Should we strive for a utopia, where mainstream investment recognizes and absorbs ‘social investment’, and becomes the main way the finance needs of frontline organizations are met? Keen observers could be forgiven for thinking that seamless integration of mainstream capital is the sole objective of social investment market development – and the ‘answer’. But while bringing mainstream capital to the social investment market is important, we argue that it’s not the whole story.
The supply side: the investors
Today’s investors have an extraordinarily wide range of options for making an impact. As the illustration below shows, there is a spectrum, at one end of which is traditional foundation orthodoxy, which sees grant funding provided without expectation of repayment. Programme funding is made on terms, but has comparatively few conditions or caveats attached.
At the other end, traditional mainstream investment seeks only financial return; or, put better, while it may not be blind to social impact, it is not explicitly socially motivated nor does it seek an explicit social return in addition to the financial return.
Between, we have what’s come to be known as social investment – a segment of the spectrum which does not have a universally agreed-upon start or end point, but which is unified by the characteristic that it is money that explicitly seeks both social impact and financial return, sometimes (though the idea of a ‘trade-off’ is disputed by some) giving priority to one or the other, but always requiring both.
The demand side: social organizations
But let’s compare the colour and shape of investors’ money to the investment opportunity landscape – the demand side of the market.
The demand side can also be plotted along a spectrum which illustrates the type of demand and the type of organization in terms of investment readiness and capacity to provide a return on investment. The spectrum illustrates the wide range of needs and capabilities. Many organizations require grant/start-up funding, the ‘philanthropic equity’ that is so important to the social sector and to the existence, let alone growth, of most social sector organizations. Some may be start-ups; others may require risk capital to establish a new programme; others will themselves be engaged in purely philanthropic activities which have no source of support other than grant funding.
At the other end of the spectrum are organizations that are not only investment-ready, but have built up an investment track record – demonstrating resilience and an ability to provide a return on investment – most often by servicing and repaying loan finance.
The social organizations
But even among those organizations which have a proven ability to take on and work with investment funding, there will be many whose need is for ‘sympathetic’ investment instruments. This might be investment which is on more patient terms than mainstream funding might offer; or which co-invests beside mainstream investors but which, as it is more risk-accepting, allows the organization to access mainstream finance. Co-investment which is subordinate to other investors would be such an example.
There are many other graphs and diagrams that illustrate this market spectrum. However illustrated, it is helpful to plot the supply side to show the range of capital available against the demand side to demonstrate how social investment capital needs to be shaped to fit those points along the spectrum where a balance of social and financial return can be found.
The mismatch between supply and demand
Such representations of supply and demand can, however, mask a mismatch between the needs and characteristics of the social organizations as investees and the demands and expectations of investors. They can also mask the mismatch in the range and suitability of instruments between the supply and demand side, as well as the volume of capital that is available to invest in organizations and the type of capital that those organizations need. As Big Society Capital reports in its Social Investment Compendium from October 2013, 90 per cent of the UK market as at 2012 was represented by secured lending; while on the social sector organization demand side the need was commonly for small deals that are traditionally rated as low credit quality.
Too much emphasis on mainstream investors?
So, is there too much emphasis on how to bring in mainstream investors rather than on addressing the complexity of the mismatch between supply and demand? As the concept of social investment has developed, there has been a strong focus on what is required to draw in capital from the mainstream markets to grow the sector, on persuading mainstream investors of the case for social investment, and on using instruments familiar to mainstream markets. In fairness, efforts to grow the market have not been exclusively directed towards mainstream capital: the market is also expanding at the other end of the supply spectrum, where there is a focus on the opportunities to bring in foundation capital, with advice and support to foundation trustees on the opportunities represented by social investment.
Focus on both ends of the market is right, to define and refine what we mean by social investment and to draw in appropriate pools of capital to invest with impact. Yet social investment is an immature market. For the market to mature, there is a need to clarify what is and is not social investment, and issues such as whether, and in what circumstances, priority should be given to social or financial return. But there is also a need to address the middle ground with investee-appropriate products.
The need for investee-appropriate products
To date, much discussion and design has focused on bringing, or adapting, mainstream instruments to work in social investment transactions: offering debt and quasi-equity options to social enterprises and charities on the assumption that investee organizations can be made investment-ready with support and advisory services. The focus has been on encouraging traditional investors to consider social investments as part of their wider portfolio.
However, there are well-recognized challenges, centred not so much on the supply of capital as on access and availability of capital to social purpose organizations at the right time and price. Dan Gregory outlines many of the challenges and steps to address market infrastructure in his 2013 report Angels in the Architecture. There remains a real need for new, market-specific products that recognize the particular needs and nature of social investees, and which offer a measurable, comparable and executable product to investors.
