Image sourced from www.shutterstock.com

The World Economic Forum reports there is widespread confusion regarding what impact investing promises and what it ultimately delivers. Some estimate it is a market worth between US$450 billion and US$650 billion within the next five years.

Yet mainstream asset owners such as superannuation and insurance funds, and private equity firms and mutual funds are still missing from this emerging global market. Key findings from the WEF report also reflect current issues facing the nascent Australian market.

Not an asset class

Impact investing seeks a social and financial return. It is not an asset class, but rather a lens through which to make investment decisions. You may ask: but doesn’t every investment have impact in terms of creating jobs, wealth and so on? Impact investing has intentionality (investments motivated by the social and/or environmental return), and requires measurement of outcomes (social impact and financial return).

Furthermore, impact investing is not synonymous with Social Impact Bonds (SIBs). There is no doubt that SIBs are an exciting and imaginative use of philanthropic dollars, yet to date they are primarily funded by the usual suspects - foundations, high net worth individuals. The market for impact investing, and the G8 Taskforce on this issue, is focused further along the continuum of mainstream investors.

Meeting market returns

Impact investing is unique in that the investor may be willing to accept a lower financial return in exchange for achievement of a social outcome; mainstream investors have thus often assumed that impact investments always generate below-market returns. Although some may remain sceptical, this is not always true. Consequently, many superannuation funds and other investors have argued that the “sole purpose test” prevents them from making such investments; yet we argue that impact investing need not conflict with fiduciary responsibilities.

An early stage market

Globally, there has been a lot of hype and buzz around this topic, making it on to the agenda of the recent G8 meeting, as governments and organisations seek to mobilise more capital to address the world’s pressing and wicked problems. Although there is an emerging global infrastructure for this sector (for example, the Global Impact Investment Ratings System), at this stage the impact investment ecosystem and its development is best understood at the country and sector level.

So where does Australia fit?

In a positive move, Australia is arguably punching above its weight in being given “observer status” on the G8 Taskforce on impact investing and the emergence of organisations seeking to develop this nascent market. In Australia, the 2011 Senate Inquiry examined how to build a local and robust impact investing market.

This resulted in the establishment of three Social Enterprise and Development Investment Funds to provide a supply of social investment funds to this market. While this was a significant step in the development of the market, we observe a rather limited deal flow in Australia. Why is this? Are there enough investor ready social enterprises? Is there enough capacity building in the sector? And if not, how can we build capacity? And importantly, who should pay for it?

Where are the asset owners?

After all, the due diligence on such investments is clearly more complex than a usual investment, and the World Economic Forum report points to the urgent need for intermediaries to connect supply with demand. Where are the asset owners such as superannuation funds in this market? We see early movement from funds such as Christian Super, yet many argue they are prevented due to the sole purpose test (assuming that impact investing means below market returns).

Yet specialist impact investment firms such as Small Giants demonstrate that this is not the case. What about rating and certification agencies in this market? Organisations such as B-Lab certify organisations as B-Corporations, verifying their social and environmental performance, thereby reducing risk for impact investors. We already have several B-Corps certified in Australia and BRW reports that the movement is gaining momentum.

Do we need different legal structures that make it possible for traditional not-for-profits to set up other entities, such as social enterprises, so they can access debt and equity finance? Several efforts are under way to establish new types of legal structures for such hybrids. For example, in the United States, there are forms such as the L3C (Low-Profit Limited Liability Company), the Benefit Corporation and the Flexible Purpose Corporation.

The understanding of impact investing in Australia is growing, yet perhaps slower than other parts of the world that were more significantly exposed to the global financial crisis. However, with the collapse of the automotive industry in Australia, the decline of manufacturing, and the imminent bust of the resources boom, maybe Australian business leaders will more actively rethink ways of doing business that have both financial and social impact, and may well better position us for a slice of the global impact investing market in years to come.