4.1 Early-stage Ecosystem
4.1 Early-stage Ecosystem
The first overarching challenge that institutional investors experience when approaching the impact investment market is the early stage of the ecosystem – 86% of US-based pension funds surveyed feel that the market seems to be niche, early stage and immature.70 As a result of the nascent stage of the sector, a number of growing pains exist.
First, as described in Section 3.5, there is a divergence between the rate of return that impact investment funds target and the rate of return that investors expect impact investment funds to generate. Research indicates that while nearly 80% of impact investment funds target market-rate returns, 60% of pension funds expect impact investment funds to actually generate market-rate returns (see Figure 16).71 Moreover, of the 200 responsible investing professionals surveyed in 2012, 74% believe that the greatest impediment to growth of responsible investing is the perception about financial performance.72 Contributing to this divergence is an acute tension that some impact investment fund managers feel between wanting to showcase their returns to prove their financial viability and wanting to withhold public reporting of financial returns to avoid being viewed as making money at the expense of the poor (the experience of microfinance in India in 2010 serves to reaffirm this concern73).
Second, there are limited mainstream intermediaries in the impact investment sector. As described in Section 3.2, there are many small, niche and specialized players. These intermediaries will need to grow and scale in order for the ecosystem to reach mainstream. Mainstream investors will need mainstream intermediaries. Impact investment products are presently difficult to distribute because investors typically buy products from names they know, not from small specialists.
Third, the track record of impact investment funds varies significantly, as illustrated in Figure 17. Few funds have deep experience working with impact enterprises and social businesses, and institutional investors perceive this; 83% of US-based pension funds surveyed feel that impact investment funds have limited track record.74 Specialized skills are required to ensure financial performance is achieved and to measure social and environmental outcomes. Until fund managers develop track records and deep experience working with impact enterprises, institutional investors will be apprehensive allocating capital to the sector.
Fourth, there are limited creative and innovative impact investment products and vehicles that would encourage mainstream capital into the industry. Presently, 83% of US-based pension funds surveyed feel that there does not seem to be enough scalable deals in the impact investment market.75 There are opportunities for innovative products to emerge, but it may simply be too early. Many impact enterprises need to grow, scale and demonstrate consistent cash flow generation; products will naturally follow. In addition to the lack of creative and innovative financial products, there is a need for an index or benchmark to which investors can compare the performance of their impact investments.76 Some organizations are attempting to solve this challenge, although results are still early stage and unproven.77
Note: 242 funds assessed in April 2013
Source: GIIN, ImpactBase