Impact Investing: How does it make a difference?

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1 Impact Investing: How does it make a difference?

2 Impact Investing: How does it make a difference? Guide 1 1. Unlocking capital at scale for businesses delivering social impact: Impact investing, put simply, is an investment approach that intentionally seeks to create both financial return and positive social or environmental impact that is actively measured, according to the World Economic Forum. Impact investing is not new, but the sector has been gaining increasing significance and scale over the last few years. At the last World Economic Forum meeting of business, government and civil society leaders at Davos, there was much talk about how the sector can become mainstream and what governments can do to support this growth globally. The view that the world of finance needs to be accountable for the positive social and environmental impact it creates through its investments is ground breaking, but also necessary, particularly post the 2008 credit crisis. There has always been a niche of investors who have sought to find a way to achieve both a social and financial return, but shifting opinions mean that the concept is now swiftly moving to the mainstream. During the economic boom years, many investors became consumed by the thrill of short-term s gains forgetting the potential longer-term impact, but then the economic crisis of 2008 happened. Nations became bankrupt, governments introduced austerity measures and unemployment rocketed -particularly among the young, posing the question: what good is investing purely for a financial return if it leaves the world in a less stable place to live in? Finance is starting to come through from governments, particularly in the UK, through Social Impact Bonds (SIBs), which are helping to draw in more professional investors on a bigger scale. That should lend credibility to impact investing and in turn help unlock capital on a larger scale and should lead to social impact on a grander scale. And mainstream finance have also been showing great initiatives. Late in 2013 Threadneedle Investments and Big Issue Invest formed a social investment partnership to launch the first daily liquid, FCA registered diversified Social Bond Fund to the UK market with the intention of achieving a positive social outcome by investing in fixed income securities of organisations which support socially beneficial activities and economic development. The fund is targeting an annual gross return in line with that of a UK corporate bond index such as the Merrill Lynch Non Gilt index, which is currently yielding about 4 percent. The fund launched with 10m of seed investment from the UK government s social investment bank Big Society Capital, and 5m in seed capital from Threadneedle, providing the bond with a firm and sustainable investment platform from which it can begin to make an impact both socially and financially. The minimum investment in the bond is 2,000 for both retail and institutional investors. 2. Bringing impact investment to the masses The more capital businesses have to finance their social projects, the greater impact they can have socially, so it is imperative that investors get used to the idea of impact investing as a way to deliver a credible financial and social return simultaneously. Impact investment intends to answer that question. By investing with the intent to create both a positive social impact and financial return investors can have the best of both worlds. The message to politicians, organisations and individual investors appears to be finally getting through. Impact Investing is beginning to provide better cash flow and financial capacity, which is helping to develop the track records necessary for social ventures to take on mainstream investment to increase their positive impact on society. Impact Investment is no longer confined to philanthropists and venture capitalists. If the impact investment market is to continue to grow then increasing awareness is a crucial factor in how large and influential this market can be. The UK has been among the leading lights in building a global social impact investment community. The British government created Big Society Capital - the first institution of its kind in the world. It hosted the G8 Social Impact Investment Forum - the first to use the G8 platform to discuss social impact investment in June 2013, and it was involved in setting up a Social Impact investment Taskforce which, in tandem with a group of development

