4.5 Best Practices of High-Performing Impact Investing Fund Managers
- The four qualities common to successful impact investing fund managers are effective partnership with the public sector, use of catalytic capital, “multilingual” (i.e. cross-sector) leadership, and integrating financial and social objectives on an equal footing.
This article explores what works and does not work in impact investing, based on the experience of 12 high-performing impact investing funds. Two years ago, we embarked on a research effort to closely examine their practices, having culled them from an initial list of around 350 funds. This small group of 12 pioneering intermediaries has successfully raised capital for some time from prominent commercial investors, among others. The funds prove the case that concurrently delivering significant social impacts and financial returns that meet or exceed investor expectations is both possible and being done at significant scale. The purpose of the research was to gain and share knowledge of what does and does not work in impact investing, based on the experience of these outstanding organizations.
The 12 funds are characterized by practices common to all high-performing asset managers: they nurture their brands, leverage relationships, are often headed or backed by uniquely reputable individuals/institutions, and demonstrate exceptional financial discipline and operational transparency. However, four attributes above and beyond these practices were found to be distinctive for effective impact investing. The sooner that funds internalize these attributes, the sooner a “small group” of pioneering funds will become a “universe” of investment possibilities.14
Practices and Recommendations
These four attributes are presented in Table 4, together with diagnostic questions and recommendations for fund managers.
Each of the 12 funds provides insight into the responses of leading practitioners to the four attributes. Together, they offer a taxonomy of common approaches within each category.
Table 4: Attributes and Recommendations
|Policy Symbiosis||Impact investing intersects with all levels of government, consistent with the promise that impact investing can deliver social and environmental benefits at scale.||Are there public sector funds, tax credits, regulations, certifications or procurement policies that might be beneficial? |
Do you have relationships with policy-makers interested in your market sector?
Do you include policy-makers at all stages of your thinking on market and field development?
|Be aware of policies that apply to you|
Cultivate relationships and be part of the conversation
Invite policy-makers to the table
|Catalytic Capital||The grants, guarantees, letters of credit, collateralization, subordinated loans, concessionary or cornerstone investments that trigger additional capital not otherwise available – all can be instrumental to a fund, from providing early funding to driving reputational benefits.||Have you looked beyond philanthropy for catalytic capital?|
Do you know the strategic reason why LPs invest, and is it in alignment with your priorities?
Do you consider others you want to invest alongside and the strategic value of having them in the deal?
Do you share ideas with others who have expertise in structuring products and blending catalytic and commercial capital?
|Think broadly about the motivations of investors|
Target and partner with investors who are aligned on both mission and strategy
Be a catalyst in your own right
Create peer groups of structural innovators
|Multilingual Leadership||Successful fund leadership is about more than simply effective financial management; it requires experience and fluency in the private, public and non-profit sectors.||Do you have the right mix of perspectives to tackle a multitude of issues and range of relationships?|
If your original backers and leaders have unmatched reputations and relationships, are they sustainable?
Are there gaps in your cross-sector expertise that need to be filled?
Do you encourage aspiring practitioners to diversify their education?
|Recognize that you will need different kinds of expertise|
Leverage strong foundations into strong teams
Be open to growth and transformation
Train the next generation of leaders to be multilingual
|Mission First and Last||Successful funds integrate financial and social objectives by establishing a clearly embedded strategy and structure for achieving mission prior to investment, enabling a predominantly financial focus throughout the life of the investment.||Do you embed mission in your structure or strategy early, explicitly and unequivocally?|
Do you devote time and resources to demonstrating impact that is proportional to the fund’s accountabilities?
Are the metrics you track well targeted to your mission, and do they help harmonize LP objectives?
Do you use the same financial processes, analytical methods and deal terms of any mainstream investor?
|Lock in mission|
Align accountability with mission
Track mission-direct metrics and strengthen feedback loops
Ensure financial discipline in investment
The funds studied utilized public policy and benefited from it, but the relationship between the funds and government entities was not just that of “recipients” and “benefactors”; it was treated as an ongoing partnership, influencing the development of public policy at the investee, market and field levels. The practice of policy symbiosis typically falls under the following, non-exclusive categories:
Foundational: The origins of the firm were rooted in a partnership with government, beyond the provision of any type of assistance (e.g. Business Partners Limited (BPL) was created as a partnership between the South African government, a leading philanthropist and some of South Africa’s largest corporations).
Financial: Government entities were direct investors in the fund. For example, the UK government provided a 1:1 investment in Bridges Ventures for every pound raised in the £40 million Sustainable Growth Fund I.
Regulatory: Government regulations influence structure, operations and investments. Huntington Capital’s first fund was registered with the US Small Business Administration. Investors in its second fund were motivated in part by the US Community Reinvestment Act and California state-level regulations.
Advocacy-driven: Funds may work directly with government to influence broader/systemic policy environments. Aavishkaar was a key player in the formation of the Indian Impact Investor Council, which creates voluntary guidelines to avoid potential crises (e.g. the Indian microfinance sector in 2010).
