The focus of “traditional” investing is on making money. You put your money to work based on your risk-return preferences and you expect to get it back in the future along with some return. You may employ a diversification strategy that exposes you to different sectors, geographies and asset classes, but the focus is on the returns generated for a given level of risk. It is less about how the money is made (what did the business do with your money, how did it generate its profits), and more about how much money is made, or how well your investments performed relative to their benchmarks.
Impact investing is also about making money, but with a key distinction. With impact investing you invest money in a venture with the intention of making a profit and generating a positive benefit to society or the environment. It is a simple idea at first glance, but what is meant by “positive benefit to society” and how do we measure this benefit? These are some of the questions I will explore in greater detail in this blog.
At the heart of impact investing is the idea that private enterprise, when designed properly, can be an engine of sustainable development and economic growth that can improve the lives of people living in poverty. Impact investors, and the purpose-driven companies they invest in, share a belief that private enterprise can generate profits and solve critical problems faced by people in the developing world.
The types of challenges that these poor people face are easy to identify. The 17 Sustainable Development Goals (or “SDGs”) and their 169 targets are a “road map” for the kinds of positive societal and environmental benefits that impact investing seeks to deliver. The numbers cited in these targets are hard to fathom. For example, over 600 million people around the world lack clean drinking water, and more than 1 billion do not have access to electricity. The traditional response of charity and international aid, delivered by non-governmental organizations, is not a sustainable approach because it depends on the generosity of others. While these efforts can play an important role in humanitarian relief, there is simply not enough donor money available to adequately tackle these problems. The private sector has to be part of the solution.
So if the aim is to achieve a positive benefit on society by addressing these development goals, is it possible to create a purpose-driven company that can deliver positive changes while generating sustainable profits? The short answer is yes. Such companies are often referred to as “social enterprises” and their creators as “social entrepreneurs.”
Some people equate “social” with “socialism,” which contrasts with the notion of private enterprise, so the label is admittedly confusing. However, social enterprises are businesses that are designed with the intention of delivering essential goods and services to people living in poverty in an affordable, scalable and sustainable manner. In this sense, impact investing and social entrepreneurship are two sides of the same coin. By providing capital to social enterprises, impact investors enable these businesses to grow, reach greater numbers customers, and thereby achieve a positive benefit on society.
The term “impact investing” was first coined in 2007, but the concept of making investments in companies that earned a so-called “double bottom line” (a financial and social return) was not new at the time. The idea started to gain mainstream media attention when Muhammad Yunus and Grameen Bank were awarded the Noble Peace Prize in 2006. Grameen Bank was neither the first nor the only successful microfinance institution at the time, but the media coverage it received brought greater awareness of the microfinance business model and the concept of a self-sustaining “social enterprise.” Yunus, a Bangladeshi professor who designed a village-based microcredit scheme in 1976 that ultimately led to the establishment of Grameen Bank in 1983, is arguably the most well-known example of a social entrepreneur.
Early microcredit programs like Grameen employed various methodologies but had in common the delivery of small loans to the working poor with little or no collateral. They defied conventional stereotypes about poor people by demonstrating both their creditworthiness and their ability to pay interest rates that allowed micro-credit companies to cover their costs. These two features permitted early microfinance institutions to achieve long-term sustainability and reach large numbers of clients. Grameen Bank, for example, currently serves over 9 million Bangladeshis with an outstanding loan portfolio of $1.75 billion.
Today, microfinance is a multinational industry that attracts billions of dollars in private capital annually. It is an example of the private sector delivering valuable, affordable services to the working poor in a scalable and profitable manner.
Having introduced the concepts of impact investing and social entrepreneurship, my next blog will take a closer look at how developing countries struggle to deliver essential services and how the private sector steps in to fill the void.
