With increasing regularity, I hear people talking about a new concept: deploying funds to earn profit while at the same time solving complex social and environmental problems, also known as impact investing. One article that stood out for me, and in fact prompted me to write this, is “Good Investments” by Dan Morrell in the Harvard Business School Alumni Bulletin. At one point the author writes: “What impact investing really needs, all agree, are pioneers.”
Impact investing advocates can sometimes give the impression that they have “outsmarted poverty” (and other societal problems) by discovering the need for this profit-making approach, one that allows high net worth individuals to further increase their assets while also having (in the words of another impact investor quoted in the HBS article) a “fabulous social impact.”
Count me as someone who does not feel that what “impact investing” needs now are “pioneers” per se. Rather, it needs pragmatic, risk-taking, deeply curious, and disciplined people with access to funding who can work collaboratively to move an old idea forward, bearing in mind the lessons of the past and the opportunities of the present.
In fact, the actual pioneers of impact investing began laying the groundwork for this latest incarnation decades ago. Think of the Ford Foundation’s work in the 1960s to establish, legitimize, and get U.S. government policy support for Program Related Investments, the “Philanthropy at Five [Percent]” movement in nineteenth century America and England, the Russell Sage Foundation’s financing of low-income housing in New York in the early 1900s, or, in more recent times, the Calvert Foundation, just to name a few.
Or simply consider the modern microfinance industry and how an ecosystem of financing mechanisms – including dozens of “microfinance investment vehicles” (MIVs) – grew up around it in the 1990s and 2000s. Even today, according to an important study by the Global Impact Investing Network (GIIN) and JPMorgan Social Finance, close to 40 percent of impact investments are in microfinance institutions (MFIs) or funds. Microfinance is the largest single sector for receiving impact investments, and is larger than its two closest competitors combined. Clearly there are strong linkages between microfinance and impact investing, and additional opportunities for sharing lessons.
It is important to remember that few if any social innovations besides microfinance have proven capable of reaching large scale and generating consistent profits – which should give people pause before they create a new impact investing “bubble.” Hopefully it will also prompt some new curiosity about what microfinance got right, and why.
It may seem uncharitable to find fault with a historical thinking among some advocates and practitioners of impact investing. Indeed, those involved in the field generally have noble intentions and some will end up making significant impact. The real danger in my mind is not failing to acknowledge earlier contributors, but rather in failing to learn from and apply their hard-earned lessons.
So here are six lessons that I take primarily out of my experience in microfinance during the last few decades.
- Carefully manage expectations
During the mid-2000s, a small but influential number of microfinance investors and practitioners began to claim that eye-poppingly high returns and high social impact were possible and in fact, should be expected. This drove a kind of informal “bidding war” with microfinance practitioners and funds feeling that they needed to keep pace with claims related to impact and financial returns in order to compete for attention and funding. Irrational exuberance took hold, and those of us who argued for restraint and realism were dismissed, at least for a time. (Perhaps people like me should have argued with more conviction.) This dynamic hastened and made more painful the inevitable reckoning, and contributed to the backlash among a handful of governments and media outlets that began in late 2010 and that has only recently began to subside. Impact investing would do well to temper expectations related to investment pipelines and financial returns, and avoid falling into the trap of creating the expectation that most future deals will be as financially lucrative as the most profitable.
- Be rigorous with the social (or impact) bottom line, and don’t confuse outputs with outcomes
Up until recently, many microfinance practitioners and advocates, myself included, under-invested in monitoring and evaluation. Tools like the Progress out of Poverty Index, the Multi-Dimensional Poverty Index, and the Universal Standards for Social Performance Management were available (the latter only in draft form until 2012), but were often forsaken in the rush to reach scale and increase profitability quickly. Instead, the lazy practice of conflating outputs – such as the number of loans disbursed or savings accounts opened – with outcomes (e.g., clients crossing the poverty line) and impact (e.g., clients crossing the poverty line compared to a control group of non-clients) became common. (In general, one should only equate outputs, which are essentially means to an end, with outcomes, which represent the end itself, if there is a deep evidence base – as in the case of vaccinations and improved public health – that the output consistently leads to better outcomes across multiple contexts.) This lack of rigor magnified the doubts about microfinance and prolonged the crises in several key markets. The IRIS standards developed by the GIIN and its allies represent a step in the right direction, but there is a way to go to make this framework both meaningful and widely used. I believe the risk of substituting outputs or even less rigorous measures of the social bottom line for outcome-oriented results is a significant one for the impact investing community.
- Don’t ignore the socio-political context in the emerging markets receiving impact investments from abroad
While the idea of wealthy people making money while (hopefully) helping to solve societal problems plays well in London, New York, and San Francisco, it can be very controversial in some emerging markets such as India, where Gandhian asceticism still influences the debate about the ethical boundaries of doing business with the poor. In 2010, the CEO of the Indian MFI SKS publicly embraced the idea of earning substantial profits (and getting personally rich) through providing loans to the poor. This position, widely reported in the press at the time, emboldened critics and contributed to the Indian government and civil society losing faith in microfinance for a number of years. This in turn ended up harming the entire sector and millions of the clients they had served. Greater modesty, humility, discretion, and honest acknowledgment of trade-offs (more on the latter below) would have served everyone better.
Bearing this in mind, impact investing should avoid triumphalist rhetoric that could embarrass local governments and NGOs with a mandate to address the issue that the investee is tackling (e.g., poverty), which could stoke resentment and attacks. Said another way, there will always be people ready to accuse impact investors and the executives at impact investees of greed, exploitation, and hypocrisy. At the risk of saying the obvious, it is wise to avoid giving them much material to work with.
