Safeguarding the Brand of Impact Investing

RUNNING HEAD: SAFEGUARDING THE BRAND OF IMPACT INVESTING 1

SAFEGUARDING THE BRAND OF IMPACT INESTING: LEARNING FROMMICROFINANCE

Author: Heber Longhurst, CFA

The International School of Management

SAFEGUARDING THE BRAND OF IMPACT INVESTING 2

Abstract

The emerging impact investing industry seeks to produce a financial return while also producing a positive social impact. This is a relatively new and innovative industry, onewith considerable promise but one that has yet to produce an IPO. The impact investing industry is similar to the microcredit industry in that it also seeks to produce blendedvalue. Many of the leaders in the impact investing industry see the reputational risks to which Microfinance has succumbed as a cautionary tale and understandably want to learn from Microfinance’s history.

This paper will introduce the impact investing industry by exploring its philosophy, its history, its challenges and itsobjectives. Subsequently this paper will discuss the pitfallsthrough which the reputation of the microfinance industry lost its lustre and ultimately this paper will explore ways in which the impact investing industry can learn from the microfinance industry.


What is Impact Investing?

The definition that JP Morgan in their 29 November 2010

report “Impact Investing: An Emerging Asset Class” gives for

impact investing is “Investments intended to create positive

impact beyond financial return” (p. 5). This definition is an

efficient and succinct definition is that in one sentence

sums up all the key characteristics of impact investing.

First that impact investing involves providing equity, debt

or mezzanine financing. While many social endeavors use

donations or grants and some impact investing schemes use

hybrid financing, in order to be considered and accepted as

an impact investment it must have equity, debt or mezzanine

financing. The second word in the definition –intended-

communicates that rather distinct from those investments

which have unintentional positive social or environmental

impact, impact investing is undertaken with the explicit

intent of producing a positive social or environmental

impact. Continued analysis of the aforementioned description

of impact investing discovers the phrase -to create positive

impact beyond financial return- positive social and/or


environmental impact should be stated as part of the stated

business strategy of the impact investing fund as well as the

social enterprise and the social and/or environmental impact

should be measured and reported. The phrase also communicates

that impact investments should return at least nominal

principal. Market rate and above market rate returns are also

within the scope of the practice of impact investment but, at

least according to J.P. Morgan’s definition are not required

for a fund to be considered an impact investing fund.

Many terms have been used to refer to impact investing

such as “socially responsible investing”, “ethical

investing”, “patient capital”, “sustainable finance”,

“community development finance”, “mission-driven investing”,

“sustainable and responsible investing”, “blended value”,

“values-based investing”, “mission-related investing”,

“ethical investing”, “responsible investing”, “program-

related investing”, “triple-bottom line”, “environmental

investing” and “governance screening” etc (Freireich &

Fulton, 2009, p. 11) . The term used in this report to refer

to investments that combine positive social impact with


financial returns in this report is impact investing as it is

more precise than the aforementioned terms and reduces

ambiguity.

Impact investing is an outgrowth of previous movements

intended to marry social impact with financial returns such

as: double and triple bottom line reporting, socially

responsible investing, corporate social responsibility,

ethical investing, sustainable finance and community

development finance (Bugg-Levine & Emerson, 2011, p. 8). It

could be argued that impact investing was the inevitable and

natural outgrowth of the aforementioned movements. However,

it is worth pointing out that there is a fundamental

difference between impact investing and socially responsible

investing. While socially responsible investing remains

primarily focused on financial returns and applies negative

screens to avoid investing in projects with negative social

and/or environmental impacts, impact investing takes this

concept one step further and explicitly targets positive

social impact as a key organizational objective, on par with

financial returns (p.9). Due to this shift in mission and


goals, impact investing applies positive screens actively

seeking out only those social enterprises, projects and

companies where a positive social impact can be achieved

while also producing financial returns (p. 9).

While impact investing is open to investing in any

sector where positive social and/or environmental impact can

be produced while simultaneously earning financial returns,

it currently focuses primarily on low income housing, rural

water delivery, health care, primary education, agriculture,

distributed utilities, restructured social spending,

education financing and microfinance (Bugg-Levine & Emerson,

p. 93). The positive social impact is being obtained by

improving beneficiaries’ standards of living through improved

environment, improved health care, poverty alleviation, job

generation and sourcing process inputs from entrepreneurs at

the bottom of the pyramid (p. 94).

