3.3 The Case for Impact Investing
The case for impact investing is driven by a set of compelling global trends. These megatrends are creating a set of social and environmental challenges that are increasingly addressed through market-based solutions, sometimes receiving public-sector support.
3.3.1 Global Mega-Trends: Shifting Consumer Demands and Emergence of New Markets
Economic and demographic mega-trends are creating a future for investing that will look different from the recent past. These trends are relevant for all businesses and the opportunities to capitalize on them can be captured through many forms of investment. However, in many cases the interconnected nature of social and environmental issues with these trends is particularly well-suited to the impact investing approach. For example, the impact investing approach can help identify new opportunities that may not be captured through evaluation of investments on financial terms alone. Furthermore, impact investing can be a means to mitigate risks associated with the mega-trends themselves – business and services that are fundamentally useful to society can be more viable in the long-term. The following discussion highlights a select group of these mega-trends which will play a significant role in shaping the future of investing.
Rise of LOHAS Consumers Around the World:
Both developed and emerging economies are experiencing significant growth of “Lifestyles of Health and Sustainability” (LOHAS) consumer segment. Examples of LOHAS businesses include organic and fair trade products, natural home goods, sustainable eco-tourism and social businesses such as TOMS Shoes, Warby Parker, Method Products and Kind Bars. LOHAS customers are interested in having the products they purchase reflect their personal values and they want their purchases to positively influence society. Since the term was established in the early 2000s, the LOHAS market has grown over 10% annually and is approximately US$ 300 billion in size.28 The 2014 Deloitte Millennial Survey reveals that nearly 30% of millennials, who are estimated to inherit US$ 30 trillion over the next 30 to 40 years, believe the success of business should be measured in terms of more than just financial performance, with a focus on improving society among the most important things that a business should seek to achieve. Furthermore, they believe business can do more to address society’s challenges of resource scarcity (56%), climate change (55%) and income inequality (49%).29 In short, consumer demand for socially conscious, health and sustainability products may increasingly create opportunities for impact investors.
Growing Base of the Pyramid Consumer Class:
The McKinsey Global Institute estimates that the global consumer class, made up of people earning more than US$ 10 a day, will have grown from 2.4 billion people in 2010 to 4.2 billion people in 2025. At that level of income, individuals in this class can make discretionary purchases such as televisions and refrigerators. Companies and investors that can adapt and innovate to effectively service this emerging class of new consumers stand to capitalize on a market growth opportunity on par with the Industrial Revolution.30
Shifting of Economic Growth to Emerging Economies:
Close to half of global GDP growth is expected to come from emerging market cities in the period from 2010 to 2025.31 From 2000 to 2010, 21 emerging economies doubled their GDP32 and in 2015, emerging markets are expected to grow by 5.4% while advanced economies are only expected to grow by 2.3%.33 It is likely that impact investments will play a significant role in this economic growth story given the strong connection between social/environmental impact, emerging market investment activity and economic development.
Increasing Constraints on Natural Resource:
Global population growth and the growing consumer base in emerging markets will continue straining global natural resources. The UN estimates that by 2030, the world will need 30% more water, 40% more energy and 50% more food.34 Potential water crises and food crises were identified in the Forum’s 2014 risk report as among the top 10 global risks.35 Additionally, the 2014 Deloitte Millennial Survey revealed that the millennial generation views resource scarcity and environmental protection as two of the top five challenges facing society in the next 5 to 10 years.36 A stable and productive global economy depends on addressing such challenges and it is likely that the private sector will be increasingly motivated to drive economic and financial value in spite of – and even from – resource scarcity and environmental protection.
Limitations of the Public Sector to Provide Services and Infrastructure:
Potential fiscal crises were identified as the top risk in the Forum’s 2014 risk report.37 Governments are currently facing a confluence of factors that threaten provision of public goods and services. Ageing populations are putting a strain on medical and social programmes. Additionally, many developed countries are still dealing with the budgetary effects of decreased tax revenues and expensive fiscal stimulus packages as a result of the global recession. While in many emerging markets, social and economic progress is leading to increased pressure on governments to improve infrastructure as well as medical and social care. In some cases where the public sector falls short, private sector investment can support financially-viable and market-based solutions to social and environmental problems.