- Avoid antagonizing adjacent industries
Microfinance practitioners and advocates, myself included, could have done a better job at building bridges with other humanitarian sectors (such as health care, water and sanitation, and refugee aid) so the people serving in these complementary areas did not feel threatened that their funding would dry up due to the attractiveness of microfinance, including its promise of paying for itself and returning profit to lenders and investors – promises that other sectors did not feel they could match due to inherent factors. I believe that the hostility that grew during the 1990s and 2000s from these communities harmed microfinance. Potential allies became skeptics, if not antagonists. In this context, I like the language on the GIIN’s website that distinguishes impact investing from grant-making, while acknowledging the value of each when done well.
- Acknowledge trade-offs
I believe that in general, there are real trade-offs between maximizing social impact and maximizing financial returns in microfinance. For a time, microfinance leaders expressed doubt this was true and belief that maximizing them both was possible. This led to a lot of wishful thinking and too little rigorous debate about how to make these trade-offs, whether at the level of managing the operations of an individual MFI or developing a balanced portfolio of MFI investees.
So I was concerned when I read in the GIIN/JPMorgan report that 60 percent of impact investors answered no to the question “Generally speaking, do you think a trade-off between financial returns and impact is necessary when making impact investments?” My answer: In general, of course there is! So the fact that 60 percent thought otherwise is concerning. (On the other hand, I was pleased to see that 40 percent did acknowledge trade-offs.)
Attracting investors who do not appreciate the trade-offs can lead to a wave of disinvestments later on. Such capital flight can in turn be destabilizing to a sector trying to manage at least two bottom lines, if not three. Grameen Foundation’s MOTIV scoring tool is one of several that rigorously score financial and social returns within a context of acknowledging trade-offs. Tools like this should be in wider use as a way of realistically evaluating investments and educating investors about trade-offs and other critical issues.
- Don’t forget the importance of local finance
Tapping into foreign sources of debt and equity capital for growth can be valuable for a social enterprise like an MFI, in part because it confers prestige and cache. But there are risks. While most foreign investors in social enterprises are well-intentioned, as a group they tend to follow fads and be a bit capricious. More important, foreign investors are easy to pillory in the local press as profit-extracting neo-colonialists. For these and other reasons, I believe it is dangerous to rely on these sources of capital and, as a result, under-invest in developing local sources of finance. In general, local sources tend to be more stable during times of crisis, and are also more politically palatable in some markets (especially when it involves equity and when the investors are earning substantial returns).
Over-reliance on foreign debt, which sometimes comes with significant foreign exchange risk, played a role in many MFIs delaying the hard but necessary work of mobilizing deposits and developing relationships with local wholesale lenders and investors. This reality is one of the reasons Grameen Foundation worked so hard, with support from the Bill and Melinda Gates Foundation, at helping three trend-setting MFIs develop robust savings offerings in the late 2000s, and it is why we set up a $31 million loan guarantee program in 2006 that was used to catalyze more than $225 million in local currency transactions benefiting qualified MFIs.
One potential area that U.S.-based impact investors could focus on is cultivating their peers in countries such as India, Brazil, South Africa, and China. They could emerge as the equivalents of the local banks that came to play such an important role in financing portfolio growth of MFIs around the world.
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One of the reasons that Social Entrepreneurship: What Everyone Needs to Know and Due Diligence: An Impertinent Inquiry Into Microfinance are two of my favorite recent books is that they do a great job of putting their subjects – social entrepreneurship and microfinance, respectively – into historical perspective. Both of these movements, it turns out, have origins that go back centuries.
In fact, when you take a historical view, impact investing is getting some important things right. It is gradually developing its own ecosystem, standards, models, consulting firms, media following, and loose network of constructive skeptics. (The Omidyar Network published an excellent paper on the evolution of this ecosystem titled “Priming the Pump.”) In this way as well, impact investing is following in the footsteps of the microfinance movement, as the latter built its own ecosystem and set standards in the 1990s and 2000s (though was late in addressing the issue of consumer protection, which it has belatedly though effectively addressed recently).
One especially useful article that could benefit the impact investing community was written by Susan Davis and Vinod Khosla analyzing the track record of the Microcredit Summit Campaign during its first decade. (The promising start and strong commitment to learning demonstrated by the impact investing fund Khosla Impact may reflect, at least in part, the fact that the man behind it thought long and hard about relevant past efforts.) Jed Emerson and Anthony Bugg-Levin’s book Impact Investing is also a balanced treatment that recognizes past efforts, going as far back as the Quakers in the 1600s.
In fact, consciously or not, some of the leading impact investors are already building on the achievements of microfinance by, in the words of Mark Straub of Khosla Impact, trying to address “the challenges of building last mile distribution, the ways of developing processes to automate and scale, [and incorporating] the notions of social collateral and trust which allowed microfinance to work.”
When I was considering writing this article, I asked my mentor Wayne Silby, an early leader in social investing, whether it was a good idea. Initially, he discouraged me from writing anything that might be considered critical about all the excitement about impact investing. “The Buddhist in me doesn’t mind who wants to take credit” for helping lay the groundwork for social or impact investing, he wrote. In general, he was excited about all the energy around this latest wave of social investing, and in particular hoped that young people would get more involved. But when I brought up the point about thinking historically potentially leading to better decisions by a new generation of socially-minded investors, he encouraged me to write it.
So let us forge ahead, aggressively using the new brand of “impact investing” if it helps bring in new resources, people and ideas. But as we do so, let’s acknowledge earlier incarnations and leaders and also draw from what they learned, so that we can humbly contribute to addressing some of the world’s pressing problems in the most effective ways possible.
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