When JPMorgan recruited for a position in its social-sector finance group last year more than 1,000 employees applied for the job. At Harvard Business School, social entrepreneurship and impact investing is now the most popular course. Impact investing might be the saviour of a finance industry tarnished in the crisis, stepping in to help solve the social problems that many governments are now ill equipped to handle alone. It is where capital markets meet benevolence. What started as a discussion around philanthropy now has the potential to become an industry in its own right.
Impact investing is, at its most basic, providing finance to non-profit or for-profit organizations and companies that will have a social impact. That might be a loan to a local housing organization or an investment in a company that is developing technologies to combat climate change.
It’s not new by any means. The wealthy have been donating and investing in companies that aim to create positive social change for more than a century. The private equity and venture capital industries, for example, emerged as a result of investments by wealthy European families after the Industrial Revolution. In the late 19th and early 20th centuries, the wealthiest names in the US, such as JPMorgan, the Vanderbilts, Rockefellers, Warburgs and Whitneys, made private equity mainstream, building railways and cultural landmarks.
That spurred the emergence of the venture capital industry after the Second World War when companies were set up by wealthy individuals to gather funding to finance start-up businesses for returning soldiers.
Impact investing looks set to follow a similar trajectory in becoming an asset class. "A change in mindset is becoming evident," says Richard Brass, director at Berenberg Bank. "Investors are actively seeking out those companies that pursue a clear sustainability agenda alongside a traditional financial return. At the same time private-wealth philanthropy is paying much closer attention to the social return from their charitable giving."
Several factors are coinciding to propel impact investing. Easier access to information has increased awareness of social issues, particularly among the younger wealthy generations. At the same time, demographics have shifted so that a large portion of the world’s wealthiest individuals are of an age at which there is an increasing sense of urgency in leaving a legacy.
Brand is also a factor. There has been a coinciding shift in perspective about the virtues of leaving behind the legacy of making money compared with a legacy of solving global issues. "Some of this new interest for sure is from individuals thinking about how they want their family name to be remembered," says Charles Lowenhaupt, chief executive of family office service provider Lowenhaupt Global Advisors. Bill Gates, for example, has inspired many wealthy individuals with the Bill and Melinda Gates Foundation, the largest in the world. Gates is more likely to be remembered for his philanthropic endeavours than for supposedly anti-competitive business tactics at Microsoft. Michael Milken is now commended for the efforts and success of his Milken Institute, rather than vilified for violating US securities laws.
Antony Bugg-Levine, Nonprofit Finance Fund
Furthermore, the downturn made philanthropists more aware of the sustainability of charities they were donating to, says Bill Woodson, head of family wealth management at Credit Suisse. "Philanthropists want to ensure that the charities they are funding have other means for raising money."
The result is that wealthy individuals and families have been re-examining how their philanthropic dollars are put to work. Typically a wealthy individual or foundation will give 5% of its portfolio away in grants and donations to selected charities, and the remaining money will be invested in assets that seek to make returns to reinvest. Now they are asking how to ensure that the remaining 95% makes an impact, and they are being met with an increasing amount of products and advice to help them.
The idea of products such as pooled financing deals or investment funds in the context of philanthropy has not been easy for the financial services industry to grasp. "There is this bifurcation of ‘I make money by investing and I make social change by giving money away’," says Bugg-Levine. As the number and diversity of companies providing solutions to problems such as climate change, disease, food scarcity and poverty increases, however, the mindset is changing and the list of profit-generating firms driven by social entrepreneurship is growing. The Gym, for example, started as a low-cost fitness centre in an inner-city London neighbourhood and grew to become a franchise. Another example is a woman who developed a new utility switch that regulates utility functions in affordable housing units, saving buildings hundreds of thousands of dollars. Or food company Gain, which aims to make cheap food more nutritious.
The most dramatic change in mindset, however, is the concept of making returns from the public sector. "It’s not just about investing in companies that will have a social impact, there are ways to fund basic social services," says Bugg-Levine. "We’ve been lending to non-profits for 30 years, and there are many ways of putting capital to work that are helpful and that provide a return. You can help solve homelessness not just by giving to shelters but by investing in sustainable programmes that save money."
Tracy Palandjian, Social Finance
She also points to Social Impact Bonds as a means of reducing the cost of incarceration to the government. Over $50 billion is spent by states on correction facilities each year "but nearly one in two offenders ends up back behind bars," she says. Social Impact Bonds could be used to pay for rehabilitation programmes to reduce re-offending, such as housing and employment assistance, rehab, and mentoring and behavioural support. If we invested in prevention programmes around re-entry, taxpayer savings could be significant."
The new model of thinking about where returns can meet social gain is at present not a part of the regular private banking model, and it means a big overhaul by the industry is called for. "The industry has employed people to help you invest money, and people who help you give money away. There is no middle ground," says Bugg-Levine.
It is a surprising but accurate judgement. Most private banks contacted for this article said that their philanthropy advisers were unable to speak about impact investing as it was not an area they looked at other than on a client-by-client basis. Nor did the advisers work with the micro-finance teams in the groups’ investment banks. Some banks said they were introducing networking events on the topic but had nothing formally established.
