Impact investors face a dilemma of their own making. On one hand, impact investing is now on the agenda of nearly every Chief Investment Officer. On the other hand, the most recent survey by the Global Impact Investment Network found only $114 billion of the $61 trillion of private fund investable assets that are categorized as impact funds.
The problem is that the term “impact investing” has become code for “investments that do not make money.” This despite the the survey by the GIIN that found 66% of impact funds target risk-adjusted market rates of return.
The perception gap represents a Hobson’s choice for venture and private equity investors focused on areas like education, health care, or renewable energy, where policy and market inefficiencies can create opportunities to tackle complex social issues and generate outsized financial returns: Make the impact argument to potential limited partners (the groups that invest in venture and private equity funds), and risk being pigeon-holed into a tiny fraction of capital reserved for impact investments. Make the case on returns only, and lose out on the small pool of limited partners eager to anchor impact funds.
A growing number of limited partners allocate a portion of funds for impact investments. But the concepts of impact investing often get conflated with philanthropy or donative capital. In an ironic twist, “impact” allocations designed to seed funds have the opposite effect: traditional, fiduciary investors frequently view the presence of impact investors as a signal that financial returns will suffer. Investments from foundations or NGOs often signal greater risk or lower returns — deterring the very market rate investors that they hope to draw into impact funds.
Bono (an investor in TPG Growth’s The Rise Fund) explained to the New York Times that impact investing has a stigma that stems from “a lot of bad deals done by good people.”
The lexicon needs to change. Dollars allocated to opportunities that do not create market rate of return should simply be characterized as donative. Managers seeking donative or concessionary capital for speculative theses should stop using the term “impact investment.”
Today’s challenge stems, in part, from the historic role of donative capital in seeding the concept of investing with a purpose. To the extent an investor is seeking a lower rate of financial return for social good, she must clearly state the price of this capital and let the investors decide. For example, an investor loaning money to an inner-city business at 4% instead of a market rate of 10% should clearly note the donative nature underlying the investment.
Impact investments should describe a category held accountable for both social impact and financial returns. We are at an inflection point in a growing number of areas where an impact orientation is fueling better-than-market returns. As Anne Field reported in Forbes, studies show impact funds can and do outperform non-impact funds in certain market segments, such as emerging markets funds or sub-$100 million funds in the U.S.. And investors from the Ford Foundation to The Rise Fund are now focused on creating top-quartile returns in a pro-social way.
As an investment firm focused on college affordability and completion, we pay close attention to the impact of our investments on students. But we don’t call our investments “impact investments.” They’re just investments.
Our portfolio companies are achieving growth because they achieve impact. We pursue metrics that tie student outcomes to economic returns. For example, Galvanize, which helps debt-laden college grads obtain job-ready skills, has among the highest job placement rates in the industry, and recently joined forces with a cross-section of universities to pioneer new quality standards for higher education.
Ponce Health Sciences University, which graduates over 10% of the Hispanic doctors in the U.S., is helping to stem the physician shortage by bringing its first-year pass rate from 68% to almost 90% within three years.
A growing cadre of investors who would not normally define their focus as “impact” realize that financial returns will be driven by investments that also drive social impact. Solving the world’s greatest challenges — from employment to energy — will create above-market returns for funds.
The private-sector capital unleashed by demonstrating that impact equals strong returns would change the face of who gets funded and what businesses people pursue.
The transformation of impact investment into a $15 trillion subset of capital markets hinges on eliminating the false-choice between returns and impact. That starts with a willingness of impact investors to leave the safe confines of donative capital — and show the world that social impact is a great business to invest in.
Daniel Pianko is the co-founder and managing director of University Ventures, a fund reimagining the future of higher education and creating new pathways from education to employment.