The basic tenet of Brest and Born’s article is spot-on—return-only investing is unlikely to create the kind of incremental social return most impact investors would expect. The article also correctly points out that few non-grant impact funders are willing to invest significant time and resources in measuring social impact beyond the most basic level. Indeed, measuring true financial and social returns is fraught with difficulties, as is striking the right balance between them. For all the brave efforts to build infrastructure for such measurements and tradeoffs, little exists that is both meaningful and practical—especially in more challenging locations and sectors.
The article is wise in citing microfinance, which provides lessons both good and bad for impact investing. On the positive side, microfinance has done a great job of combining up-front capacity building with patient capital, and it does lots of social good from a financially sound and scalable basis. But microfinance also highlights the peril of letting hype run ahead of substance. There are lessons to be learned from a mismatch between the objectives of the management and the return expectations of investors. Meanwhile, interest in and resources for impact investing are increasing, often with unrealistic expectations about targeted financial returns, social impact, and sector and investor classes being reached.
This all could seem like a “perfect storm”—lots of interest and resources welling up around impact investing, combined with a shortage of investment-ready deals and methods—which is further complicated by mixed sources of funding and the sense that tradeoffs should be made between return and social impact. There are few practical ways for investors to measure, compare, or judge the returns and tradeoffs, and even fewer methods outlining how to combine the elements needed to produce positive results. (The elements include business advisory services, patient investment capital, business knowledge, and connections, among others.)
Before we despair, there are a few reasons for hope. First, there may not actually be much tradeoff—indications suggest that the returns on many “normal” private equity funds have been considerably less than presumed. When we are working from this standard, if impact funds can make high-single-digit or low-double-digit returns, this will likely not represent much of a loss compared to return-only investing.
Second, the traditional philosophical aversion to mixing grant money with for-profit capital is wearing down. Blending runs risks, but it also holds promise for tiered capital structures, using mostly—if not entirely—commercial structures. Problems arise mainly when subsidies are denied or hidden. The industry would do better to be fully transparent about financial returns and social impact, which would help those within the industry and beyond to recognize that subsidies are essential to compensate for market failures, and not just in underdeveloped markets.
The article correctly raises the need for business advisory services (BAS) in helping to build strong enterprises. This dual approach is gaining momentum as a number of BAS facilities are placed alongside impact investing funds—a healthy admission of the shortage of high impact, investment-ready deals. Those hoping to succeed in impact investing in tough emerging markets will need to cultivate and develop the enterprises far more intensely than return-only investing would allow. Yet there are scant methods for delivering, tracking, and measuring the practical BAS impacts.
At Grassroots Business Fund (GBF), we are wrestling with many of these same issues. GBF works to select investments that bring important social benefits to large numbers of the poor, but do so in a financially sustainable way. To pursue this mandate, we have chosen a dual structure: a for-profit (but socially minded) fund that handles the investments and a nonprofit that does capacity building (BAS) during a limited period for the fund’s investees. This capacity building is a vital part of GBF’s model and enables the business success and social impact of our investments.
We’ve decided on radical transparency for our financial returns and social impacts. We hope such transparency will continue to make us and our clients better and will help the field draw from our experience. When framing and delivering our technical assistance (BAS) and when measuring our social impact, we try to bring to our work solid investment practices and considerable experience investing in tough markets. Above all else, GBF is committed to keeping our rhetoric in line with our accomplishments, our metrics simple and practical, always carrying a benefit to the investee, and reporting our returns and lessons learned beyond our stakeholders.