Origins of the project
The impressive growth of sustainable, responsible, and impact investing is well-documented, and almost every indicator points to this trend continuing. But is the market ready for that growth? In what ways could the growth of the market outpace its development? What risks or challenges may emerge or become more pronounced over time?
We have already seen examples of the market’s growing pains – most notably in the overheating of the microfinance market in India and the controversial implications of the market’s early IPOs.2 3
These challenges have complex causes and consequences, but with thoughtful, collective effort, there is an opportunity to both address the risks of similar problems before they hinder progress and to capitalize on the opportunity of growing interest in impact investing in a way that can articulate and drive real impact instead of “putting impact in the appendix.”4
As part of its field-building work, Omidyar Network set out to explore one such potential challenge, described in a recent Stanford Social Innovation Review article from Paula Goldman and Lauren Booker Allen:5
“When industry leaders coined the term impact investing eight years ago, they used a ‘big tent’ approach to unite diverse players around a shared purpose. The movement aimed to develop a common language for diverse sets of investors … as well as to attract new capital to the space … This big tent approach has yielded tremendous benefits – as evidenced by all of the recent momentum.”
The article goes on to posit that, in light of the increasing diversity and complexity of impact investing, the market needs to be parsed to define “the tables under the big tent.” Without an improved classification, the market risks increased misunderstanding, inefficiencies, and misalignment that will impede its development.
With Omidyar Network’s support and ongoing input, Tideline created the Navigating Impact Investing project in Fall 2015 to explore the need for enhanced classification in impact investing, with the foundational goal of optimizing the process of matching an investor’s unique risk, return, and impact preferences with the right investment opportunities. The concept of “impact classes” emerged from this work as a way of sorting the impact investment market and is discussed in more detail in later sections.
Over the last six months, Tideline has led a broad research effort designed to be driven by practitioner input and current market practices. The research has included:
• Literature review and desk research – of over 200 sources including from field-level impact investing reports and literature on impact performance and evaluation, SRI and ESG, philanthropy and public sector, and portfolio construction
• Extensive market outreach – including over 1,000 pages of transcripts from 45 expert interviews
• Convening – of over 30 practitioners at SOCAP and two project Advisory Group meetings, culminating in an in-person meeting in February with over 40 participants, hosted by BlackRock in New York
The goal of the research and outreach has been to translate the findings into prospective solutions, including for accelerating the process of matching asset owner and investment manager expectations, helping asset owners deploy capital more efficiently, and setting up the market to aggregate data in a way that allows for more useful in-depth analysis over time.
Assessing market needs
According to recent research from Barclays, investors express significant interest in impact investing (two-thirds of high-net-worth clients report being at least moderately interested) but lack the “knowledge, guidelines, or frameworks” to act on.6 Many established, specialized players are able to successfully manage this confusion, with some seeing a competitive advantage in being able to navigate the field effectively. “The lack of clarity hasn’t been a barrier to us. It gives us an advantage,” one interviewee told Tideline. But the confusion has created real barriers for new investors who want to invest for impact, but find the field difficult to parse (see “Hypothetical consequences of real-world confusion” below).
Less clarity also means less efficiency. Investors and investment managers lament the bespoke, drawn-out effort required to determine which counterparties are aligned on key impact considerations. While the “big tent” approach to describing impact investing has helped “dissolve the age-old thinking that doing good and doing well are separate domains,” it is becoming increasingly difficult to find the right peers and partners.7 “Everyone is speaking the same language but meaning different things,” explained another project interviewee, a point reinforced by J.P. Morgan and GIIN’s 2015 survey of the market: Two-thirds of practitioners agreed the lack of a common way to talk about impact investing remains a key challenge for the field.8
Moreover, the challenge identified as most limiting to the growth of impact investing both in the GIIN’s 2015 survey and again in 2016 is the “lack of appropriate capital across the risk/return spectrum.” J.P. Morgan and GIIN explain: “Several respondents highlighted the wide variety of opportunities in impact investing that cut across the risk-return spectrum, and noted that greater transparency about this diversity would be beneficial to the market as a whole.”9 In particular, the surveys indicated capital for seed, early, and venture-stage enterprises is lacking, as well as “risk-willing capital that would accept higher impact in lieu of higher financial returns.”10 With more visibility into the market, investors will better understand where their capital is most needed and the many different ways to achieve their impact objectives throughout the risk-return spectrum.
In “Parsing Impact Investing’s Big Tent,” Goldman and Booker Allen articulate the same priority, and identify the lack of an accepted taxonomy as a primary root of the challenge: “For one, helping investors better understand the space would accelerate their assessment of where they can ‘play,’ leading to more efficient, optimized capital allocation aligned with varying investor risk, return, and impact expectations.”
The categorization of the market into “financial-first” and “impact-first” investors and “market-rate” and “concessionary” investments (see the box below titled “The financial/impact return tradeoff”) has had the unintended effect of highlighting dichotomies where there actually is a rich spectrum of investments with different interplays between financial and impact return. Many impact investors are not seeking market-rate returns (41 percent are principally targeting below-market rate returns, according to the GIIN’s 2016 Annual Impact Investor Survey11), and many of those targeting market-rate returns are also interested in a better articulation of the difference in the impacts of different investments.
Finally, alignment of motivations and expectations among impact investors and investment managers remains a critical issue for the field. Conflicts often arise when motivations and expectations are different and not clearly understood or articulated.