Another crucial aspect to impact investing as well as to

social enterprise is not only actively seeking to make a

profit in a financially sustainable way, but also to dedicate


funds toward types of investments, projects or regions that

are less likely to attract traditional and more risk adverse

investment (Yunus, 2007, p. 25).

All investments and all business activity are capable of

generating positive social impact by generating employment,

and economic productivity. Many even produce positive social

impact at the bottom of the pyramid where the needs are

greatest. The difference between traditional profit-only

business and impact investing is that impact funds and social

enterprises make the positive social impact an explicitly

stated part of their strategy, objectives and purpose on par

with financial returns (O’Donohoe, Leijonhufvud & Saltuk,

2010, p. 5).

Impact investing is also closely allied with

philanthrocapitalism which is a movement designed to use

donations to produce sustainable social impact by donating to

projects which could eventually become financially self-

sustaining businesses (Bishop & Green, 2008, p.6). While both

impact investing and philanthrocapitalism involve funding


productive enterprises, the key distinction is that impact

investing does not involve donations but rather actual

investments in the enterprises’ capital structures. While

philanthrocapitalism seeks that the project eventually become

financially profitable, impact investors are already seeking

financial returns (O’Donohoe, Leijonhufvud & Saltuk, 2010, p.

5).

Another predecessor and more closely allied with impact

investing is micro-credit and later, micro-finance. In fact,

since micro-finance seeks to obtain both financial returns

and a positive social impact it is fair to include mico-

finance under the broader umbrella of impact investing even

though micro-finance predates, the term impact investing. The

key evolution from microfinance to impact investing is the

recognition that the world’s poor need more than financial

services and that there are other fields where financial

returns can be obtained while alleviating poverty and

suffering (Bugg-Levine & Emerson, 2010, p. 45).


One of the more interesting and controversial questions

in impact investing is whether there should be a trade-off

between financial returns and social impact or whether the

increased risks of social ventures require greater financial

compensation (O’Donohoe, Leijonhufvud & Saltuk, 2010, p. 6).

Some pension funds and foundations require that the

investment produce a competitive financial return in addition

to a social return while other foundations which seek tax

benefits under the Program Related Investments section of the

IRS tax code require an investment to prioritize social

impact (p. 21-22). According to the report “Insight into the

Impact Investment Market: An in-depth analysis of investor

perspectives and over 2,200 transactions” written on December

14th 2011 report by Yasemin Saltuk of J.P. Morgan Social

Research and Amit Bouri and Giselle Leung of the Global

Impact Investing Network “The average baseline expected

return for developed market equity investments is 19% annual

IRR, while the same figure for emerging market equity

investments comes in at 18%” (p. 13). Although equity return

expectations are similar in developed markets and emerging


markets it is worth pointing out that the standard deviation

of return expectations in developed market equity is 14%

while the standard deviation of return expectations in

emerging market equity is lower at 9% (p. 14). When asked

about expected returns in debt investments investors

generally expected impact debt returns to be higher in

emerging markets (p. 17).

Muhammad Yunus believes that for a company to be

considered a social enterprise it must not pay any dividends

(Yunus, 2007, 26). From the author’s personal interactions

with impact investing funds in Mexico as well as social

entrepreneurs, it has become apparent that there are many in

the impact investing industry in Mexico who do not subscribe

to Yunus’s strict notion which prioritizes social impact

above and beyond paying dividends. A key example is Alvaro

Rodriguez of the Venture Capital fund, IGNIA, in Mexico who

during the executive certificate program organized by

Universidad Anahuac and RiskMatics (2012) expressed his

belief that for the industry to become well established it

must necessarily produce returns in excess of market returns.


In their December 14th 2011 report, Amit Bouri & Giselle

Leung of J.P. Morgan Social Finance Research pointed out that

91% of all investments in impact investing are made in hard

currency which theoretically passes the currency risk from

the investor to the investee (p. 11). This raises the

threshold of responsibility and expectations faced by social

entrepreneurs.

