I would suggest placing all concessionary investments in the proceed with caution category, not because they aren’t likely to be impactful, but because they are likely to be impactful in the wrong way.
Making a concessionary investment runs the not insignificant risk of dangerously distorting markets, especially nascent ones. Markets develop most efficiently when they have discipline, which – for better or worse– profit-seeking investors provide much of the time. Concessionary investors (and philanthropists) can provide discipline, too, but only when they’ve done the careful work of identifying specific market failures and target their grant or concession toward overcoming it (and not provide some actor in the system free subsidy). This catalyzes the market for many more commercial and philanthropic opportunities later on and is how impact investing can provide huge leverage to existing philanthropic budgets. It’s why I’m such a big advocate. There are many, many market failures out there to address.
My fear, though is that as impact investing grows in popularity, the many philanthropists who give their money away sloppily (which is most) will also ‘impact invest’ it sloppily. Whereas the distorting effects of sloppy grants and donations have long been contained to the nonprofit sphere (how many nonprofits are completely ineffective and should no longer exist but thrive on fundraising prowess or funder laziness?), sloppy impact investments risk distorting much larger sectors (clean energy, for example) whose success requires compatibility with disciplined commercial investors.
I can’t overemphasize this risk: Impact investors cannot concede returns whenever they feel like it, even if out of the goodness of their hearts. Otherwise we will build a space in which no serious financial entities will ever want to operate, crowding out high quality entrepreneurs and fund managers for ones who simply tell good stories.
Thank you Paul for the article.
I agree that the impact of the investment itself needs to be taken into account, and as you say that will depend on the capacity of the investee to find those funds from other investors or at other rates. I don’t know if the green-red-yellow labelling system will be feasible, because ‘social impact’ is much more difficult to measure than calories or sugar, but it is worth thinking about it.
Dear Jason, you seem to have quite a faith in “serious financial entities” and “high quality entrepreneurs and fund managers”, and not in “sloppy grants and donations”. Given the performance of the financial markets in the last few years, as well as the highly efficient role of many nonprofits, I would be cautious of letting the impact investing world be ‘swallowed’ by traditional financial markets.
As you say, philanthropists and concessionary investments can play an important catalytic role in this market, but also a role of keeping it true to its original vision - which I understand is fuelling a more social or impact economy as well as changing the way we invest.
Thank you for being such a staunch and lucid advocate for the under-utilized concept of additionality. Root Capital (and I personally) share your concern about the lack of traction around additionality in impact investing.
It is in every impact investor’s interest to avoid inflating expectations of impact beyond what we can demonstrate in the long run. The microfinance industry learned this the hard way. The impact industry now has an opportunity to learn from the microfinance experience by embracing the concept of additionality, finding ways to measure it, and reporting on it publicly. Doing so will distinguish a financial market that has impact from a financial market that is inflated by a bubble of expectations of impact.
The choice facing impact investors is not whether we should ever report on additionality or not. In time, as scrutiny grows, I suspect we will have to. Our choice is between reporting on it now, in a manner and on a timeframe that gives us space to do the job well and helps us to increase our impact in the process, or be forced to do so later, under more strained circumstances, by increasingly skeptical upstream capital providers.
Perhaps the barrier is difficulty of measuring additionality; but it is not so hard to get estimates that are good enough to guide investment decision-making. For instance, another forum in which Root Capital participates, the Council on Smallholder Agricultural Finance (CSAF), is developing a definition of additionality and a standardized set of additionality metrics that are tailored to our particular corner of the impact investing market.
The specifics of additionality will surely vary between providers of debt, early-stage equity, growth equity, and so on, but that should not stop anybody. We can all start small in our respective sub-sectors and build it from the bottom up.
Certainly, there should be room in impact investing for a spectrum of approaches, from high to low additionality and everything in between. No impact investor should try to score cheap points by critiquing another investor’s chosen position on the spectrum. But we should at least recognize the spectrum and make clear our positions on it, and to do that, we need transparent additionality metrics.
Impact investing is in the equivalent of the early primary season of the political election cycle. Our focus should be winning the general election, not beating up the other primary candidates. Pre-competitive collaboration on the topic of additionality is necessary for impact investing to win the general election that is coming in five to ten years, when the world asks us, “So? Did impact investing have an impact?”
