Features | August 29, 2018

Segmenting the market can unlock impact capital

Chris Jurgens and McKenzie Smith
Guest Author

Chris Jurgens

Guest Author

McKenzie Smith

ImpactAlpha’s What’s Next series, produced in partnership with the Global Impact Investing Network, provides a platform for practitioners and experts to reflect on the future of impact investing. The GIIN’s Amit Bouri kicked off the series with a call for the development of a trusted identity for impact investing. What’s next for impact investing? Send your responses to [email protected].

In 1908, the Ford Motor Company’s first Model T rolled off the assembly line. Henry Ford’s introduction of the first mass-produced vehicle transformed the automotive industry 110 years ago this September. In those early days, consumers didn’t have many options. As Ford famously said of the Model T, “you can have whatever color you like, so long as it’s black.”

Today, consumers have hundreds of choices, from low-cost compact sedans to powerful pick-up trucks to high-end hybrid sport-utility vehicles—all customizable with myriad features, and of course, available in the color of your choice.

This array of options can be bewildering for consumers. Over time, the industry has developed a range of tools and standards to help navigate the market for choosing an automobile. Fuel-economy standards help us assess the environmental impact of the vehicle and the cost of owning it. Safety standards and ratings help us assess risk. Specialized intermediaries and online tools are available to help buyers screen vehicles and features based on the factors most important to them.

We urgently need this same sort of market infrastructure for impact investing. We need a set of shared definitions, tools, standards, and data that can enable investors to better navigate an increasingly diverse market. Such tools will help them deploy capital to the investment opportunities that best fit their impact goals, financial return expectations, and risk tolerance.

This is especially critical now that impact investing has transitioned from a nascent market – akin to the Model T era – in which investment opportunities were limited to a few asset classes, impact sectors, and geographies – to one more analogous to today’s automotive industry. From institutional investors integrating ESG considerations, to private equity firms raising large scale impact funds, to community development foundations deploying impact investments to complement their grantmaking, we’ve experienced a rapid expansion of impact investing across public and private markets. These investments are in both developed and emerging economies, and span a full range of social and environmental impact areas.

Market segmentation

As the GIIN argues, this diversity is both a major strength for the industry and a source of confusion. That’s why we think that the GIIN Roadmap’s call to “clarify the roles of various types of capital” is so critical to the future of impact investing, and an essential part of defining the industry’s identity.

At Omidyar Network, we have emphasized market segmentation as a means to improve market navigability and clarify where investors with distinct risk, return, and impact expectations can most effectively play. The industry needs more sophisticated approaches to classify and cluster investments not only by sector, asset class, and risk-return profile – but also by the type of impact sought, and by the ways in which investors contribute to impact.  This would enable new capital to come off the sidelines and more efficiently flow to the market segments it is best equipped to finance.

We envision a future where finding the right impact investing vehicle is as easy as finding the right automotive vehicle. We’re focused on three field-building priorities to help make that possible:

1. Moving beyond the trade-off debate. We need to move beyond the unproductive “impact vs. financial returns” debate that implies an inherent, inverse trade-off between these two dimensions. The reality is that there are many permutations of risk, return, and impact that are possible in different parts of the market.

As an active impact investor for more than a decade, we have seen that it is possible to achieve high levels of impact and risk-adjusted market rate returns at the same time – in certain sectors and markets—but also recognize that other types of impact may require a greater risk-tolerance or flexibility on returns. Building on our work in Across the Returns Continuum, this fall we’ll publish a series of articles in which leading investors discuss their own approaches to managing the interplay of risk, return, and impact. We hope this series helps impact investors old and new acknowledge the many approaches to impact investing across the continuum, and we encourage other investors to continue the conversation by sharing their own strategies.

2. Moving towards a common approach to categorizing and measuring impact. While we already have well-established ways to segment investments by risk and return, the impact investing sector still lacks a common convention for impact measurement and management.

We’ve been proud to support the Impact Management Project (IMP)’s pioneering work to develop “shared fundamentals” for impact management. IMP provides industry actors – from asset owners to intermediaries to entrepreneurs – with:

  • A common vocabulary for defining different types of impact;
  • A nuanced way to describe multiple dimensions of impact; and
  • A framework for categorizing the distinct ways an investor can contribute to the underlying impact of an investment.

Adopting this approach will help investors articulate their impact goals and communicate where they play in the market, and we encourage others to consider how IMP’s insights can inform their own impact management practices.

3. Increasing market transparency. Finally, we need better data on the performance of impact investments – both to inform investor expectations and underpin efforts to segment the market.

We’re encouraged by the development of more evidence on the financial performance of in impact investing, and we see the next frontier as developing data and benchmarks that integrate both financial and impact performance. We applaud the efforts of the Council on Smallholder Agricultural Finance (CSAF), a coalition of leading agricultural lenders that are working together to build a dataset that examines both the financial and impact performance of their collective portfolios. This is enabling transparent benchmarking of agricultural loans and yielding insights on which segments of the market offer commercially viable rates of returns, and which segments require a degree of “smart subsidy” in order to achieve greater reach or depth of impact on smallholder farmers.

We see this as a model to replicate in other segments of the impact investing market in order to drive greater transparency and clarify the roles that different forms of capital can play in order to achieve different types of impact.

Going forward, we invite all impact investors to consider ways that they can help lay the groundwork for a stronger industry identity. With the GIIN Roadmap in hand, we know the way to our destination, but let’s make sure we have the infrastructure in place to ensure we get there in the right vehicles.

Chris Jurgens is the director of impact investing Omidyar Network and McKenzie Smith is a program manager at the firm.