This means demand is at present being met by independent organizations such as Nonprofit Finance Fund or Veris Wealth Partners, which is a wealth manager entirely dedicated to investing money in socially responsible firms, or financing or investing in organizations that have a social impact. "Very few firms have the experience in impact investing," says Patrica Farrar-Rivas, chief executive of Veris. "Consultants, asset managers and now private banks may offer a few select products, but they don’t have a view of the entire landscape."
Bugg-Levine says it was not until last year that private banks started to consider an offering to their clients in social-impact investing.
"It’s a real challenge for the private banks, which are not organized to suitably address impact investing," says Bugg-Levine. "You tend to have this barbell where the CEOs and chairmen understand the importance as it shows the bank is doing good and it is good for recruiting – and the 27-year-old Harvard graduates at the banks are really keen to be involved. But then there are the bankers in the middle who are just not set up to have the resources to find opportunities and build products, or work out how to fit it in with their clients." That is changing, he adds. One leading wealth manager has already launched an impact investment fund as a private placement. JPMorgan Private Bank is also launching a private placement deal with its social-sector finance group – a group that formed three years ago to conduct research and seek investments with social impact on behalf of the bank itself.
Adjusting the mindset to making returns from social gain, and reorganizing the business to address impact investing, are not the sole challenges for private banks. Developing products or locating third-party products in a new asset class comes with risks attached. In impact investing, there is the risk, as with any investment, that returns will not be made or that loans will not be repaid. The skills for effective due diligence in this new sector will have to be developed.
Perhaps the biggest risk, however, is that the social gains towards which the money was allocated might prove disappointing. Measuring social impact is not as precise a science as measuring returns. The metrics are beginning to be set up, says Farrar-Rivas. "It’s a new set of measures and clients want their own. How are they tracking performance? Is it by the number of jobs created? The energy saved? The number of properties restored? These kinds of measures will be as important as financial returns."
And Bugg-Levine says that, at the same time, financial returns need to be met. Returns typically range from 1% on a loan to 10% on a private equity investment in a company. "It’s not a case of saying: ‘Oh well, it didn’t make money but it did benefit society’," he says. "The social mission should not result in lower standards in creditworthiness or it misses the point."
At these early stages of development, financial institutions are looking to work with foundations and organizations that have experience in impact investing not only to increase their knowledge but also to develop collaborative initiatives. Some are placing investment bankers in secondment positions with foundations, for example, for mutual education on how capital markets and funding social change can interact. "There will need to be a recognition that none of us alone will get the job done, and investments are not enough. Nor are loans," says Bugg-Levine. "Grants will always be needed, as will government support. The exciting thing about impact investing is that it could encourage a complete capital solution. So how can we put the grant money together with the investment money and work out whether a credit enhancement or a loan-loss guarantee might work or whether to hire a new CFO and bring in intellectual capital? That’s when the breakthrough will really happen in how financial markets address social change."
Private banks will play a vital role in creating the impact-investment industry. Berenberg’s Brass says it is an area that suits the private banks perfectly. "The core of private wealth management is tailoring investment mandates and showcasing investment opportunities. It is also about helping clients that wish to do so to use their wealth to the long-term and sustainable benefit of others."
Woodson at Credit Suisse says it is imperative that private banks move into impact investing. "It’s likely that the first steps some private banks take will be to partner with external impact-investing managers, and be a distribution channel for those," he says. "We are well down the road in evaluating such managers. It’s a return on investments to make that sort of commitment to philanthropy. Firstly it creates goodwill with the client and translates into referrals or longer and deeper relationships. And secondly, to execute on these strategies, clients will create charitable organizations themselves that will require an adviser. We would want to be that adviser." As private banks begin to create products, Farrar-Rivas says she hopes that they will realize that this is a long-term project. "If their initial products fail to produce the social or investment returns forecast, I hope they understand that there are thousands of ways to structure products and don’t just give up on impact investing based on one initial attempt," she says.
Making impact investing scaleable will be crucial for the private banks. Jacqueline Elias, co-head of the philanthropy centre at JPMorgan Private Bank, says it is one of the main challenges. "The deals to fund are somewhat limited and sometimes quite small compared with a lot of the fundraising we do," she says. "An organization may be trying to raise just $15 million for example." She says the will is there but it will be a case of working out how to bundle or structure the products.
Like private equity and venture capital, however, impact investing has the opportunity to be rolled out to institutional investors, retail investors and to have greater capital markets involvement. The Rockefeller Foundation, for example, is supporting the Calvert Foundation to develop additional products for retail impact investors. Margot Brandenburg is associate director at the Rockefeller Foundation and has been working with peers to assess what it would take for impact investing to become an industry in its own right.
"There is no doubt about the challenge," she says. "It requires an industry infrastructure, impact rating systems, reporting standards and online clearing houses, social exchanges, basic research and policy frameworks and new products and intermediaries. But it is coming. ImpactBase, an online clearing house of impact-investing funds, contains 130 funds at the moment, many of which have become more sophisticated, and now we are finally seeing movement from the private banks, for which product needs to exist at scale. This is good, because the scale of problems is beyond the government and private foundations to address alone. If an industry is developed, it could bring in the capital markets and, with it, tens of trillions of dollars."