Building on the role asset classes play in traditional markets, the Navigating Impact Investing project zeroed in on the concept of “impact classes:” a clustering of investments on the basis of their impact characteristics, intended to capture the full breadth of impact investing activity across asset classes, sectors, and public and private markets.
This working paper posits that a limited, agreed set of “classes” could bring tremendous efficiency benefits, particularly when making product selection and portfolio allocation decisions – a perspective validated by early outreach. In a recent survey of 27 leading practitioners introduced to the impact class concept, including members of a dedicated project advisory group (see Appendix for the full list), 76 percent strongly agreed or agreed that impact classes will “help asset owners and advisors filter down the range of impact investing opportunities to find those appropriate for an asset owner’s preferences to aid in individual investment and portfolio allocation decisions.”
There is broader support still for the overarching hypothesis. Eighty-one percent of respondents agreed that “the field of impact investing needs a broadly accepted (and applied) framework for categorizing the many ways in which funds/intermediaries create impact through investment.”
At the highest level, the Navigating Impact Investing project is an exercise in thought leadership. The audience for the work is the impact investing market writ large. However, in the process of attempting to build a real, actionable impact class framework that works for investors across all asset classes, it has become clear that, for some actors in the market, the challenges of allocating capital on the basis of impact are more acute. Those looking to match investor preferences with investment opportunities – namely asset owners and their advisers – have expressed the most interest in and are likely to benefit most directly from the introduction of impact classes, even as efficiency improvements at that level flow to the field as a whole.
Goal of the working paper
This working paper is intended to provide an overview of findings to date from the Navigating Impact Investing project and introduce the impact class concept. Further work is needed to develop the impact class concept into an actionable tool that is ready for broad adoption. This paper is intended to be an intermediate step in the process of arriving at a fully formed framework, providing an opportunity to share the latest thinking on the development of impact classes, to highlight related work from others in the field, and to synthesize the input and feedback received thus far from practitioners.
There are a number of key issues that lie ahead, including further engaging the market to inform and test the design of impact classes, determining the best means for encouraging adoption, and creating related materials for dissemination and education. We welcome the input and engagement of readers.
The financial/impact return tradeoff
The idea of a spectrum between pure financial return and pure social or environmental return has long been at the root of attempts to categorize the impact investing market. While impact investing is situated between traditional finance and philanthropy in these conceptions, in practice, investment managers found themselves being pushed toward one end of the spectrum or the other (toward “impact-first” or “financial-first”), in part because asset owners were generally more accustomed to either investing or philanthropy, and in part because the market lacked the shared language to easily talk about impact and financial return occurring together.
More recent frameworks have been developed that introduce the idea of financial and impact returns occurring in “lockstep,” or attempt to better demonstrate the diversity of the field. In these depictions, impact investing is often placed among a range of related approaches to investing with impact,12 including through responsible and sustainable investing, such as in the Bridges Spectrum of Capital below.
Nonetheless, the stigma of a necessary financial/impact tradeoff persists and has discouraged some practitioners from identifying as impact investors at all. As one practitioner from a development finance institution noted in a project interview: “[The impact investing field] is too broad for us to get comfortable aligning with it without confusion. Our core business is to make good investments that have a positive impact but generate market return. We do not want to be confused with an impact investor who is willing to compromise [on returns].”
Although recent research from Cambridge Associates and the GIIN,13 as well as the Wharton Social Impact Initiative,14 has dispelled the inevitability of the financial/impact tradeoff (by demonstrating that impact investing private equity funds seeking market-rate returns perform competitively), this too has inadvertently reinforced the outdated “impact-first” and “financial-first” dichotomy,15 together with the new shorthand that has arisen in its place, categorizing impact investments as either “market-rate” or “concessionary.”16 In practice, all impact investors – including the 41 percent not seeking market-rate returns according to the 2016 GIIN survey17 – have diverse and complicated financial expectations, which often relate directly to the impact goals being pursued. This implies that a more nuanced understanding of the intersection of impact and financial performance is needed.
2 The Economist (2010). “Discredited: A string of suicides puts microlending under the spotlight.”
3 Consultative Group to Assist the Poor (2007). “CGAP Reflections on the Compartamos Initial Public Offering: A case study on microfinance interest rates and profits.”
4 Quote from Tideline Navigating Impact Investing project interview with an impact investment manager.
5 Goldman, P. and Booker, L. (2015). “Parsing Impact Investing’s Big Tent.” Stanford Social Innovation Review.
6 Barclays (2015). “The Value of Being Human: A Behavioural Framework for Impact Investing and Philanthropy.”
7 Goldman, P. and Booker, L. (2015). “Parsing Impact Investing’s Big Tent.” Stanford Social Innovation Review.
8 J.P. Morgan Social Finance and Global Impact Investing Network (2015). “Eyes on the Horizon, the Impact Investor Survey.”
10 Global Impact Investing Network (2016). “2016 Annual Impact Investor Survey.”
12 Morgan Stanley (2016). “Investing with Impact: Creating economic, social, and environmental value.”
13 Cambridge Associates and the Global Impact Investing Network (2015). “Introducing the Impact Investing Benchmark.”
14 Wharton Social Impact Initiative (2015). “Great Expectations: Mission preservation and financial performance in impact investing.”
15 Fulton, K. and De Bruin, C. (2013). “Let the scaffolding fall.” Monitor Institute.
16 Foley, S. (2015). “Impact investing must be more than a buzzword.” Financial Times.
17 Global Impact Investing Network (2016). “2016 Annual Impact Investor Survey.”