Impact Investing in the United States

The idea behind impact investing is that it generates measurable, beneficial social or environmental impacts alongside financial returns.

A report from J.P. Morgan and the Global Impact Investing Network (GIIN) of 125 major fund managers, foundations, and development finance institutions found $46 billion in impact investments under management, a nearly 20 percent increase from the prior year (see below).

Intersection with International Development

Differences between Foreign Direct Investment, Development Aid, and Impact Investing

Foreign Direct Investment (FDI), Official Development Assistance (ODA), and Impact Investment are all mechanisms that promote international economic development. However, there are important differences between these three mechanisms that international development policymakers and practitioners should understand and take into account when designing and implementing development initiatives.

Official Development Assistance (ODA):

The source of ODA are the governments of industrialized nations
The objective is to support development initiatives in poor and emerging countries, fund basic needs such as education, health and security, and contribute to long term economic development and the eradication of poverty
Takes the form of money and technical assistance. According to the Organization for Economic Co-operation and Development (OECD), ODA must be concessional in character and convey a grant element of at least 25 percent. [1]

Foreign Direct Investment (FDI):

The source of FDI are private companies from developed countries
The objective of FDI is to profit from the growth opportunities, natural resources, new markets, and low production costs that developing countries offer
Takes the form of capital, infrastructure development, human resources, and skill transfers. “The investing company may make its overseas investment in a number of ways—either by setting up a subsidiary or associate company in a foreign country, by acquiring shares of an overseas company, or through a merger or joint venture” [2]

Impact Investing:

The source of impact investment funds includes commercial banks, individual investors, entrepreneurs, non-profits, foundations, governments, corporations, and development finance institutions.
The objective of impact investing is to generate financial returns as well as positive social impact on a broad range of socioeconomic sectors including energy, healthcare, housing, water, etc. International impact investments tend to flow to regions that attract more ODA but less FDI. [3]
Takes the form of loans or equity to finance high impact businesses. Early stage social enterprises also benefit from grants, seed capital, and technical assistance from foundations, philanthropists, governments, and development finance institutions.

Potential Challenges in International Impact Investing

Establishing effective cross-sector partnerships

Across sectors there are different types of actors including governments, development agencies, private companies, NGOs, foundations, and banks— all with different structures, policies, and incentives. Subjectivity in investors’ goals creates challenges for collaborating and deciding what is most important to invest in. [4]

Governance problems

Investors must navigate policies of local governments. There may be uncertainties around property rights or contracts, for example, that require local expertise that is hard for investors to find.

Risk tolerance of investment firms

Different institutions have different levels of risk tolerance. Risk is generally higher when working in emerging markets. Risks may include: political instability, economic instability, corruption, natural disasters, and conflict.

Working in informal markets

At the base of the economic pyramid there are either no functioning markets or very informal markets with informal workforces. To attain success, it is crucial for investors to understand these environments.

Measuring impact

Measuring impact is particularly difficult in emerging markets.

Private Foundation Impact Investing Regulations

In April 2016, the US Treasury Department and IRS finalized regulations that make it easier for private foundations to make Program-Related Investments (PRIs), which are investments – such as loans, loan guarantees, or equity investments – made primarily to accomplish a foundation’s charitable purposes, and not to generate financial returns. Program-Related Investments are one example of such a financing tool that is not a grant, nor just an investment, but is in some ways like both. Some private foundations have a long history of using Program-Related Investments to make charitable investments that are intended to produce significant charitable returns, but generally negligible financial returns. A private foundation’s Program-Related Investments count towards the annual distribution that the foundation must make each year and receive other tax-favored treatment. Therefore, Program-Related Investments have typically been treated as a part of a foundation’s grantmaking budget.

The Program-Related Investments regulations, proposed in 2012 and finalized today, provide nine new examples illustrating how a foundation can use Program-Related Investments to advance its charitable purpose. Many foundations have had misperceptions of the rules governing Program-Related Investments and many believed that expensive processes, such as specific IRS approvals or legal opinions, were necessary to safely use this tool. The new regulations, which closely follow the proposed regulations, illustrate the wide range of investments that might qualify as Program-Related Investments, including those accomplishing a variety of charitable purposes and utilizing a variety of financial arrangements. Thus, today’s guidance reassures foundations that a wide range of investments can qualify as Program-Related Investments and reduces the perceived need for legal counsel or IRS rulings in many cases.

