Do Impact Investments Need Subsidies?



Impact investors may not be all that interested in jump-starting new ventures that aim to provide vital services to the world’s poorest people after all.

But a new report from Acumen Fund – one of the earliest impact investing funds – and the Monitor Group suggests there is another class of funders who should play that role. They’re called philanthropists. (The report was funded by the Gates Foundation, the world’s largest philanthropy, though the report notes the conclusions “do not necessarily reflect” the foundation’s views.)

The report, “From Blueprint to Scale: The Case for Philanthropy in Impact Investing,” takes on the issue that has been vexing many would-be impact investors: the shortage of investable deals combining significant positive impact on disadvantaged populations and some level of financial return.

The report identifies a “pioneer gap” that is choking the pipeline of potential deals. Unlike angel investing in advanced markets for technology or health care, investments in new ventures for the “bottom of the pyramid” can’t promise outsize returns to outweigh the early risks. Likewise, most such “inclusive” businesses can’t cover the costs of testing and refining their often novel business models, nor pay for the market development needed to create customer demand for new approaches or whole new categories. “This poses a question: how will promising inclusive business models get to these later stages where they become investable without support earlier on in their journey?”

Monitor found that only six of 84 impact funds investing in Africa offered early stage seed capital. Even Acumen, which initially made investments in high-risk early stage ventures, has dramatically changed its approach to focus on later-stage opportunities. Acumen’s investments in “blueprint” stage companies dropped from 64 percent of its portfolio in 2001-2004 to 11 percent in 2009-2011.

Acumen’s new caution is not hard to understand. Its portfolio companies have an average after-tax loss of 20 percent, and even its eight most profitable investments return profits of just 6 percent. Despite its investments to enhance value and manage risk, Acumen merely expects its capital to be returned, “far off the expectations of mainstream financial-first investors,” as the report notes. Monitor’s analysis of 50 inclusive businesses in Africa found net operating margins of between 10 and 15 percent.

“The dirty secret is, I’m not seeing a lot of people making money in this field,” Jacqueline Novogratz, Acumen’s founder and CEO, said at the Global Philanthropy Forum in Washington, D.C., where the report was released. “The real metric is, are we changing lives?”

To mitigate low and volatile returns, the report proposes a strategy it calls “enterprise philanthropy,” in which strategic grants take on the roles of risk capital and market development. The report provides case studies in which such grants have generated impressive social returns, as in the Shell Foundation’s early grants to Husk Power Systems, which is now providing electricity generated from rice husks to 25,000 households in Bihar, India, and the Gates Foundation’s investments in demand-generation in India for drip irrigation systems from Global Easy Water Products. Instructively, it also provides a case study of a failure, in which Acumen’s wrote off its investment in First Microinsurance Agency in Pakistan, which offered polices to cover adverse health events.

The report is likely to fuel the debate about whether impact investing, absent subsidies, can really deliver the social transformation its champions sometimes promise. But it argues that for foundations, enterprise philanthropy that serves to attract private investors can be a high-leverage – and high-impact – strategy.

“Many pioneers will fail,” the report concludes, “but some will succeed and establish, in time, effective market-based models into which billions of dollars of impact capital can be directed to improve the health, education, livelihoods and security of our poorest and most vulnerable communities.”

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