The Dilemma of Social Impact Investment Strategy
Rodney Schmidt, Principal, Intellexys International
rschmidt@intellexys.com
The strategy question
How do we, and how should we, select social impact projects for investment?
This depends, of course, on what we think of social impact. We agree it is framed by the Sustainable Development Goals, but beyond that investors have trouble telling the difference between creating social value and producing social impact. (Attridge and Engen, Blended finance in the poorest countries, 2019:17ff; Daggers, What do you mean?, 2019; Financial Times, Impact investing must resolve its identity crisis, 1 May 2018; Global Steering Group for Impact Investment, Impact Summit 2018 - The power of impact, 2018:2)
Ways to invest in social impact
There are three main modes of investing in social impact, on a spectrum of private-public partnerships: impact investing, blended finance, and social finance. Impact investors invest independently; blended finance commercial investors and public agencies or private philanthropists co-invest; and governments fully back social finance projects.
Common to the three modes is social impact investment strategy – the choosing of projects yielding preferred combinations of financial and social returns. Impact investors choose projects for the double bottom line. In blended finance vehicles the public agency or philanthropic underwriter selects projects for social impact, while the commercial investor requires financial returns from the same projects. The selected projects yield financial returns that may range from low to high, depending on the willingness of the underwriter to contribute concessional finance – to subsidize the commercial investor. Finally, in social finance governments choose high social impact projects that yield low or no financial returns.
The dilemma
The dilemma of social impact investment strategy is that these are not free choices, because project financial and social impact returns interact. The interaction, usually treated in terms of trade-offs (impact investing) or investability (blended finance), is rooted in market failures. Hence the range of private-public investment partnerships. Some parts of social value can be produced by private agents; others can only be provided in the form of public goods. Most goods and services embody mixtures of private (economic and financial) and public (social) value. This is why impact investing is feasible, and why blended finance vehicles deploying concessional capital, with appropriate project selection, do not distort markets.
The OECD expresses the dilemma of social impact investment strategy this way: The 2030 Agenda calls for the most ambitious financing strategy for sustainable development yet, with a dual challenge of mobilizing unprecedented volumes of resources, and leaving no one behind. (OECD, Social impact investment 2019, 2019:26)
Omidyar Network, a high profile impact investor, poses the dilemma as a question: Under what conditions should an investor accept a risk-adjusted below-market return in exchange for an opportunity to achieve social impact? (Bannick, et al., Across the returns continuum, 2017:2)
A corollary of the strategic social impact investing dilemma concerns the nature of social impact itself. Social impact is social value produced outside of markets. And social impact investing is private provision of public goods.
Investment vs impact?
Impact investing, sometimes called SDG investing , and blended finance are usually motivated in terms of the need to raise commercial capital to fill the SDG financing gap, estimated at $2.5 billion annually. Success is normally measured by investment volumes and financial returns. Nearly all impact investors seek market-rate financial returns. (Mudaliar, et al., Annual impact investor survey 2019, 2019:13,33; OECD, Social impact investment 2019, 2019:57) Most blended finance vehicles target large institutional commercial investors that likewise require market-rate financial returns, and try to maximize leverage ratios – mobilized commercial finance to catalytic, often concessional, public or philanthropic finance. (Attridge and Engen, Blended finance in the poorest countries, 2019:11; Blended Finance Taskforce, Who is the private sector?, 2018:7; Development Finance Institution Working Group, Blended concessional finance for private sector projects, 2017)
In impact investing and blended finance there is a general belief that maximizing commercial SDG financing is equivalent to optimizing social impact and the SDGs. (Daggers, What do you mean?, 2019) But that would only be true for social value created within competitive markets where, on the margins of production, financial rates of return equal social rates of return. Where markets fail – and the SDGs and sustainable development itself are most naturally interpreted as comprised partly or mostly of public goods – financial and social rates of return are not equal. Then social impact investment strategy is not the same as commercial investment or portfolio selection strategy.
Social impact investment performance
In practice, nearly all impact and blended finance investments, about 95%, are in hard economic sectors in middle-income countries. (Attridge and Engen, Blended finance in the poorest countries, 2019:12,46-47; Development Finance Institution Working Group, Blended concessional finance for private sector projects, 2017:4; Mudaliar, et al., Annual impact investor survey 2019, 2019:19-20; OECD, Amounts mobilized from the private sector, 2020:4-5; OECD, Making blended finance work for the Sustainable Development Goals, 2018:26-27; OECD and UNCDF, Blended finance in the least developed countries 2019, 2019:11,29; UNECOSOC, Report of the inter-agency task force on financing for development 2019, 2019:87) Particularly, most are directed to renewable energy or microfinance projects. These are by now mature industries that already have been favored with government subsidies.
Such tunnel vision is hardly what we would expect of social impact investment strategy. Impact and blended investing undoubtedly create economic and social value, as does most commercial investing. It is harder to say that impact and blended investing produce social impact or accomplish sustainable development.