We’d go further and say that the need for investee-appropriate instruments is more pressing than the design and replication of products for investors that look and feel like mainstream instruments: market-specific products, once terms become standardized and volume begins to build, should find their place among investors.
The needs of organizations at an early stage of development or which are partly grant-dependent merit particular attention – described as the ‘pioneer gap’ in the Monitor/Acumen Fund report From Blueprint to Scale. Vibrant and innovative product development should equally focus on this part of the market. Because such products will almost certainly be blended products, which require subsidy or philanthropic support, investors are likely to be philanthropic or mission-motivated individuals or foundations. The ultimate ambition has to be for blended products and deal structures to become more normal, not only for foundations but also for retail and even commercial investors – but for the moment, product development for these organizations should not see mainstream investors as the design priority.
Social investment will develop its own mainstream
A call for product innovation is not just a call for new technology. Truly new, innovative products such as the social impact bond, or institutions such as Big Society Capital, are rare. But they are not unique, and we should use our collective ingenuity to develop market-appropriate products which speak exactly to the needs of social organizations and which are effective in supporting their impact, sustainability and growth. Some of the most effective innovation will be made in smaller steps: standardizing terms, simplifying documentation, increasing transparency, reducing transaction costs, pooling expertise in outcome metrics and so on. The UK’s recently announced Social Investment Tax Relief represents a great opportunity to innovate.
Social investment must establish its own concept of mainstream: it is a distinctive segment of the wider market with its own set of norms and expectations. This will offer instruments which range from those which are more attuned to philanthropic needs and objectives to instruments that are indistinguishable from commercial investment, except that social impact is an explicit purpose of such investment. And, most important, we should relish the challenge of unlocking new ways of matching the needs of social purpose organizations with the needs of retail, foundation and mainstream investors.
Jane Newman (above) is international director of Social Finance and Hannah Goldie is a Social Finance analyst.
This article was written in a personal capacity, inspired by a conversation with John Kingston.
Mainstream or not mainstream: is this the right question?
Since impact investing has got the attention even of the G8 summit, debates are multiplying on how to grow this into an asset class and bring it into the ‘mainstream’. The controversy is big, polarized by the two ends of the spectrum: (a) philanthropists fearing that bringing impact investing to scale will deprive it of its soul by subordinating social considerations to risk-adjusted return targets and (b) asset managers seeing in impact investing a spin for investment products that are appealing to an increasingly socially aware investor community.
Mainstream or not mainstream? In asking this question, are we not about to succumb to one of the major bugs that impact investing so vigorously seeks to overcome: the bug in the economic system caused by the perceived purpose of scale?
We are used to arguing that prosperity is a result of growth which is a function of scale. Hence, we should focus on how to scale social sector organizations in order to maximize their social impact – so we argue with the social half of our brain. Or we should look at how to make impact investing accessible to the largest possible community of ‘mainstream’ investors – so we argue with our financial market logic.
Both avenues are likely to fail: scale isn’t necessarily the objective of a social enterprise if its purpose is to provide a lasting solution to a social issue. The most lasting solution to a social issue remains its elimination – which would actually require social enterprises to work towards the erosion of their business basis. On the other hand, scaling the capital available for impact investing without investment opportunities that can absorb it will create the next bubble – and we know the result.
Why can’t we stop reasoning in supply and demand terms and think about what is at the root of impact investing: purpose. A social sector organization is not an end in itself; nor are financial instruments for social impact that don’t fit the needs of social sector organizations as agents for social change. Shouldn’t we finally start designing instruments in response to a need to deliver specific social value – and consider both financial markets and social sector organizations merely as means to achieve it?
So the issue about the ‘mainstream’ or not has relatively little to do with social sector organizations becoming ‘mainstream’ investment targets, or with the question of whether impact investing can become an asset class in its own right. Making social impact investing mainstream rather depends on whether we succeed in making social impact tradable. To date we still reason that social value creation may not be for generating profits. Social value should be provided for free (grant-based models) or at least for no more than its cost (e.g. Yunus’ social business model). However, if we allow social value only to trade at cost rather than for its ‘market value’ for its stakeholders, we implicitly deprive social enterprises of their means to grow – and of their access to non-philanthropic investment capital. Hence, mainstream or not mainstream – that is not the question. Rather we should ask whether we have the guts to price social value to truly integrate it in the economic decision making process. If we do, impact investing will be ‘mainstream’.
Uli Grabenwarter is head of strategic development at European Investment Fund. Email firstname.lastname@example.org