Piecing Together Impact Investing, $4 Billion at a Time

Whatever the reason for growth in double bottom line funds, the important point is that we can now have the conversation, thanks to the data. And the data is grounded in the perfectly workable definition of impact investing that we already have at our disposal.
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One of the great myths about impact investing is that the practice is ill-defined and therefore lacks integrity.

In reality, the two clear-cut requirements of an impact investment provide a perfectly sufficient foundation: one, that impact investments are made with the explicit intent to create social and/or environmental benefits in addition to financial returns; and two, that those benefits are quantified.

These are high bars to clear for sure. Intent means that social or environmental purpose (some call it a "theory of change") is baked into the DNA of an investment strategy. Quantifying benefits means that social or environmental impacts are measured and reported, at the very least to clients.

But the difficulty of making a real impact investment should not be confused with the ease of identifying when an investment does in fact make the cut.

Determining intent can be as simple as scanning a fund manager's website, or reading the fine print of an investment mandate or Request for Proposal. And impact investors typically make it known that they prioritize and devote resources to measuring social performance, even if it's harder to tell exactly what proprietary data is being tracked and reported to clients.

In truth, concerns about the opaque definition of impact investing stem primarily from two related factors: first, the diversity of activity that impact investing encompasses, which gives the impression of dilution; and second, the overarching lack of data on this activity.

Diversity is desirable of course, allowing investors to seek impact in many different ways. But scant data makes it difficult to understand how the same high bar of intent and measurement can and should be applied to all impact investments, whether they are in cash, equity, or debt, or focused on any of the major impact investing themes, including community development, clean water, renewable energy, agricultural productivity, access to finance, health care, and education.

The "know it when you see it" burden of proof might have been adequate for true believers. However we need to ensure there is both more, and more organized, information on precisely what impact investing entails for prospective new entrants.

The recently launched, two-year research initiative The Impact Investor is indicative of the effort required. Another exciting development is the Impact Investment Profile Series from the Global Impact Investing Network.

Focusing on one sub-sector of impact investing as an example, InSight at Pacific Community Ventures has just published a white paper on the size and scope of U.S. private equity investing for social benefit. This is where investment funds seek financial returns in addition to explicit social outcomes like quality job creation in underserved markets, management and employee diversity, or the delivery of products and services with community benefits.

The verdict: At $4 billion, and with 69 fund managers (or "General Partners/GPs"), the market represents a fraction of the more than $1 trillion in total private equity investments in the U.S., but is larger than previously reported and expanding rapidly.

The 69 GPs fall into three broad categories:

  1. Thirty "financial first" GPs, which manage $2.1 billion in impact investing strategies (out of total firm-wide assets of $70 billion). Financial first GPs seek social outcomes as a secondary priority and include traditional private equity firms with separate accounts tailored to pension fund economically-targeted investment programs like at the California Public Employees Retirement System and some minority-owned GPs capitalized by pension fund "emerging manager" initiatives;
  2. Fourteen "impact first" GPs, which manage $400 million in impact investing strategies (equal to all firm-wide assets). Impact first GPs seek financial return as a secondary priority and include a number of community development-focused managers, purpose-driven funds aligned with faith-based, charitable and other mission-oriented organizations, and venture philanthropies.
  3. Twenty-five "double bottom line" GPs, which manage $1.5 billion in impact investing strategies (also equal to all firm-wide assets). Double bottom line GPs explicitly describe financial returns and social outcomes as equal in priority and include a maturing group of impact first GPs unwilling to cede ground on financial returns, firms that look completely conventional but invest for a double bottom line across all assets, and a group of new and untested funds created by seasoned private equity professionals moving into impact investing.

The double bottom line category of GPs is especially ripe for additional research. The number of these funds has tripled in the past ten years (from eight to 25). Further, newer double bottom line GPs tend to be larger than older firms, suggesting funders are more convinced that the strategies of recent arrivals can concurrently deliver market-rate financial returns and documented social benefits.

Whatever the reason for growth in double bottom line funds, the important point is that we can now have the conversation, thanks to the data. And the data is grounded in the perfectly workable definition of impact investing that we already have at our disposal.

What remains to be done is not redefining impact investing, but applying the established definition market-wide, revealing the extent to which the activity has become a force to be reckoned with, $4 billion at a time.

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