NexThought Monday: Expanding the Universe of Impact Investing: How international NGOs can access investor capital to increase their impact on a large scale
Craft microbrews. Vintage craft cocktails. Obscure single-origin coffees and teas. Kale. These items drum up excitement among small and sometimes overlapping communities. But by and large they are just small segments of larger product categories that each appeal to a larger universe of consumers.
If you consider impact investing as an investment category, you might say it’s only recently begun to move beyond the craft stage of product variety.
Impact investments started out as mostly start-up or early-stage investments in small but promising companies that aim for a measurable social impact on their target markets. Sometimes they’ve been market-return, and sometimes they’ve been concessionary-return investments. Green bonds have been a promising expansion in the product category, as well as some of the growth private equity funds now making the rounds in Africa, South Asia and other underserved places.
But what is next? How diverse can the product category of impact investing become?
My (Manuel) colleagues and I at Zurich Insurance Group started to grapple with impact investing in late 2010, with the release of the landmark JP Morgan/Rockefeller Foundation paper declaring impact investments to be an emerging asset class. We found ourselves somewhat of an outlier in early discussions with the World Bank, IFC and others about the topic, as a global insurance group with more than $200 billion in assets under management and a desire to make impact investing relevant to the whole pot.
At Population Services International (PSI), my (Brian) colleagues and I were curious about how we might be able to access impact investing capital as a way to do what every nonprofit hopes to do—diversify its funding sources. While others have since joined us, PSI was also something of an outlier when it started out in 1970, applying commercial approaches to solve complex public health challenges.
After Zurich’s chief investment officer, Cecilia Reyes, met PSI’s Kate Roberts, at Roberts’ presentation on philanthropy and corporate social responsibility at a July 2012 conference, our organizations soon started focusing on a mutually fascinating question: How might large, international NGOs access private, institutional investor capital in a way that could increase their impact on a large scale?
The resulting report co-authored by Zurich and PSI, just released, outlines six ways.
The report is just one step in the journey toward a world where impact investing works for a larger universe of private investors and international NGOs. In the coming year, Zurich and PSI will be working together to develop the conceptual framework for one of those six types of transactions, the development impact bond.
Tackling the question of how to structure these deals, or the pricing model needed to capture the associated risks, will be important concepts to help catalyze an expansion of the universe of impact investors and impact investment opportunities.
Many questions lie ahead for each of our organizations.
On PSI’s side, the most important questions are: Which of PSI’s large-scale or potentially large-scale interventions could be better financed using private, market-return seeking capital? And where could the additional freedom to pursue a bottom-line social outcome really create more impact than working with large donor support, which typically locks-in project inputs up front?
For PSI or any future NGO engaging in such a deal, thinking through the implications of the flexibility a development impact bond transaction could grant is a top priority. If there was a given situation where the NGO could choose between market-return seeking investors and concessionary-return seeking investors or donors and achieve the same impact, the choice is obvious: Don’t take investors’ money. However, accessing investor capital could provide additional freedom to design and adapt programming on the fly in order to achieve bottom-line impact.
From the investor side, what the investor in such a vehicle is really being asked to do, of course, is to make a bet that the NGO will deliver the agreed-upon social impact in time. In return for that risk, the investor would receive market-rate interest from a donor who has been satisfied by the social impact delivered.
The task for Zurich is to provide a framework to help investors to determine the interest rate to charge. Our company will have to figure out how to take into account all the financial risks—environmental, social and governance factors included—that we would consider for traditional investments, and add to that the risks that can be associated with investing in social impact.
Among many factors, we’d have to assess the NGO’s ability to deliver on what they promise based on its previous track record. We’d have to model the ability of the NGO or its donors to pay back the investment. And we’d need to model all those probabilities in a way that is replicable for other investors, for other NGOs, and across different thematic areas: health, education, agriculture, and so on.
Ultimately, we want to put all investors, not just Zurich, in the position of having the instruments ready that help them to choose between investments with reliably-priced risk-return profiles, one or more of which may have measurable social impact on top of market-rate returns. At that point, we hope the right choice would be obvious—and we’ll be able to say impact investing is a true investment category, supporting all kinds of NGOs, and appealing to every kind of investor – not just the ones that love kale.