Paul, I really enjoyed this article, as this is a matter very close to the heart. I don’t think the market should wriggle off the hook. We can go quite some way to assessing additionality - even by asking very basic questions during the due diligence phase, such as ‘was other funding available?’ or, ‘what would have happened if the funding wasn’t available and so the project didn’t go ahead?’. That would at least be a start when determining social impact, even if measurement is tricky.
Colour coding interesting idea, although in this instance would be very subjective and we’d have to have some kind of framework that would be absolute. Fat and calories can be totted up more easily than social impact!
As the impact investing market advances, we’re grateful for thoughtful engagement about the ways to ensure that impact investing consistently achieves meaningful social and environmental benefit. On the issue of additionality, it’s important to note that this term can have different (sometimes co-mingled) meaning with respect to impact investing. For the purpose of this comment, we are responding specifically to the initial assertion by Paul Brest in this article that additionality requires that “the investment provides the enterprise with capital that would otherwise not be available or that would not be available on as favorable terms.”
GIIN Managing Director Amit Bouri wrote here on the SSIR blog last fall that evidence of additionality may be a useful consideration for impact investors, but that it is not necessarily a pragmatic threshold for determining whether an investor is an impact investor. He elaborated:
“Requiring additionality as a defining criterion [for impact investment] also inherently marginalizes the impact investment market, implying that it will never be robust, with competing investors vying for good deals and bringing with them all the benefits of a healthy investment market. With multiple investors who might be able to make a given investment, the counterfactual to one investor closing a deal may then be that another impact investor makes the investment instead. This would be intrinsic to a well-functioning market, which is necessary to have scale and to provide competitive pricing and liquidity for investors and investees.”
At the GIIN, we look to investor intention and commitment to impact measurement to hold investors and enterprises accountable to their social and environmental goals. Intent and impact measurement, while not perfect, are widely-accepted defining characteristics of impact investing, and also reflect investor commitment to social and environmental good that may be influential throughout the life of an investment, for example through board participation or in the investment exit. Further, our experience does not suggest that superior impact is necessarily derived from concessionary investment capital. Impact and effectiveness depend on a number of factors beyond whether capital is concessionary or not. “Per se” rules should be regarded with skepticism.
Even with a range of opinions, debates such as these are constructive in their pursuit of further understanding about how we can better achieve positive impact through investment. At the GIIN, we are committed to increasing the scale and effectiveness of the impact investing market globally, and we encourage collaborative dialogue to foster this growing field.
Especially since the GIIN is such an important player in the impact investing market, I appreciate Luther Ragin’s engaging in the conversation. But his determination to avoid asking whether an investment actually has impact—that is, whether it increases the outputs of an enterprise, which is the question captured by the concept of “additionality”—ironically undermines the great potential of this emerging field.
First, Luther confuses additionality with concessionary capital. In fact, impact investors can increase the outputs of their investee enterprises while making good market-rate returns (1) by finding investment opportunities that ordinary commercial investors do not notice or mistakenly regard as riskier than they are, and (2) by keeping those enterprises true to their social missions when their investors and boards may be tempted to compromise social benefits for financial gains.
Second (quoting his colleague Amit Bouri), Luther asserts that additionality implies that the impact investing market “will never be robust with competing investors vying for good deals and bringing with them all the benefits of a healthy investment market.” On the contrary, the great promise of impact investing is that concessionary capital is only a phase that investments pass through on the way to normal competitive markets. Once the enterprise is supported by customers and ordinary commercial investors, impact investors can rightly declare success and move on to new impact opportunities. In other words, impact investments are the rockets that get an enterprise or sector into orbit.
Finally, no one would deny that an impact investor was creating additionality just because some other impact investors might fill the gap. But additionality is dubious when an enterprise is fully funded by ordinary commercial investors who have no social goals, and it certainly does not exist in large cap publicly traded markets.
Luther wants to leave the definition of impact to an investor’s good intentions. While this may not be the road to hell, it surely is the road to a prolonged purgatory for impact investing.
COMMENTS
BY Jason Bade
ON October 8, 2014 04:18 PM
I would suggest placing all concessionary investments in the proceed with caution category, not because they aren’t likely to be impactful, but because they are likely to be impactful in the wrong way.
