While the recent report of the G8 Social Impact Investment Task Force has the potential to advance the field of impact investing, it subverts this goal by virtually omitting the key factor of “investment impact”: whether an investment has the potential to improve the social, environmental, or health outcomes of an investee enterprise. Just because an investee is doing great things doesn’t mean that your investment will help it do more or better.
The G8 report cites very optimistic predictions about the growth of impact investments. But the danger of ignoring investment impact, sometimes termed “additionality,” is that the sector will appear to grow through the self-delusion of investors without actually increasing its social impact.
The G8 had several working groups. The Impact Measurement Working Group extensively analyzed the important question of whether the investee enterprise itself has impact. But a particular investment can only have impact if it increases the quantity or quality of an enterprise’s social outputs—for example, more disadvantaged students receiving better educations. And this requires that either: 1) the investment provides the enterprise with capital that would otherwise not be available or that would not be available on as favorable terms, or 2) the investors or their agents provide significant non-financial benefits to the enterprise, such as technical assistance or keeping the investee true to its social mission.
The social impact of investments can be arrayed on a spectrum ranging from very high to negligible. Concessionary investments—investments that expect below risk-adjusted returns—lie at the high end. Because ordinary commercial investors are not willing to sacrifice returns, concessionary investments are likely to increase the output of an enterprise that is capital-constrained.
Investments in large cap, publicly traded companies lie at the low impact end of the spectrum. To take just one example, while telecommunications companies create enormous social benefits, it is the nature of public markets that my buying stock in AT&T—even many millions of shares—will not extend service to a single new mobile phone user. My dollars go to another investor, not to the company.
There’s a large middle area, mainly populated by venture capital and private equity where, because of information asymmetries, non-concessionary investments may increase enterprises’ social outputs. Whether or not impact investors can make a difference—whether they create additionality—depends in large measure on whether or not commercial investors are adequately capitalizing the enterprises. For example, a savvy impact fund manager may scope out a combination of financial and social opportunities that other managers regard as too risky, thus providing its investors with good financial returns as well as impact. And, again, the investors may play a role in protecting the enterprise’s social mission.
An impact investor whose investment provides additionality is like a driver who has his foot on the gas and is actually making the car move toward its destination. An investor who does not provide additionality is like a child playing with a plastic toy dashboard which, as the ad says, “creates realistic driving fun.”
Additionality is not a novel concept. Indeed, it plays a central role in the value-added analysis of Bridges Ventures, a highly regarded pioneer impact investing firm. Bridges’ Impact Report explains: “Our additionality analysis asks whether our target outcomes will occur anyway, without our investment. In this sense, additionality defines our impact, allowing us to tell our investors whether their funds are creating societal value.”
Yet the main G8 document does not say a word about investment impact or additionality. The Impact Measurement Working Group’s report refers briefly to the concept in a few obscure lines at the end of its 32-page report. Although the minimal representation of public equities in the Asset Allocation Working Group’s pro forma impact portfolio is a sign of its appreciation of the issue, it too is silent on the subject.
Why does the report ignore or relegate to a dark corner such a fundamental concept? Based on communications with some of the G8 report writers and others in the field, the main concern seems to be that the concept will confuse and discourage potential impact investors. One of the Measurement Working Group members wrote to me saying, “there was collective feedback that each investor should decide whether to give weight to additionality for himself/herself.” But one might say exactly the same thing about assessing the enterprise’s impact, to which the entire Measurement Working Group’s report is devoted.
While the Impact Measurement Working Group states that investors should have the tools to ascertain additionality, it makes no effort to suggest what those might be. But actually, it is easier to estimate the additionality of investments than the impact of the enterprises themselves. So in an effort to stimulate the development of such tools, here’s a proposal that banks, impact investment fund managers, wealth managers, and intermediaries in the field such as the Global Impact Investing Network (GIIN) could readily adopt. It is quite similar to Bridges’ high-medium-low scoring of additionality in the report mentioned above.
Because quantitative indicators of nutrition—such as calories, fat, and salt—confuse most consumers, some food stores and cafeterias use a simple traffic-light labeling system: green for healthy, red for unhealthy, and yellow for in-between.
Players in the impact investing system could label their investment products along similar lines.
- Green for concessionary investments and for non-concessionary investments that self-evidently provide funds to undercapitalized enterprises, or where the investor provides unique and significant non-financial benefits. (Even here, some concessionary investments might be market-distorting, so a degree of caution is always warranted.)
- Red for most investments in public markets, and for investments in enterprises that are equally attractive to ordinary commercial investors—except where impact investors use shareholder activism to press the firms toward impact-driven strategies.
- Yellow for the large realm in-between. As with actual traffic lights, yellow means “proceed with caution.” If the investee enterprise is attracting lots of commercial capital, then an investment will likely produce little or no impact. But if the investment will meaningfully reduce the cost of capital to the enterprise (or provide non-monetary benefits that will increase its impact), the investor can proceed with some confidence.
Whether or not such an approach is the best way to provide investors with the tools to measure their impact remains to be seen. In the realm of food, the traffic light system is not attractive to vendors who profit from selling unhealthy junk products, and many consumers ignore the traffic lights, wanting to believe that foods they like are healthy notwithstanding the signal. As applied to impact investing, the system may encounter similar resistance from some banks, wealth managers, and fund managers, and from investors themselves, for whom questions of actual impact may reduce the warm glow of doing a good deed. But these problems will abide the day.
The G8 group has completed its work and disbanded. But given the GIIN’s commitment to increasing the effectiveness of impact investing, that organization would seem ideally suited to carry forward such an exploration.