Knowledge @ Wharton, By Jacob Gray
June 09, 2014
Seven years ago, a group of investors met at the Rockefeller Foundation’s Bellagio Center to discuss what they had learned from a relatively new form of investing. The term “impact investing” emerged from this meeting. Since then, the impact investing industry has grown to attract a range of investors who want to achieve two goals through their investments: financial returns and social or environmental impact. Some impact investors invest directly into social enterprises; others choose to invest in funds or social impact bonds. A range of products has surfaced to meet the demand, and new infrastructure for measuring financial and social impact results have been developed.
In their new book published by Wharton Digital Press, The Power of Impact Investing: Putting Markets to Work for Profit and Global Good co-authors Judith Rodin, president of the Rockefeller Foundation and past president of the University of Pennsylvania, and Margot Brandenburg say that impact investing is no longer only for high-wealth investors. They offer guidance on how any investor can get started with their first impact investment.
In this interview for Knowledge@Wharton, Jacob Gray, senior director of the Wharton Social Impact Initiative, speaks with Rodin about what impact investing is, how it compares to traditional investing and philanthropy and what’s next for the field. Rodin also responds to the naysayers.
An edited transcript of the conversation follows.
Jacob Gray: A lot of people have heard the term “impact investing,” but not everyone knows what it means. Can you sketch out what impact investing is?
Judith Rodin: It’s the intention to produce both a social or environmental and a financial return. It is a conscious investment that looks for a double bottom line.
Gray: In The Power of Impact Investing, you talk about impact investing as existing on a continuum, with traditional grantmaking over here and traditional financial investing over here. Are impact investors people who are coming at this from more of the grantmaking perspective, trying to find new ways to do good? Or are they coming from the traditional finance perspective, trying to make their capital work harder?
Rodin: As the field started to develop, it was people who were investing philanthropically through grants, through family foundations or other kinds of grantmaking and who were looking for ways to develop further flows of capital, where they could use their grantmaking to help bring in another kind of investor, sometimes by de-risking the investment or being that first tier of concessionary financing, and then allowing another investor to come in. They found that that helped to build the field and build that capacity. In fact, the term “impact investing” was developed at the Rockefeller Bellagio Conference Center in 2007, when we convened a group of investors to talk about what they had learned working in the space.
Interestingly, we have been working more recently around the world, rather than just in Europe and North America, and what we are finding is the gateway in Asia, in Latin America and in Africa is from the financial investor who is becoming more socially responsible in his or her own country, who is starting to think, ” I know how to do financial [investments] and maybe I can put that money to work for social purpose.”
Gray: In the book, you cite the example of d.light, the solar technology company, which is a really accessible example of a social impact enterprise; in other words, an enterprise in which impact investors put their money. Can you talk about how that company works and what its social theory of change is?
Rodin: Electricity poverty is one of the root causes of poverty globally. People who have no source of lighting that is reliable tend to use kerosene … or they burn wood, and that is environmentally unsustainable. How do we get either solar or battery light [that allows] people, often in very remote areas of the world, to have access to lighting? D.light started as a very small, almost flashlight model or idea.
We ran a competition for them because they wanted to know if they could scale their technology to light a whole room…. The winner was somebody in China, and they helped d.light to develop the technology to light a room, [which] allowed them to go to scale. Then impact investors started coming in…. That’s one example where there is direct investment into a social enterprise, and that’s wonderful for some impact investors, and we give a lot of those examples in the book. [Direct investors are] people who … really want to engage with the enterprise, and they want to see and feel the outcome of the work.
But not every impact investor is like that. Some impact investors really have very strong views about social purpose, but feel that they don’t have the time or the experience or the energy, frankly, to engage that deeply with the enterprise itself. Just as in the financial-only industry, there are funds for investing in the social enterprises that do the social and financial due diligence. The investors then invest in the funds. Sonen Capital is a very well-known one now, but there are many other great funds….
Gray: I was an impact investor for 14 years before I came to Wharton, and over time, the field has really professionalized and changed. Whereas fund managers, when I started, might have been more like the executive director of a nonprofit, now we’re seeing something different. Can you talk a little bit about the sophistication of the industry now?
Rodin: The reason that is important is twofold. One, the sophistication of the industry is helping it to grow, so we have very experienced people now who are experienced investors doing it. But, it also is a stamp of approval. We’re seeing people leave Goldman or J.P. Morgan or the traditional investment banks and move into this space in really interesting ways. My favorite group is a group that invented the social impact bond, Social Finance.
Those are young folks who went the investment banking route and stayed for about eight or 12 years. Then, with the leadership of Sir Ronald Cohen in the U.K., started Social Finance and invented this amazing impact investment instrument — different from a fund and different from investing in a social enterprise — called social impact bonds. Rockefeller funded bringing it to other places in the world, and we are scaling it in the U.S.
Gray: That’s very exciting…. Can you talk a little bit more about the overall scale? How big of an industry is this? What’s the promise that’s so exciting to the Rockefeller Foundation?
