ImpactAlpha, March 12 – Impact investors who seek to “do well by doing good” may want to spare a thought for a different type of investor, whose capital is critical to the success of many high-impact enterprises.
Those enterprises, and even entire sectors, could not have developed but for “catalytic capital” from investors who can accept higher risks, lower returns, more flexible terms or longer repayment periods.
Now, three investors who together have put nearly $1 billion toward such catalytic investments are making the case that more foundations, development-finance institutions and wealthy individuals should allocate resources to investments that are sometimes dismissed as concessionary or criticized as subsidies.
The John D. and Catherine T. MacArthur Foundation is committing to invest $150 million in matching funds for investment managers and other intermediaries that can demonstrate the power of catalytic capital. The first $30 million investment, matched by $30 million from the Rockefeller Foundation, will seed investments in Rockefeller’s “Zero Gap” portfolio of innovative financial structures aimed at meeting the Sustainable Development Goals.
The MacArthur and Rockefeller foundations, together with Omidyar Network, are launching the Catalytic Capital Consortium, dubbed C3, to increase the use of such tools.
“There is a lot of unmet need for catalytic capital,” says Debra Schwartz, managing director of MacArthur’s impact investing portfolio. “We want very much to see market-rate capital grow and continue to grow. But we have to recognize that market-rate capital doesn’t work in all circumstances. If we don’t have a healthy commitment to the catalytic piece, we’ll be leaving impact behind.”
The C3 effort is, in part, an attempt to rebalance the discussions surrounding impact investing as the field has moved from its philanthropic origins towards commercial approaches that aim for risk-adjusted market rates of return. Another grouping, Impact Capital Managers, comprised of three-dozen venture capital and private equity, debt and hedge fund managers managing some $8 billion in assets, issued a report last year seeking to prove out the thesis that social impact can deliver higher, not lower, financial returns.
The report accompanying the launch of the Catalytic Capital Consortium, in contrast, shows how concessionary terms can help enterprises generate impact and attract additional investment that would not otherwise be available. “Investors with the willingness and ability to be flexible on risk-return requirements are relatively rare in capital markets today but invaluable for the growth and scaling of impact enterprises and development of new impact industries,” the report says.
The two investment approaches are often simply two sides of the same coin. In “blended finance” structures, for example, catalytic investors may take higher-risk or lower-return positions in the capital stack in order to attract more commercially minded investors into the same deals. Another sign that the two approaches are more complementary than competitive: the “Alpha in Impact” and “Catalytic Capital” reports were both prepared by Tideline, an impact investing consultancy.
The new consortium will try to determine how much catalytic capital is available today and how much is needed to bridge capital gaps, for example, for fulfilling the Sustainable Development Goals. Last year’s annual survey by the Global Impact Investing Network found that only 5%, or $11.4 billion of roughly $228 billion in impact assets under management, targeted such concessionary returns. Yet availability of “appropriate capital across the risk-return spectrum” has long been cited as the biggest market challenge.
At first blush, one foundation investing in another foundation may not appear particularly catalytic. But the $60 million in matched capital from MacArthur and Rockefeller aims to catalyze more than $1 billion in capital targeted at meeting the Sustainable Development Goals, a modest down payment on the estimated $5 trillion to $7 trillion annual gap for financing the SDGs. The collaboration will help launch Rockefeller’s new Impact Investment Management platform and add “program-related investments” to the grants that Rockefeller has so far used to build the Zero-Gap portfolio of 50 promising financial vehicles across 28 countries.
“We must find innovative and catalytic solutions to mobilize private capital to close this widening gap between those with hope and prosperity, and those without,” Rajiv Shah, Rockefeller’s president, said in a statement.
MacArthur is looking to make additional investments this year and has invited proposals for matching capital from investment managers in both emerging and developed markets. Possible areas include forest conservation, sustainable agriculture, inclusive entrepreneurship, education, reproductive health, energy access and refugee finance.
The new report suggests catalytic capital can be deployed at any stage of an enterprise’s development, from seeding to scaling to sustaining. Early-stage capital can help enterprises with uneven cash flows, longer runways to profitability or modest operating margins. By lowering risks or raising returns for other investors, catalytic capital can help enterprises attract commercial capital needed to scale.
“This initiative has the potential to help investors better target catalytic capital to where it can have the greatest impact,” said Mike Kubzansky, managing partner at Omidyar Network.
Catalytic investors are not limited to philanthropic foundations. The $400 million family office Ceniarth, for example, is shifting more than $300 million over the next decade into its “impact-first capital preservation” strategy. “This approach dictates that we lead with impact, sourcing only opportunities that have demonstrable outcomes in underserved communities, while not being bounded by market-rate return expectations,” Ceniarth’s Greg Neichin wrote in ImpactAlpha in January. Ceniarth and Rockefeller were the first investors in CrossBoundary’s $16 million fund to finance solar mini-grids to expand access to energy in Africa.
MacArthur’s signature catalytic investment is its Windows of Opportunity initiative, launched in 2000, which provided nonprofit affordable housing developers with enterprise-level (rather than project-level) financing to enable them to better compete for properties. By MacArthur’s estimates, its investments of more than $150 million over 15 years enabled the nonprofits and supporting funds to attract more than $9 billion in permanent capital and preserve more than 150,000 units of affordable housing.
A recent example is the $40 million investment, effectively a grant, from the Chan Zuckerberg Initiative to seed a $500 million affordable housing fund for the San Francisco Bay area. The slug of concessionary capital will make it possible for the new fund to provide affordable housing developers with lower-cost loans while attracting additional investors with competitive returns.
“It’s a game changer,” Maurice Jones, CEO of LISC, the largest nonprofit community development financial institution in the country and the manager of the new fund, told ImpactAlpha. “We are taking more risk in this fund and we can do so because of the different capital stack we have. We have to take that risk here to get to the results that we want.”
The Catalytic Capital Consortium will have to wrestle with what level of subsidy is required – and appropriate. Omidyar Network and others have cautioned that too much or the wrong kind of subsidy can distort markets, impede competition or prop up unsustainable enterprises. From another direction, critics have become more outspoken about public-sector subsidies for private initiatives, such as Amazon’s now-abandoned plans to build a second headquarters in Long Island City in New York.
“Different institutions have different parameters,” MacArthur’s Schwartz told ImpactAlpha. “We may wish they didn’t have them. But if we want to bring their money to the table, sometimes this is what it takes.”
Disclosure: ImpactAlpha has received sponsorship and other financial support from the Rockefeller and MacArthur foundations, Omidyar Network and Tideline.