This article is part of “Investing in Racial Equity,” an ImpactAlpha series in partnership with Living Cities that explores how foundations and financial institutions can deploy capital to close racial wealth gaps and create opportunities in America’s cities.
ImpactAlpha, April 25 – Race-neutral efforts to boost economic opportunity have failed. Going forward, organizations across sectors must deliberately incorporate a racial lens into their economic security efforts.
That’s the biggest lesson from Living Cities’ 10 years of impact investing. We have been making impact investments for a decade through two structured debt funds, the Catalyst Fund and Blended Catalyst Fund, that total approximately $80 million from third-party investors.
After 33 transactions and $57 million deployed, we have seen first-hand that impact investing has the potential to drive measurable outcomes for low-income people in America. We have also learned about what does and does not work, and pivoted our investment approach accordingly.
Apply a racial lens. Build a local ecosystem. Invest in people. Work together. Take risks. Lessons from our experience may help inform the growing number of foundations and financial institutions using capital for social change:
1. A race-neutral approach to promoting economic opportunity does not work
Wide and extremely damaging wealth and income gaps between blacks and Hispanics, and whites, have persisted for generations. Race-neutral efforts have failed. Going forward, organizations across sectors must deliberately incorporate a racial lens into their economic security efforts.
Living Cities’ Blended Catalyst Fund has recently focused its investment approach on closing racial wealth gaps by supporting the creation of jobs, income and wealth for low-income people of color in U.S. cities.
The fund recently invested in the Propeller Social Venture Fund, an up-to $2 million fund in New Orleans that lends to early stage entrepreneurs of color who have trouble accessing credit through more traditional means. Businesses run by people of color are more likely to employ people of color and to support the creation of wealth for entrepreneurs of color. The Propeller Social Venture Fund allows the Blended Catalyst Fund to support the creation of jobs for people of color.
In addition to providing capital, the Propeller Social Venture Fund provides technical assistance to its borrowers. That reduces risk by increasing the likelihood they will be able to grow their businesses and repay debt.
2. Location, location, location
A robust ecosystem enhances the likelihood of a deal’s success. In Detroit, we learned that capable players that are well-nested in their collective community vision are key to driving big results.
Detroit was part of Living Cities’ Integration Initiative. The initiative was first launched in 2011 to test whether integrating public sector leadership, collective impact and capital innovation to “open-source” social change would lead to better results for low-income people, faster.
In those early years, we learned that places need to have the appropriate ecosystems in place to deliver social change capital at scale. We studied the “capital absorption” challenge and identified a few capacities places need to realize their vision for economic justice in their community: local partners, the right resources, and a cohesive strategic plan.
3. People matter
Management teams and co-investors can make or break a deal. Partnering with effective teams of highly skilled and complementary people mitigates many impact investing risks.
Whenever we diligence a new investment opportunity, we carefully vet management teams to ensure they have sound judgment, a commitment to impact and a track record of generating positive financial returns.
The general partners for our venture capital funds repeatedly emphasize the importance of management teams for their portfolio companies. The companies are often at such an early stage that there is little other information. They look for teams led by mature CEOs who have a track record of growing businesses, building teams, strategic capital-raising and exits for investors. They look for CEOs who have previously failed and learned from their mistakes.
We also vet our co-investors, to ensure we share similar objectives and philosophies around impact. We need our co-investors to be good partners, particularly if our governance and/ or our decision-making rights are intertwined.
4. Collaboration is required to create transformative change
As the proverb says, if you want to go fast, go alone. If you want to go far, go together.
Collaboration is required to drive the systems-level change we need. Unfortunately it is also hard, expensive, and time-consuming, with differences in legal restrictions, organization and program-level priorities, risk-return profiles and language.
Living Cities’ first impact investing debt fund, the Catalyst Fund, pooled $38 million in capital from 10 investors to test and scale promising practices to improve the lives of low-income people in U.S. cities. Living Cities spent almost two years raising the Catalyst Fund.
Four of the Catalyst Fund investors – including the Kresge Foundation, Dignity Health, and AARP Foundation, and McKnight Foundation – were either entirely new to impact investing or very early in the work. Testing and learning together helped accelerate adoption. The investors’ board members were reassured that tools of capitalism could advance their foundation’s mission – a more radical idea at the time.
5. Impact requires intentionality and measurement
Find the right borrowers for your social-impact desire and theory of change.
If your goal is to support second-chance employers, brownie-maker Greyston Bakery, with its focus on workforce development, could be an eligible borrower. If your focus is on improving health, Greyston Bakery is less likely to fit.
When closing a new deal, ask borrowers to define specific social metrics. Set targets against those metrics throughout the life of the loan. Then, regularly track performance. Impact data can prompt discussions with borrowers about what is not working financially or programmatically.
Attempt to understand the data in the broader context of outcomes-level change. Consider the broader impact of a job on a person’s life. This intentionality will help ensure that borrowers and investors have a mutual understanding of the intended social and financial outcomes.
6. Innovation comes with risk (and failure)
Risk is inherent when exploring new financial models for social good.
Living Cities’ early investments in “pay for success” transactions were experimental in design and have yielded mixed results. Living Cities’ first pay-for-success investment was in 2013. Since then, we have made 9 pay-for-success related investments.
The Denver Supportive Housing Social Impact Bond Initiative is an $8.6 million project that scales the services of two local non-profits to provide intensive wrap-around services to 250 chronically homeless individuals who are “high utilizers” of court, jail, detox and emergency room services.
Program participants are placed into permanent affordable housing developed with the project, with supportive services. The city of Denver is making two separate outcomes payments: the first around housing stability and the second based on a reduction in the number of jail days. The Blended Catalyst Fund invested in the “jail days-reduction” tranche.
The payments for the separate outcomes are not codependent. But there is an assumption that individuals who spend more time in housing are less likely to spend more time in jail. The first 18 months of the project provides promising evidence that the program is meeting or exceeding its housing stability goals, according to the first evaluation of housing stability outcomes published in October 2017. Participants are getting housing and staying housed.
It is too early to draw conclusions, but preliminary analysis of jail stays among early participants who were housed also shows that the approach is working.
Other pay-for-success transactions Living Cities has invested in have yielded mixed financial and programmatic results. The pay-for-success field is still emerging. Issues like correlation and co-dependency of outcomes that trigger repayment, appropriate types of evaluation, financial structure, policy changes, governance and disclosure, are still being resolved.
Despite the risks, we were interested in the potential of pay-for-success: the innovative financing structures; cross-sector collaboration between private investors, non-profit organizations and government; data collection and evaluation; increased accountability for results; and the potential for scaling social solutions that work. Catalyst Fund investors have supported the pay-for-success transactions, knowing the funds had a mandate around innovation and had been structured to absorb certain amounts of financial loss.
Living Cities has a mandate around transparency. Our impact investing strategy focused on racial equity will yield new lessons that we will share. We also support and applaud our co-investors and other organizations and individuals who are applying a racial equity lens to their work.
Brinda Ganguly is the Managing Director of the Catalyst Loan Funds, Living Cities.
Brian R. Nagendra is Assistant Director of the Catalyst Funds, Living Cities.