Making a concessionary investment runs the not insignificant risk of dangerously distorting markets, especially nascent ones. Markets develop most efficiently when they have discipline, which – for better or worse– profit-seeking investors provide much of the time. Concessionary investors (and philanthropists) can provide discipline, too, but only when they’ve done the careful work of identifying specific market failures and target their grant or concession toward overcoming it (and not provide some actor in the system free subsidy). This catalyzes the market for many more commercial and philanthropic opportunities later on and is how impact investing can provide huge leverage to existing philanthropic budgets. It’s why I’m such a big advocate. There are many, many market failures out there to address.
My fear, though is that as impact investing grows in popularity, the many philanthropists who give their money away sloppily (which is most) will also ‘impact invest’ it sloppily. Whereas the distorting effects of sloppy grants and donations have long been contained to the nonprofit sphere (how many nonprofits are completely ineffective and should no longer exist but thrive on fundraising prowess or funder laziness?), sloppy impact investments risk distorting much larger sectors (clean energy, for example) whose success requires compatibility with disciplined commercial investors.
I can’t overemphasize this risk: Impact investors cannot concede returns whenever they feel like it, even if out of the goodness of their hearts. Otherwise we will build a space in which no serious financial entities will ever want to operate, crowding out high quality entrepreneurs and fund managers for ones who simply tell good stories.
BY Guillermo
ON October 9, 2014 03:20 PM
Thank you Paul for the article.
I agree that the impact of the investment itself needs to be taken into account, and as you say that will depend on the capacity of the investee to find those funds from other investors or at other rates. I don’t know if the green-red-yellow labelling system will be feasible, because ‘social impact’ is much more difficult to measure than calories or sugar, but it is worth thinking about it.
Dear Jason, you seem to have quite a faith in “serious financial entities” and “high quality entrepreneurs and fund managers”, and not in “sloppy grants and donations”. Given the performance of the financial markets in the last few years, as well as the highly efficient role of many nonprofits, I would be cautious of letting the impact investing world be ‘swallowed’ by traditional financial markets.
As you say, philanthropists and concessionary investments can play an important catalytic role in this market, but also a role of keeping it true to its original vision - which I understand is fuelling a more social or impact economy as well as changing the way we invest.
BY Mike McCreless
ON October 9, 2014 06:40 PM
Dear Paul,
Thank you for being such a staunch and lucid advocate for the under-utilized concept of additionality. Root Capital (and I personally) share your concern about the lack of traction around additionality in impact investing.
It is in every impact investor’s interest to avoid inflating expectations of impact beyond what we can demonstrate in the long run. The microfinance industry learned this the hard way. The impact industry now has an opportunity to learn from the microfinance experience by embracing the concept of additionality, finding ways to measure it, and reporting on it publicly. Doing so will distinguish a financial market that has impact from a financial market that is inflated by a bubble of expectations of impact.
The choice facing impact investors is not whether we should ever report on additionality or not. In time, as scrutiny grows, I suspect we will have to. Our choice is between reporting on it now, in a manner and on a timeframe that gives us space to do the job well and helps us to increase our impact in the process, or be forced to do so later, under more strained circumstances, by increasingly skeptical upstream capital providers.
Perhaps the barrier is difficulty of measuring additionality; but it is not so hard to get estimates that are good enough to guide investment decision-making. For instance, another forum in which Root Capital participates, the Council on Smallholder Agricultural Finance (CSAF), is developing a definition of additionality and a standardized set of additionality metrics that are tailored to our particular corner of the impact investing market.
The specifics of additionality will surely vary between providers of debt, early-stage equity, growth equity, and so on, but that should not stop anybody. We can all start small in our respective sub-sectors and build it from the bottom up.
Certainly, there should be room in impact investing for a spectrum of approaches, from high to low additionality and everything in between. No impact investor should try to score cheap points by critiquing another investor’s chosen position on the spectrum. But we should at least recognize the spectrum and make clear our positions on it, and to do that, we need transparent additionality metrics.
Impact investing is in the equivalent of the early primary season of the political election cycle. Our focus should be winning the general election, not beating up the other primary candidates. Pre-competitive collaboration on the topic of additionality is necessary for impact investing to win the general election that is coming in five to ten years, when the world asks us, “So? Did impact investing have an impact?”