3 finance institutions, is focusing on social impact investment and international development. The Social Stock Exchange which connects publicly-listed social impact businesses with investors was launched by the UK Prime Minister during the G8 Forum and has become a key component of the impact investing infrastructure. Where once philanthropic grants were almost the sole funding for organisations intending to make a possitive impact there are now many more avenues that charities and businesses can explore.. Alongside traditional grants and mainly government issued Social Impact Bonds, growing numbers of foundations are now providing different forms of repayable finance to social enterprises and charities. These have enabled organisations to tackle poverty and disadvantage, strengthen communities, create jobs and drive growth on a grander scale. While the involvement of governments and large foundations will certainly help lend credibility to impact investing, to truly unlock the door to the large scale capital needed to deliver profound social impact, a common investment framework must be created. Development of best practice must also be implemented, both in governmental policy and more broadly, to gain the trust of the broader investment community. That is what the guardians of impact investment are trying to achieve and where Socially Responsible Investing (SRI) has struggled in the past. To help standardize measuring and reporting, the Global Impact Investing Network (GIIN) has created Impact Reporting and Investing Standards (IRIS), a catalogue of generally accepted performance metrics. In other parts of the sector, the SROI Network (Social Return on Investment) is also contributing to industry best practise, as is GIIRS (Global Impact Investing Rating System). In creating an investment framework and implementing best practice rules, impact investing will have the credibility required to be adopted by investors on a much bigger scale, opening the door to potentially huge sums of investment. According to a recent report by JP Morgan, Impact Investors have committed $9 billion in 2013, with a predicted market opportunity of between $400 and $650 billion by Addressing key social and environmental issues: which businesses Once investors realise the huge potential impact investing has in terms of intended social and environmental impact and potential financial returns, this will unlock a huge amount of untapped capital. This will in turn increase financial returns and make an even greater positive impact on society. Impact investment already covers a broad range of businesses, in areas such as affordable housing and property, community services, employment and training, financial inclusion, health and social care, transport and communications, and utilities and the environment. Causes that funds can target include areas such as biodiversity, ecology and ecosystems, eco-tourism, education, pollution reduction, green- and clean-tech, climate change, poverty alleviation, recycling, renewable energy, social finance and financial exclusion, sustainable forestry and farming, sustainable transport, waste reduction and water. Investors may have a personal connection with a particular issue and seek to direct investment where it most counts for them. Providing the investment is intended to make a social or environmental impact, there are a growing number of investment vehicles available across asset classes, to include fixed income, public equities, real estate, infrastructure, investment funds, debt and exchange traded funds. 4. Delivering financial returns alongside social impact: how it s done There are two key features of impact investing. The first is the intent of the investor to generate a measurable social and/or environmental impact through investments this is what differentiates impact investing from much broader Socially Responsible Investing (SRI). The second is to generate an appropriate measurable financial return on the money that has been invested - this is what differentiates impact investing from a purely philanthropic pursuit. Investors don't typically have to give up part of their financial return to compensate for having an impact.

4 For instance, Golden Lane Housing 2013 Bonds provides the finance the charity needs to provide housing to people with a learning disability. It has so far provided 1,208 people with a learning disability with secure accommodation. Last year Golden Lane Housing increased the number of tenancies for people with a learning disability by 116, an increase of 8 percent on 2011/12. Golden Lane s bond pays a fixed rate of 4 percent interest a year over the five year fixed term, well above current interest rates on savings accounts at high street banks. Investors should hold investees accountable for both financial returns and social impact in making impact investments. It is important that investors define their objectives: assessing risk and financial returns versus the potential social and environmental impact against those the investor can match his/her expectations and decide whether the investment is appropriate for them. For instance Clean Drinking Water, an India-based impact investing fund manager, started investing in microfinance institutions more than ten years ago. After delivering 14 percent returns to investors the fund manager decided to raise a second fund, which invested in a company that sets up water purification plants in rural villages. The plants are owned by the local community and operated by the installation company, which sells the purified water to the village at affordable rates. The installation company also trains local entrepreneurs to develop businesses that deliver water to neighbouring villages. For many years SRI has been tainted by the common misconception that it was difficult to make a decent financial return for the risk involved, but as the Clean Drinking Water fund has proved, impact investing can deliver above market rate returns. A study by US investment bank JP Morgan found that the expected returns of many existing social impact investments in emerging markets are up to as much as 25 per cent, while in developed markets there are return expectations of up to 20 per cent. Figures published at the 2014 World Economic Forum in Davos showed that 79 percent of money managers running impact funds believe they can deliver an at market return for investors. Having said this, financial returns from impact investments can vary just like any other investment: from return of principal to above-market rates of return. 5. Available products Investors fresh to the impact investing world might be surprised to learn that just like in more traditional investment markets, impact investors have vast swathe of investment products to utilise. They can make their investments through traditional routes such as listed or unlisted funds or funds-of-funds like those offered by asset managers like Clean Energy Access a 150 million euro European private equity fund, which invests between EUR 2-10 million in companies that provide clean electricity to rural communities in developing countries with limited access to energy. Investments can also be made into listed securities such as equities. APR Energy, for instance, provides short-term power solutions to markets that would otherwise have to go without. There is a close correlation between economic growth and demand for electricity so the absence of reliable supplies places a substantial headwind on growth and development. APR Energy is one of Morgan Stanley s 14 focus stocks for Social and Environmental benefits. Details of listed and unlisted business which might be considered as an impact investment can be found on websites provided by organisations such as the Social Stock Exchange and the RBS Social Enterprise 100 (SE100), which are opening up impact investing to retail investors, as well as making it more attractive to mainstream investment. Although in its embryonic stages, a debt market also exists for impact investing. Investors can purchase Social Impact Bonds (SIBs), which are usually issued by governments although investment banks such as US giant Goldman Sachs have begun writing them too. SIBs, also known as pay-for-performance contracts, can be used to funnel private capital into social services providing economic solutions to social problems. Investors pay the up-front costs of the intermediary, with the expectation that the government/enterprise will pay back investors out of savings accrued from the program s success. Private equity vehicles and venture capital, which were originally at the heart of socially responsible investing, are still very much a favourite for impact investors. According to a survey by JP Morgan in conjunction with the Global Impact Investing Network, 83 percent of a select group of impact investors said that they had used private equity

