Gail Moss outlines the concept of impact investing and how it relates to mission-based investing, which is often used in the foundation sector
Successful impact investing is a holy grail for any institution whose purpose is to provide benefits for a group of people – the ability to use the investment for the good of the institution’s member or client base, while also achieving a positive financial return. This can be done, for instance, in the form of loans or guarantees, which can then be leveraged by beneficiaries to get further loans from banks.
The concept of socially responsible investing (SRI) is widely understood throughout the pension fund world. But it is not impact investing.
SRI often uses investment screening to exclude companies that do not fit the investor’s ethical values, or to include companies that do. It may also include strategies such as the use of voting rights to influence companies to have a positive social or environmental impact.
Impact investing is more proactive; it directs money into businesses that solve social problems while returning the capital invested, often with an added financial return.
It is commonly employed by many charitable foundations, which supplement their grant-making activities by investing part of their endowment in related social enterprises. This form of alignment between the foundation’s mission and its investment is often known as mission-related investing (MRI).
For the foundation, MRI is a way of furthering its purpose at a time when there are fewer resources on the grant-making side of the balance sheet.
So a foundation set up to give grants to provide, say, education for disadvantaged people may also lend money from its endowment to enterprises working in that area.
“Handing out grants means the foundation makes a 100% loss on the amount it has given, whereas a traditional investment would normally return 100% of capital, plus any interest,” says Melinda Weber, managing partner at Impact in Motion, a Munich-based think tank and promoter of impact investing. “Between these two extremes is a space within which institutions can use a combination of tools to achieve social impact with some sort of financial return.”
MRI is a growing trend in the foundation sector. Many European foundations already invest part of their portfolios in this way, and a study commissioned by the Association of German Foundations showed that 45% of the country’s biggest foundations intend to do so in future.
For those institutional investors that want to achieve impact through investments, there are a number of pooled funds available, including the UK’s Big Issue Social Venture Fund and the Social Venture Fund II UK. The latter is the first social venture capital fund in the UK helping to bring social innovations from Europe to the UK. These include Auticon – a social business employing people with Asperger’s autism as consultants in software testing, for which they have above-average capabilities – and Kinderzentren Kunterbunt, which runs affordable childcare centres. Both these businesses operate in Germany.
Although a prime motive for impact investing is to help specific groups of beneficiaries or society in general, there are also good financial reasons for pension funds to turn to impact investing.
“First, they can integrate ESG [environmental, social and governance] criteria in order to reduce risk over the long term,” says Weber.
Next, she says that with returns from fixed-income investment currently in decline, institutions have to look for new sources of return, so a small allocation to private equity (including venture capital) or debt investments, which are the common asset classes for impact investing, can earn money, and also create a beneficial effect.
“Furthermore, as an alternative asset class, impact investments help to diversify the portfolio,” Weber says. “And small and medium-sized enterprises, which are often the recipients of impact investing, are likely to be uncorrelated with financial markets.”
The State of Social Enterprise Survey 2011, published by Social Enterprise UK and based on over 800 responses from the UK social enterprise sector, shows that these businesses can even be recession-busters.
Despite the recession, 58% of social enterprises had grown over the previous year, compared with 28% of small and medium-sized enterprises (SMEs). They are also outstripping SMEs in business confidence, with 57% of social enterprises predicting growth, in comparison with 41% of SMEs.
They also lead in terms of innovation: 55% of social enterprises had launched a new product or service in the previous year, as opposed to 47% of SMEs.
“The reason why social businesses can perform better and are more stable in economic downturns is that they serve real demand,” says Weber. “They provide products and services that society really needs, such as mobile applications to transfer voice into text for hearing-impaired people instantly.”
Alfred Slager, professor of pension fund management at TiasNimbas Business School, Tilburg University, has started a research project into the relationship between pension funds and impact investing, says pension fund trustees can approach it in three different ways.
“They can take into account the values and preferences of participants by excluding certain investments,” he says. “Or they can consider it from a financial point of view and look for investment opportunities to generate returns. Finally, they can regard themselves as investors taking some responsibility for well-functioning markets.”
There are, of course, risks in impact investing, one being that social enterprises are unlikely to have the track record that an established business will have developed over several years.
But – apart from paying out benefits – pension funds do not have a defined mission in the same sense as foundations.
However, Slager says that a fund’s responsibilities can be defined more broadly. “They should start from the participants’ point of view,” he says. “For instance, if the pension fund is in the health sector, it would make sense if its investments included shares in hospitals or other healthcare enterprises, because that has an impact on the sector it is working in.”
Slager says impact investing also helps the pension scheme itself, because the investments have the same DNA as the scheme members, thus improving inclusivity.
It can also indirectly help the members: “Pension fund investment in its own sector helps the stability of that sector and the participants’ job prospects,” he says.
Impact-investment projects are already being supported by pension funds.
For example, Greater Manchester Pensions Fund (GMPF) and Manchester City Council are working on an investment model for developing mixed housing across the city. Under the pilot, council-owned land will be developed, with a quarter of the 240 homes being sold, while the rest are let. Finance, including the GMPF’s stake, will be channelled through the Greater Manchester Property Ventures Fund.
Similar schemes include the North West Evergreen Fund, which provides capital for regeneration projects in northwest England at competitive commercial rates, and the Foresight Environmental Fund, which invests in waste recycling and renewable energy projects in London. Both of these have pension fund investors.
A recent report from the Smith Institute – Local Authority Pension Funds: Investing for Growth – found that trustees are showing growing interest in, and action towards, developing new and alternative sources of investment.
In spite of this growing interest, impact investing is not an investment for everyone, says Rupert Greenhalgh, the report’s author,
“If your plans are to invest locally, as a local government pension fund, then you have to consider whether there is sufficient scale, performance and diversification in your area for investment,” he says. “Furthermore, investors may see the sector as too complex and time-consuming. For example, where it’s a building project, investors may ask themselves if they want to spend all their time being property managers.”
There can also be other drawbacks to hands-on investing. For instance, a pension fund in the education sector investing in a school might place a trustee on the board of governors, potentially creating a conflict of interest if the investment doesn’t work out.
There should always be stringent financial appraisal of the risk/return equation, with a decision as to whether the fund is prepared, if necessary, to sacrifice potential reward in return for positive impact on the economy.
“Pension funds will only be interested in investments giving good rates of return,” says Greenhalgh. “All investments have to stand up on their own two feet.”
Slager says more accessible financial structures need to be developed if impact investing by pension funds is to increase: “There is interest right now in building roads and bridges in the Netherlands using social enterprise-type funds,” he says. “But, this is treated as an alternative investment, and the environment for alternatives is not great at present.”
“Most pension funds are still waiting for the first movers, the catalysts, to become involved,” says Greenhalgh. “Until you demonstrate impact investments are an investable asset class, it could be difficult to get traction, but there are lots of people interested.”