In short, traditional notions of value-creation held by investors and society are going to be changed by increasing consumer demand for social value products in developed markets, the need for social inclusion to support growth in emerging markets and projected scarcity of natural resources. Impact investing is one approach well-suited to capitalize on these trends.
3.3.2 Public Sector Support
Similar to the public sector policies that helped launch the professionally managed venture capital sector in the mid-1960s through to the 1970s,38 governments are beginning to sponsor and support initiatives that facilitate the flow of capital to social entrepreneurs and investment managers who link social outcomes to financial returns. Such public policy initiatives can come in the form of incentives or reduced regulatory barriers which partially “de-risk” investments and catalyse the impact investing ecosystem. We have highlighted below some of the key policy actions underway in the UK, India, France and the US. While such public sector support is not expected to make impact investing immediately compelling for all investors, it can have the effect of making it easier for otherwise reluctant actors to engage.
UK – Social Investment Market Stimulus:
Big Society Capital (BSC), a UK social investment company established by the Cabinet Office and launched as an independent organization in April 2012, seeks to have a transformative impact on the social investment market in the UK. It aims to do this by providing access to capital for social investment intermediaries as well as by increasing awareness of and confidence in impact investing by promoting best practices, sharing knowledge and fostering links between social investment and mainstream capital markets. The bank was initially financed with £ 400 million of dormant bank assets and £ 200 million invested by four large financial institutions.39 Since inception, the organization has committed nearly £ 150 million in investments to specialist organizations that invest in charities and social enterprises.40
Additionally, the UK has introduced legislation that provides tax advantages to impact investors. The Seed Enterprise Investment Scheme (SEIS) was launched in April 2012 and was formed to stimulate entrepreneurial activity. SEIS provides a de-risking mechanism for start-up investors by offsetting income tax liabilities by up to 50% on qualifying investments that do not succeed. Additionally, in March 2014, a 30% income tax relief measure was announced for new social investments, the same as the rate for enterprise investment schemes and venture capital trusts.41
India – CSR Requirements:
Although not directly related to impact investing, examples from India show how government regulations can lead capital toward social and environmental impact. As of mid-year 2014, companies in India that meet certain tests of size (for example, companies with a net worth of INR 5 billion, or at the time of publishing, approx. US$ 83 million) are required to formulate a CSR policy, to spend 2% of average annual net profits on CSR activities and to monitor such activities.42 Additionally, for more than 40 years, the Reserve Bank of India has required that state-owned and private banks make at least 40% of their lending activity to certain priority sectors; foreign banks must meet a 32% threshold. Priority sectors include agriculture, small enterprises, education and housing.43
France – Pension Fund Requirements:
Since 2010, France has required organizations that provide employee savings plans to offer at least one “solidarity-based” – or impact – plan. Such plans must invest between 5% and 10% of their capital in social enterprises. This adds up to € 2.6 billion (US$ 3.5 billion) in invested capital.44
US – Social Investment Market Stimulus:
In 2011, the US government announced the launch of the Start-up America initiative designed to spur high-growth entrepreneurship in America. A key contribution to this initiative from the Small Business Administration (SBA) is the Small Business Investment Company (SBIC) Impact Investment initiative. The initiative has committed to making US$ 1 billion available to investment funds licensed as SBICs provided that half of the capital is deployed into impact investments. Impact SBICs currently manage US$ 176 million in assets and have invested in 17 companies which collectively employ 1,500 people.45 According to the SBA, eligible impact investment can be either location-based or sector-based. Location-based investments may fall into three categories: low- and moderate-income areas, rural areas or economically-distressed areas.46
Beyond the efforts of the SBA to spur impact investing in the US, the Department of Commerce has also been active in supporting impact investing. In the past year, the International Trade Administration, a bureau within the Department of Commerce, has certified two trade missions to Europe. Each mission involved European LPs meeting with 10 US-based fund managers focused on impact and sustainability strategies.47 Additionally, there are dialogues around including impact investing and sustainability language in trade agreements.
As the public sector looks for ways to continue supporting the mainstreaming of impact investing, incentives and regulations need to continue supporting impact investing beyond philanthropic activity. Detailed policy levers have been outlined in a recent report from the Asset Allocation Working Group of the Social Impact Investment Taskforce, established by the G8 countries.