The Impact Investing Benchmark is a great start towards making the impact investing universe more credible and factual. There have been a lot of anecdotal data points on internal rates of return and fund performance that have been floating around for several years, but the GIIN and Cambridge Associates have taken a very important lead to make sense of this in a more aggregate and rigorous manner. It is my hope that we are able to build upon this start with not only more data, but also the experience of fund managers and others to support the continued growth of the impact investing industry.
Given the newness of the sector and the small sample sizes in the study, conclusions are not the most important part of this report. But one point that caught my attention was the analysis on fund size and performance. Compared to the comparative universe, smaller impact funds ( less than $100 million) have handily outperformed, but as we move to larger impact funds, the same performance differential does not exist. I do not think we have enough data as yet on impact funds that are larger than $100 million (they constitute only 15 out of the 51 funds in the impact universe, but 503 out of 705 in the comparative universe).
Of course a thin data set is to be expected in a new investing strategy. The preponderance of smaller funds can also be explained by the fact that most impact businesses are relatively new and, thus, perhaps incapable of absorbing larger investment sizes. Importantly, this also reflects the “capital gap” we are facing in the impact investing space. As a fund manager focused in India for the past 11 years, I still feel more comfortable raising five distinct $10 million to $15 million impact funds rather than a single $100 million impact fund!
We still have a very small number of institutions that are devoting serious capital to impact investment or have dedicated resources to manage these investments. Yes, the number of limited partners (LPs) making impact investments is growing, but most of these new players (such as family foundations and high net worth individuals) are more comfortable with smaller starting investments in the $2 million to $3 million range. The handful of pension funds and insurance companies willing to make larger investments are the exception rather than the norm.
Is this because general partners in the impact world have evolved faster than LPs and we need more proof before we can expect larger checks? This is quite possible. But it could also be the case that we aren’t doing enough to push the boundaries of impact and are following a rather conservative approach. For example, how many innovations have we really seen in fund structures, a point that has been heavily debated and discussed in impact forums for the past four to five years? How many large LPs are open to moving away from, or willing to modify, conventional fund structures? From our own fundraising experience, I can easily say, “hardly any.”
Innovation should not be limited to how social enterprises operate on the ground. If we want to push the impact agenda, innovation should continue to flow through the value chain. We need to see innovation in the allocation of funds, the structuring of funds, and the incentivization of fund managers. For example, there is still widespread reluctance to experiment with longer tenure funds. The achievement of impact outputs or outcomes is still not a common criterion for carry distribution even though we have come a long way in standardizing impact measurement. Our own sponsor, at Lok Capital, is actually a nonprofit. For us, it was not easy raising the first two funds because we found it tough to convince potential investors that a not-for-profit can manage and run a for-profit fund, even though we thought it was a perfect way to build our own motivations into our structure. More people are getting comfortable with our structure now, but that probably has a lot do with our track record. This is just another example of the industry taking time to embrace new structures.
We hope the development of this benchmark, and its ongoing regular release, will not only bring more investors with bigger pocketbooks into the space, but also help drive the innovation that is so important for the growth of the sector.