Impact Investing: An Alternative to Meeting Social Challenges

The development community has long acknowledged the potential role of the business sector in social and economic development. To complement the efforts of governments and civil society organizations, impact investors have added a business approach to tackling the world’s social challenges, and are driving a revolution that could fundamentally change  how people think about development and investment.

Even before the term impact investing was coined in 2007, the idea gained momentum and attracted the attention of major players across the private sector, civil society, and the public sector. Goldman Sachs and Morgan Stanley  structured and issued bonds worth more than $100 million to provide financing for vaccine campaigns, and microfinance institutions. Philanthropists such as Bill Gates, George Soros, and Pierre Omidyar have also made impact investments with profits reinvested to their foundations. The International Finance Corporation of the World Bank Group has invested in private companies to seek both financial and social return ever since its inception in 1956. The Commonwealth Development Corporation (CDC) of the UK government was also an active impact investor even before the term was created.

According to the Global Impact Investing Network (GIIN), “impact investments are investments made into companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return.” Impact investors and social entrepreneurs have become impatient with the traditional and bifurcated view that investors should only focus on financial returns, and that only philanthropists and civil society should devote themselves to the purpose of creating social good. Impact investors marry profit and purpose by financing profitable businesses that solve social and environmental problems.

Source: The Rockefeller Foundation, J.P. Morgan http://www.rockefellerfoundation.org/uploads/files/2b053b2b-8feb-46ea-adbd-f89068d59785-impact.pdf
Source: The Rockefeller Foundation, J.P. Morgan

Though this seems like an exciting and innovative way to address the world’s ills, two concerns quickly arise. First, how can we be sure impact investing is more than an advertising gimmick, and that it’s actually making a difference? To address this issue, the Rockefeller Foundation, J.P. Morgan, and USAID launched the Impact Reporting and Investment Standards (IRIS) in 2009 to provide a relatively comparable measure of the social performance of impact investments. Businesses that receive impact investment funds must have an intention to create positive social impact incorporated into the business strateg,y which then must be measured to determine the success of the investment. Furthermore, impact investors are supposed to adhere to the principle of additionality- investments should target businesses for which sufficient private capital could not be obtained on reasonable terms. Impact investments should be made in undercapitalized places, or undercapitalized sectors, or in an asset class that is not readily available.

A second concern that arises is how  profitable businesses can intentionally generate a positive social or environmental impact. In practice, impact is usually generated by expanding access to basic services, such as education and housing for the poor, or through production processes that provide job opportunities, or create other forms of benefits to society. While CSOs might create the same impact, profitable businesses help make the impact more sustainable.  CSOs face uncertainty in their funding, but profitable businesses can always turn to retained earnings and therefore are much less reliant on outside finance.

An example of impact investing done right is the story of the pioneering telecommunications company in Africa, Celtel.  In 1998, an experienced Sudanese entrepreneur and engineer named Mohammed Ibrahim encountered a number of difficulties when he planned to build a telecommunications company that targeted Sub-Saharan Africa. Ibrahim had a hard time convincing mainstream investors for start-up capital because investors felt Africa was too unknown and risky, and there was virtually no infrastructure for telecommunications back then. The UK government’s CDC stepped in and provided $22.5 million of private equity in Ibrahim’s company. The CDC subsequently invested three more rounds of capital to help Celtel reach 6 million customers, and generate annual revenue of more than $1 billion. In 2005, Celtel was bought by the Kuwaiti mobile operator MTC for $3.4 billion, and the CDC received a handsome return on its shares.

Access to mobile technology has created enormous opportunities for the poor on the world’s least developed continent. Mobile technology has transformed Africa, and mobile phones have become an essential part of economic life. On a continent where most people do not even have a bank account, mobile banking has enabled millions of Africans to transfer money, pay bills, or even buy electricity with their cell phones.

Impact investing is still in its infancy, and is far from being mainstream. However, it holds the potential to unlock an enormous amount of private capital to meet the world’s pressing social and environmental challenges in a more efficient and sustainable way.

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