One of the challenges in the development of the impact

investing industry is measuring the social impact, this is

crucial to safeguard the reputation of the impact investing

industry by preparing against funds and self-defined social

entrepreneurs with no desire to produce a positive impact

seeking to attract investment funds by pretending to be

impact investing funds (Bugg-Levine & Emerson, p. 164). The

industry is seeking to remedy this situation by establishing

uniform and objectives standards to measure the various types

of social impact, this initiative is being carried out by the

Global Impact Investing Network (GIIN) and the set of

measurement standards is known as GIIRS (Global Impact

Investing Reporting Standards) (p. 177). The goal which the


impact investing industry seeks to achieve is standardized

social impact metrics similar to IFRS or GAAP in accounting

which would allow external auditors to publish opinions on

the companies’ and funds’ reliability of reported social

impact measurements and external rating agencies which would

provide social impact and sustainability ratings (p. 185).

HOW MICROFINANCE LOST ITS VENEER OF MORAL PROBITY

Concerns began to emerge regarding the ultimate benefits

of microcredit as soon as an industry originally driven by

not-for-profits and charitable donations began to be more

commercialized, more profitable and accept more investments

from profit-only investors. Two of the more controversial

companies in this sector are Gentera (formerly Grupo

Compartamos) in Mexico and SKS in India. It is worth noting

that the author of this report is prohibited from owning

stock in companies he covers but has a buy recommendation on

Gentera’s shares (COMPARC*).

Following the IPO of the company formerly known as

Compartamos in 2007, concerned microfinance leaders gathered


to issue the Pocantico Declaration wherein they mentioned

their concerns regarding the lack of transparency in the

industry, a lack of connection with clients, the rising risk

of over indebtedness among clients, and extraordinary profits

which could erode public support for the industry, especially

in cases where the firm receives public funds (The Pocantico

Declaration, 2008). According to Jessica Papini (2008)

several signers of the Pocantico declaration has stated in

interviews that they were concerned about the high level of

profits creating the impression of poor people being

exploited and others expressed concerns about the high levels

of interest rates actually damaging the poor rather than

helping them (p. 8).

The spectacular IPO that created concerns, however,

wasn’t Compartamos’ but SKS’, after the stock rallied 476% in

the first two weeks following its IPO the global media and

politicians were alerted to the profits being made, consumer

advocates pointed out coercive claims processes, dishonest

lending practices. The media was full of pubic declarations

by politicians regarding debt-induced suicides contrasted


with multimillion-dollar paydays for SKS founders and

investors. The scandal reached a stage where in Andhra

Pradesh state regulation was being drafted to shut down

commercial microfinance (Bugg-Levine & Emerson, 2011, p. 48-

49). Following the media frenzy related to SKS, microcredit

has had to incur additional efforts to maintain and regain

credibility among some segments of the market.

While there are many studies which seem to indicate that

the impact of microcredit is net positive, when interacting

with poor and vulnerable clients at the bottom of the pyramid

companies should pay careful attention, not only to the real

ethical concerns but should be especially careful regarding

the reputation risks involved and how these could spill over

to an entire industry. Reputational deterioration can imply

an increase regulatory pressure (to the point where

commercial microfinance was made illegal in Andhra Pradesh),

increased compliance costs, and more difficulty in obtaining

financing. Reputational hazard can also make it more

difficult to attract talent and clients.

HOW IMPACT INVESTING CAN AVOID LEARN FROM MICROFINANCE


Microfinance has done a great job benefiting from

thoughtful collaboration and brand management. However, it

has also encountered many pitfalls which impact investing

will eventually face as well. It would only make sense for

the impact investing community to proactively implement

measures proactively to avoid making the same mistakes (Bugg-

Levine & Emerson, 2011, p. 47).

The public controversy and the infighting which began in

microfinance following the transition from a donor-funded

innovation to a capital market driven and for profit social

business underlines the danger of overselling the social

impact of any type of investment and also underscores the

lingering skepticism that many people have about the moral

legitimacy of for-profit businesses that sell basic services

to poor people (p. 47).

According to Anthony Bugg-Levine and Jed Emerson there

are three basic questions that the broader impact investing

community must ask. These questions are: “who controls the

brand?”, “how do we sustain collective leadership?” and “how

much can investment really contribute to ending poverty?”


The microfinance community is splitting into two camps

where one side sees non-profit microfinance as a legitimate

means to promote economic development, but resists the

intrusion of commercial capital seeking a social return. On

the other hand, there is a group which sees the profitability

of microfinance institutions as the lynchpin which enables

them to reach more customers more rapidly by tapping into

global financial markets (p. 50). The main way to avoid

skepticism is through standardized, measurable and objective

results.