5 funds, while the same survey also noted 66 percent of respondents used private debt and 44 percent used equity-like debt, an asset class that typically offers more flexibility than straight equities in terms of both liquidity and tenor. Commingling funds, such as the Threadneedle UK Social Bond fund also serve as innovative forms of partnership among previously isolated capital providers and they can multiply the impact of capital while preserving their contributors interests. Together with a plethora of investing options, investors can also choose the degree to which they are actively involved ranging from passive investments to more active, direct investments. Longer-term, the availability of traditional financial structures will attract more investment capital and support further market growth. 6. Examples of impact investments There are many examples of how an investor can put their money to work, targeting areas from affordable housing and property, to utilities and the environment and much more in between. Social Impact Bonds (SIBs) allow government to put money into the black holes of public service, or they can appoint a commercial 3rd party to deliver the service. They run it on a commercial footing, delivering the impact yet providing a return to the investors who have committed the capital to make it all work. Rather than focusing on inputs (e.g. number of doctors) or outputs (e.g. number of operations), SIBs are based on achieving social outcomes (e.g. improved health). on offer from impacting investing and SIBs. Goldman Sachs recently launched two such bonds - one targeting the reduction of reoffending among teenagers at New York s Rikers Island jail, and the other intended to help children from low-income families in Utah prepare for kindergarten. The success of the bonds are being monitored by other large investment banks, such as JPMorgan, which are actively investigating the huge potential on offer within impact investing. For investors looking for a more traditional approach to impact investing via established equity markets there are plenty of options. For these types of companies, and those not listed on official stock exchanges, to be recognised as potential candidates for impact investments they need awareness to be raised by organisations such as the Social Stock Exchange and Ethex. They are helping to promote companies working to provide a measurable social and environmental impact and a financial return. Veolia Environment and Sonova are just two such examples of listed equities that could be deemed suitable for an impact investment portfolio and the financial return can be measured through the companies share price performance and dividends paid. Sonova s business addresses hearing impairment, which in turn helps speech development, social integration, and mental fatigue associated with hearing loss. Veolia s operations help ensure access to clean drinking water by managing water and waste water services for both local authorities and industries. It is also leading the transition from landfill to recycling and helping to improve its clients energy efficiency. The first SIB, the Peterborough Social Impact Bond, was set up in the UK in 2010 to fund work with 3,000 male, short-sentence prisoners leaving Peterborough prison to provide intensive support to prisoners and their families, help them resettle into the community and prevent reoffending therefore driving down the costs of running prisons and reducing potential unemployment. Since the Peterborough Social Impact Bond, 30 million has been dedicated to the Department for work and pensions Innovation Fund in 2011 and 600 million of capital was committed to Big Society Capital in Investment banks are only just waking up to the potential ImpactBase provides a similar service to that of the Social Stock Exchange and Ethex but for impact investment funds such as Low-income Housing, a private equity fund based in Brazil which targets the delivery of market-rate financial returns and social benefits to rural communities in South America. It has attracted a range of different investors from large financial institutions to private family offices, development organizations, and large-scale foundations. The fund has made an investment of $4 million to a provider of affordable homes designed for low-income families in rural settings, focusing particularly in areas affected by natural disaster.

6 The breadth of investments on offer should help drive interest in impact investing. A survey by the ethical bank Triodos found that as many as 3 million investors across the UK could consider social investment within the next year and could double each year for the next three to four years. The outlook for the sector is definitely on the upswing!

7 References 1 - Perspectives on progress: The Impact Investor Survey, JP Morgan, G8 Social Impact Investment Forum: Outputs and Agreed Actions, Cabinet Office, Investing with Impact in the Public Equity markets, Morgan Stanley, Growing the Social Investment Market, Cabinet Office website, Social Impact Bonds, Cabinet Office website, 2013