Beyond Program-Related Investments, some private foundations are making prudent investments for both charitable purposes and financial returns. As these mission-related investment practices gained popularity, philanthropy and impact investing leaders questioned whether it was permissible to make an investment for both a charitable purpose and financial gain through the foundation’s investment portfolio (rather than its grantmaking budget, as is generally the case for Program-Related Investments). Some indicated to the Administration that there was a need to provide clarity on this type of “double bottom line” investing.

In the fall of 2015, Treasury and the IRS issued guidance clarifying that private foundations could make prudent mission-related investments. This new guidance assures private foundation leaders and investment managers that it is possible to make a prudent investment that advances the foundation’s charitable purpose, even if the investment offers a lower rate of return, higher risk, or lower liquidity than alternative investments that do not further charitable purposes. Specifically, the guidance provides that when deciding how to invest the foundation’s assets, a foundation manager can factor in how the anticipated charitable outcomes from the investment might further the foundation’s mission in addition to the financial returns that are typically considered. Thus, a foundation may prudently choose to make investments that provide both a charitable and a financial return without fear of facing a tax penalty.

These two actions by Treasury should remove confusion and signal to the field that a foundation can use its financial assets in a variety of ways to accomplish its mission. With increased comfort about using a variety of prudent financial tools, private foundations can continue to help create safe communities, strengthen schools, and achieve other charitable goals that make our country a place where everyone has the opportunity to succeed.

Selection of Impact Publications:

Investing for Social & Environmental Impact – Monitor Institute : The Monitor Institute’s 2009 report describes the emergence of the impact investment industry and provides key definitions that have helped guide the industry’s development over the past several years.
Spotlight on the Market: The Impact Investor Survey – J.P. Morgan Social Finance & The GIIN JP Morgan and The GIIN have been conducting surveys of the impact investment industry for the past several years. The May 2014 survey provides the latest information about market trends, industry performance and deal flow, among other topics.
Private Capital, Public Good – National Advisory Board on Impact Investing In June 2013, the G8 established an international Social Investment Task Force to identify ways government, business and philanthropy can help develop the impact market. The U.S. National Advisory Board, which report to the task force, recently issued a report that looks specifically at measures that can be taken in the United States.
From the Margin to the Mainstream – World Economic Forum: The World Economic Forum has published several reports on the state of the impact market and the best practices of the impact investing industry. This report focuses on ways impact investing can achieve scale and attract “mainstream” capital.

Selection of Impact Organizations:

B Lab: SBA has signed a Strategic Alliance Memorandum with B Lab, in an effort to build interest in impact investing and social entrepreneurship. B Lab is a non-profit organization that “serves a global movement of entrepreneurs using the power of business to solve social and environmental problems.”
The Global Impact Investing Network (the GIIIN): The Global Impact Investing Network (the GIIN) is a “not-for-profit organization dedicated to increasing the scale and effectiveness of impact investing.” The GIIN makes available a variety of resources, including research on impact investing, a database of impact investment funds called ImpactBase and a membership list that includes many of the most prominent actors in the field.
Rockefeller Foundation: The Rockefeller Foundation has been a major supporter of the impact investment industry since it first gained prominence in 2008. The foundation provides a variety of resources and reports on its website.
Mission Investors Exchange (MIE): Mission Investors Exchange is a membership organization for philanthropic investors, such as foundation. The MIE website has “an extensive library of reports, guides, articles, research, case studies, stories from the field, investment policy templates, and conference and webinar archives.”
INSIGHT at Pacific Community Ventures: INSIGHT is the research arm of Pacific Community Ventures, a California-based community development organization. INSIGHT is “a thought leadership practice that provides non-financial performance evaluation and policy research services to people trying to solve social problems through business.”
Initiative for Responsible Investment at Harvard University (IRI): The Initiative for Responsible Investment “promotes the development of theory and practice of responsible investment through research, dialogue and action. The IRI works across asset classes to build communities of practice around innovative responsible investment strategies and catalyze new opportunities and concepts in responsible investment.”

Resources

Notes

oecd.org (2013). Official development assistance—definition and coverage.
investopedia.com (2013). Foreign Direct Investment—FDI.
Simon, John and Julia Barmeier. More than Money: Impact Investing for Development. Center for Global Development. 2009.
Born, Kelly and Paul Brest. Unpacking the Impact in Impact Investing. Stanford Social Innovation Review. 201

Impact Investing