One of main initiatives to demonstrate that impact

investing companies are really producing a positive social

impact is the Global Impact Investing Reporting System

(GIIRS) and the Impact Reporting and Investment Standards

(IRIS) which was created by GIIRS (p. 36). Financial

accounting benefits from the Generally Accepted Accounting

Principles (GAAP) or the International Accounting Standards

(IAS) which standardize and regulate the ways in which

financial information is accounted. Within the investment

management community the CFA Institute has developed


standardized ethical codes for investment behavior as well as

the Global Investment Performance Standards (GIPS) by which

portfolio return reporting can be standardized and compared

on an apples-to-apples basis.

The measurement of social impact is complicated because

rather than simply measure the social benefit you must also

measure the difference between the social benefit with the

impact investing intervention and what it would have been

without this intervention. Some will try to prioritize health

care, others will try to prioritize employment and economic

gains, others would prefer to prioritize female empowerment,

while some would prefer to focus on environmental impact.

While it is a complicated process, impact investing is

seeking to create objective standards which could be applied

universally whereby impact investing could be measured. It

would also be a positive development for the impact investing

field to have some form of independent certification similar

to that provided by credit rating agencies whereby a fund or

a social entrepreneur needs to demonstrate a certifiable

social impact in order to benefit from the brand of impact


investing (p. 135). This certification could reduce the

practice of “greenwashing” in impact investing by separating

the actual impact investing funds from the frauds.

Additionally, a rigorous, objective and independent

certification could also increase the flow of funds into

impact investing. Currently if a large mutual fund or pension

funds wants to dedicate a small portion of its investments

into impact investing it can’t really tell if the venture

capital fund, private equity fund or social entrepreneur

really produces blended value or whether they produce a

tangible and measurable social impact. If governments or

other independent parties could certify impact investing

funds independently there would be less opacity and a greater

flow of funds (p. 135). One of the problems with independent

certification, however, is that social entrepreneurs serving

the bottom of the pyramid are in a low margin business and if

they partner with a venture capital or private equity fund

the objective will be to scale the project for a successful

exit strategy. In addition to the already complicated task of

producing both financial and social returns this proposal


would also task the social entrepreneur and/or the impact

investing fund with producing a measurement of the social

impact when the IRIS and GIIRS are not yet fully developed.

However, there are some funds that are supporting GIIRS and

IRIS by implementing these reporting standards and are also

contributing to the debate to improve the reporting

standards. In Mexico IGNIA and Promotora Social Mexico stand

out for their contributions in this area. I think it is

crucial for the industry to begin with measurable and

credible social impact metrics to avoid reputational risks.

Another important area where impact investing funds can

learn from microfinance is in terms of collective leadership

and industry infrastructure. When the microfinance industry

was primarily donor based and was mostly non-for-profit there

was no problem with governments and charitable donations also

funding industry infrastructure such as: data platforms,

rating agencies, coordination bodies etc. However, once

commercial microfinance began to make headlines the question

arose as to whether it made sense for taxpayers’


contributions and charitable donations to be supporting an

industry with considerable profits (p. 35).

As will all venture capital, angel investing, and

private equity industries, the impact investing industry

needs more ways for the funds to meet both investors and

entrepreneurs. In this case, since both the social

entrepreneurs and the capital market providers with an

interest in social business are limited and niche markets it

becomes even more difficult to make these connections. It

would also be beneficial to have impact investing

clearinghouses, specific indices which measure impact

investing returns, independent rating agencies which rate the

funds not only on financial returns but also on demonstrable

social impact. While industry insiders claim that there are

philanthropists willing to fund the infrastructure of the

industry even with profitable, commercial impact investing

funds (Bugg-Levine & Emerson, 2011, p. 53). In Matthew Bishop

and Michael Green’s book “Philanthrocapitalism”