Rodin: Rockefeller became interested in this because when you look at the magnitude of philanthropy around the world, which is enormous and wonderful, and you add to it the magnitude of development assistance that comes from individual countries — such as USAID [United States Agency for International Development], the DFID [Department for International Development] in the U.K. and so many others around the world — it doesn’t get to the trillions of dollars that we are going to need to solve the social and environmental problems. I mean this really broadly because I call crumbling infrastructure in the United States a social problem.
Unless we really catalyze the private sector and private capital, we are not going to solve all of the social problems. When you bring in private capital, you bring market forces to [bear on] philanthropic do-good impulses, and we feel that’s really important. It is wonderful to feel good, it is very important to do good, but it is most important to have impact. It has been a combination, in a very interesting way, of unleashing private capital, but unleashing market-force thinking into this field. It will never replace philanthropy and grantmaking, nor should it.
Philanthropic capital is America’s risk capital, after all. It’s our tax-advantage dollars, so we ought to be doing the most risky pilots if we’re doing concessionary financing. With another group of foundations, we put in a $50 million first tier about 15 years ago for the [Michael] Bloomberg administration to build affordable housing [in New York City]. The commercial banks wouldn’t lend for the acquisition and preconstruction costs, so we guaranteed the banks the first $50 million of risk, and then they put in $350 million, and the affordable housing started to be built. There are so many ways that grants and concessionary financing will always be useful….
We talk in the book about … why the field wasn’t accelerating quickly enough. A lot of [investors said,] “I know how to do the financial due diligence, but I don’t know how to do the social due diligence.” What does social impact look like? How will I measure it? How will I know that I’ve succeeded? We at Rockefeller invested in most of the metrics that are currently being used by the field, the impact rating system and the global impact rating system that rates both the performance of the funds and rates the social impact of the social enterprise.
Gray: I want to get to a question about the critics of this industry. One of the more pithy ones is Marc Andreessen of the venture capital firm Andreessen Horowitz who compared impact investing to a houseboat. He said, “It’s not a great house and not a great boat.” Pithiness aside, is there an inherent tension between the desire to push toward purpose and the push toward profit? Is there any fiduciary duty, risk or pressure that is intentioned here?
Rodin: Yes, there absolutely is a tension, and that’s why I said we never want to stop grantmaking; we never want to stop innovative venture capitalists like Marc and Ben [Horowitz], from being financial-only investors. Marc is a great philanthropist and a friend of mine. He is investing, making a lot of money and then, with his wife, Laura, giving philanthropically. That’s a wonderful thing to do. That’s the traditional model…. But there are lots of people now who really want to be in between, who are willing to take a somewhat lower rate on financial return….
It’s never going to be triple-digit, but there are double-digit impact investing funds. For example, Generation Capital, which is a pool of public equities that do alternative energy, is turning double-digit returns. The Rockefeller endowment has a traditional investment in them.
There is a wide and widening pool of investors who are willing to take fixed income rates in order to have high social return. The impact investment also runs along a continuum. There is financial first with social second, and vice versa. You can sort of mix the pie in whatever way meets both your social purpose and investment goals. People love that.
Rodin: Particularly, perhaps, among the younger generations. I wonder if you also see this. Among Wharton students, we see that impact investing has gone from an oddity to a really highly respected side pursuit, and now to what people see as really a nascent or maybe proto-nascent industry. The students are actually paying attention, like they could actually get a job in this field.
Rodin: Absolutely. We see survey after survey [that reflects that.]… J.P. Morgan and the Global Impact Investors Network (GIIN), which we helped to start, [surveyed] a group of impact investors. Between 2013 and 2014, the amount that was being invested by this group went up 19%, from about $10.6 billion to $12.7 billion or something in that range. Ninety-one percent of them said that they had met their financial objectives and 99% said that their investment had met their social objectives. The development of networks, the development of metrics and sharing data, and more performance data now coming out from older funds, such as those that you worked on and others early in the game, are really bringing more people into the field. Young people are so excited about this. They see the world in need of change, and they want to touch and feel it, and if they can use capital to make that happen in a really constructive way, it’s really attractive.
Gray: As a closing question, what’s next in this field? What is going to be the next big jump or the next lever? Is there a public policy that needs to be built around it?
Rodin: Yes. The next big jump will certainly come through public policy. Right now, ERISA [Employment Retirement Income Security Act] requirements, for example, in the United States and some comparable types of legislation elsewhere, prevent many of the pension funds from taking large positions in impact investing funds, because it doesn’t meet the hurdle of the financial return that they need to [achieve]. At one point, the ERISA requirements were lower, then Congress raised them again about 20 years ago. As this field matures and as government starts to see that it can attract this kind of capital — as the U.K. government saw in the development of the social impact bond, which is really getting a private investor to pay for a public program — then public policy around all of this will change. That will have an absolutely accelerating effect on the field because it will unleash significant amounts of potential capital.
See the video and read the transcript on Knowledge @ Wharton.