BY Iona Joy
ON October 10, 2014 04:27 AM
Paul, I really enjoyed this article, as this is a matter very close to the heart. I don’t think the market should wriggle off the hook. We can go quite some way to assessing additionality - even by asking very basic questions during the due diligence phase, such as ‘was other funding available?’ or, ‘what would have happened if the funding wasn’t available and so the project didn’t go ahead?’. That would at least be a start when determining social impact, even if measurement is tricky.
My recent report, ‘Smart Money - understanding the impact of social investment’ talks about this a lot. http://www.thinknpc.org/publications/smart-money/
Colour coding interesting idea, although in this instance would be very subjective and we’d have to have some kind of framework that would be absolute. Fat and calories can be totted up more easily than social impact!
BY Luther Ragin, Jr., GIIN
ON October 23, 2014 12:36 PM
As the impact investing market advances, we’re grateful for thoughtful engagement about the ways to ensure that impact investing consistently achieves meaningful social and environmental benefit. On the issue of additionality, it’s important to note that this term can have different (sometimes co-mingled) meaning with respect to impact investing. For the purpose of this comment, we are responding specifically to the initial assertion by Paul Brest in this article that additionality requires that “the investment provides the enterprise with capital that would otherwise not be available or that would not be available on as favorable terms.”
GIIN Managing Director Amit Bouri wrote here on the SSIR blog last fall that evidence of additionality may be a useful consideration for impact investors, but that it is not necessarily a pragmatic threshold for determining whether an investor is an impact investor. He elaborated:
“Requiring additionality as a defining criterion [for impact investment] also inherently marginalizes the impact investment market, implying that it will never be robust, with competing investors vying for good deals and bringing with them all the benefits of a healthy investment market. With multiple investors who might be able to make a given investment, the counterfactual to one investor closing a deal may then be that another impact investor makes the investment instead. This would be intrinsic to a well-functioning market, which is necessary to have scale and to provide competitive pricing and liquidity for investors and investees.”
You can read the full column here:
http://www.ssireview.org/up_for_debate/impact_investing/amit_bouri
At the GIIN, we look to investor intention and commitment to impact measurement to hold investors and enterprises accountable to their social and environmental goals. Intent and impact measurement, while not perfect, are widely-accepted defining characteristics of impact investing, and also reflect investor commitment to social and environmental good that may be influential throughout the life of an investment, for example through board participation or in the investment exit. Further, our experience does not suggest that superior impact is necessarily derived from concessionary investment capital. Impact and effectiveness depend on a number of factors beyond whether capital is concessionary or not. “Per se” rules should be regarded with skepticism.
Even with a range of opinions, debates such as these are constructive in their pursuit of further understanding about how we can better achieve positive impact through investment. At the GIIN, we are committed to increasing the scale and effectiveness of the impact investing market globally, and we encourage collaborative dialogue to foster this growing field.
BY Paul Brest
ON November 10, 2014 01:34 PM
Especially since the GIIN is such an important player in the impact investing market, I appreciate Luther Ragin’s engaging in the conversation. But his determination to avoid asking whether an investment actually has impact—that is, whether it increases the outputs of an enterprise, which is the question captured by the concept of “additionality”—ironically undermines the great potential of this emerging field.
First, Luther confuses additionality with concessionary capital. In fact, impact investors can increase the outputs of their investee enterprises while making good market-rate returns (1) by finding investment opportunities that ordinary commercial investors do not notice or mistakenly regard as riskier than they are, and (2) by keeping those enterprises true to their social missions when their investors and boards may be tempted to compromise social benefits for financial gains.
Second (quoting his colleague Amit Bouri), Luther asserts that additionality implies that the impact investing market “will never be robust with competing investors vying for good deals and bringing with them all the benefits of a healthy investment market.” On the contrary, the great promise of impact investing is that concessionary capital is only a phase that investments pass through on the way to normal competitive markets. Once the enterprise is supported by customers and ordinary commercial investors, impact investors can rightly declare success and move on to new impact opportunities. In other words, impact investments are the rockets that get an enterprise or sector into orbit.
Finally, no one would deny that an impact investor was creating additionality just because some other impact investors might fill the gap. But additionality is dubious when an enterprise is fully funded by ordinary commercial investors who have no social goals, and it certainly does not exist in large cap publicly traded markets.
Luther wants to leave the definition of impact to an investor’s good intentions. While this may not be the road to hell, it surely is the road to a prolonged purgatory for impact investing.