philanthropists who provide the initial funding for projects

which might eventually become profitable are called


philanthrocapitalists (Bishop & Green, 2009, p. 10). The

willingness of these type of philanthropists to fund the

infrastructure could be most likely due to the fact that the

incipient industry hasn’t had many successful exits and has

not yet seen a headline grabbing IPO. Once this occurs the

enthusiasm of philanthrocapitalists could dry up. Another

alternative would be to learn from microfinance and to begin

by discussing the option of cross-subsidies whereby once the

philanthrocapitalism begins to dry up the more profitable

impact investing funds begin to cross subsidize the newer

funds by funding the industry infrastructure (Bugg-Levine &

Emerson, 2011, p. 54). This type of cross subsidies in 100%

profit oriented industries might not make sense, but in an

industry where the funds have a dual mandate to produce

financial profits and a social return some of these cross-

subsidies might be justified for the social return that they

produce. We can already see in Mexico some efforts by IGNIA,

Promotora Social Mexico and New Ventures Capital to fund

infrastructure, training and education which benefit all the

funds in Mexico. Furthermore, as the impact investing


industry, even under the most optimistic scenario will most

likely always remain small it is unlikely that many of these

funds become direct competitors in the way that they do in

more profit only types of business.

Another important area where impact investing can avoid

the reputational pitfalls of the microfinance industry is to

avoid over-selling the social impact. Within microfinance

there are debates regarding whether or not microfinance can

and should serve all customers. Compartamos explicitly states

that the very bottom of the pyramid need government handouts

and that they are mostly focused on poor who are doing a

little better, while Grameen tries to spread the benefits to

the bottom of the pyramid. There is also a debate as to

whether microfinance is really a poverty eradication tool

within the customers it does serve. While there are many

microfinance customers who do benefit, when the industry’s

promises are too optimistic, than the individual cases of

microfinance customers who still wallow in poverty can

undermine the message. In other words, instead of selling

impact investing as the silver bullet or as a poverty


eradication tool it would make sense more sense to sell it as

a tool that directs economic opportunities to poor

communities. It would also make sense to highlight that the

ultimate solution must be obtained through cooperation with

public sector funds, pure philanthropy and profit only

enterprises (p. 54). Just as microfinance can be seen as a

necessary but insufficient measure, impact investing should

begin by selling itself not as the silver bullet to end

poverty but as additional shot in the silver buckshot which

could eventually create the conditions necessary to lift the

poor out of poverty.

CONCLUSION

While there are many, many business enterprises less

noble or beneficial than those which explicitly seek to make

a social impact such as microfinance and impact investing,

there are also many ethical and reputational considerations

which these types of social business must also take into

account.

Humanity is appropriately very sensitive to any activity

which could potentially exploit the vulnerable, and making a


profit off of individuals, families and communities at the

bottom of the pyramid has to make efforts in addition to

those generally required of traditional businesses. On one

hand, they need to implement internal controls, standards and

procedures to avoid the obvious potential ethical violations.

On the other hand, due to society’s skepticism about making a

profit off the bottom of the pyramid additional measures are

required by impact investing and microfinance funds simply to

avoid reputational hazard. An industry that specifically

seeks to produce both social and economic value (blended

value) has the added burden of finding a way to demonstrate

that it does indeed deliver what is promised without

overpromising.


REFERENCES

Bishop, M. Green M. (2008). Philanthrocapitalism: How giving can save

the world. New York, NY. Bloomsbury Press.

Bugg-Levine, A., Emerson, J. (2011). Impact investing: Transforming

how we make money while making a difference. San Fransisco, CA:

Jossey-Bass

Bishop, M., Green, M. (2008). Philanthrocapitalism: How giving can save

the world. New York, NY: Bloomsbury Press

Freireich, J., Fulton, K., (2009). Investing for social &

environmental impact: A design for catalyzing an emerging

industry. Monitor Institute retrieved from the world wide web

at http://www.monitorinstitute.org/impactinvesting

O’Donohoe, N., Leijonhufvud, Ch., Saltuk, Y.(2010). Impact

investments: An emerging asset class. J.P. Morgan Global

Research

Saltuk, Y., (December 14 2011). Insight into the impact

investing market: An in-depth analysis of investor

perspectives. J.P. Morgan Social Finance Research


The Pocantico Declaration (2008). Retrieved from:

http://www.smartcampaign.org/storage/documents/Pocantico_De

claration.pdf

Yunus, M. (2007). Creating a world without poverty: Social business and the

future of capitalism. United States: Public Afairs

http://www.smartcampaign.org/storage/documents/Pocantico_Declaration.pdf

http://www.smartcampaign.org/storage/documents/Pocantico_Declaration.pdf

Safeguarding the Brand of Impact Investing

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