Opportunistic: The fund makes an effort to identify and leverage discrete, non-systemic opportunities for government to support the success of portfolio companies. Managers of SEAF’s Sichuan SME Investment Fund in the People’s Republic of China (China) worked closely with local public officials to leverage their knowledge of, and influence over, government processes.
In the field of impact investing, catalytic investments encourage the flow of capital for strategic reasons, beyond the pursuit of financial return alone. All 12 funds studied benefitted from or deployed catalytic capital for one of four distinct purposes:
Sustaining: Some segments of impact investing require ongoing grants or concessionary investments, particularly where market failure is endemic. Accion Texas receives half of its US$ 14 million operating budget for making high-impact microloans from grants—a proportion that is shrinking but will likely never reach zero.
Seeding: Making first investments in a fund enables operations to commence, and helps to develop a track record needed to attract other capital. Deutsche Bank’s Microfinance Consortium I was made possible by a grant from the UK Department for International Development (DFID), which provided the operating budget during fund creation.
Risk-reducing: Financial risk for investors can be managed by tiered capital structures. RSF Social Finance (RSF) uses an “integrated” lending approach, tapping philanthropic capital to make more borrowers eligible for RSF financing.
Signalling: Large, reputable investors often elevate the recipient’s perceived credibility and visibility. Elevar Equity’s first fund received an early programme-related investment from the Omidyar Network, which introduced Elevar Equity to other investors and provided added comfort to potential capital providers.
Broadly, three approaches exist for achieving multilingual leadership in an organization: individual (principals with deep/broad experience); institutional (defined governance structures); and acquired (recruiting necessary talent). Founders and leaders of the 12 funds studied often had experience across multiple, essential areas (e.g. finance/business, policy and impact/philanthropy), providing them with essential multilingual perspectives. Diverse experience was especially important in influencing four stages of fund development:
Creation: Enabling fund managers to think outside traditional investment models/approaches and create innovative solutions
Capital development: Facilitating engagement with a wide range of stakeholders
Pre-deployment: Understanding dynamics of various enterprises and a range of financial and non-financial tools needed for businesses to flourish
Accountability: Communication and rigorous tracking of financial and impact results
Mission First and Last
Successful funds seamlessly integrate financial and social objectives, establishing a clear mission that embeds the delivery of impact through structure and investment strategy. Knowing early and explicitly that impact is in a fund’s DNA, all parties (investors, investees, and the fund itself) are able to move forward with the investment disciplines akin to any other financial transaction, confident that mission drift is unlikely. The four categories below emphasize important differences in the key elements of mission first and last: intention, or how mission is embedded in the structure/strategy of a fund; and accountability, or the way that a mission is revisited, evaluated and reported throughout and at the back-end of the investment cycle.
Structure: Mission is locked into the DNA of the fund through an external designation, registration or special-purpose corporate form. A fund’s performance is assumed to be consistent with this structure, and accountability is often limited to the form’s requirements. Calvert Foundation manages a Community Investment Note, registered in nearly all 50 US states, that is accessible to non-accredited investors. The impact thesis and constraints of the fund are built into the registered security.
Strategic: Mission is embedded in an investment strategy that explicitly targets certain enterprises or populations, often with defined attributes that are generally understood to be inherently impactful. BPL targets SME growth broadly in South Africa, but takes care to identify viable companies located in urban and rural areas and/or run by women and/or indigenous entrepreneurs. These businesses have been plainly underserved by mainstream capital markets, particularly for the provision of risk capital/finance, in which BPL specializes.
Investor-driven: These funds are created in close collaboration with investors for whom the fund is meeting a very specific mission objective. Demonstrating impact against this objective is an important element of accountability. SEAF’s Sichuan SME Investment Fund answered a clear need for two key investor groups: a US insurance company eager to demonstrate its support for Chinese enterprise, and DFIs committed to capitalizing small business development in China.
Thematic: These funds embed mission in an investment strategy targeted towards sectors that have potential for social/environmental impact, although the sector may include many other non-impact investments. Accountability relates to demonstrating that investments within these sectors have been impactful. The Bridges [Ventures] Sustainable Growth Funds I and II focus on a cluster of issue areas including health, education and the environment, where social or environmental need creates a commercial growth opportunity for market-rate or market-beating returns.
To be sure, neither a “small group” of successful intermediaries nor the relatively limited number of investors who have supported these funds is enough to mainstream impact investing – an indication instead that insight into best practices has remained in relatively closed circles. We call this initial growth period the “1.0 era” of impact investing. Anecdotal “observation” rather than broad “evidence” has been the main organizing principle during this time, and few investors have had the benefit of observation.
The key to mainstreaming –to entering the “2.0 era” – is to shift emphasis from the “why” of impact investing to the “how”; to ground our thinking in the experiences of funds with veritable track records of successful financial and social performance across geographies, investment strategies and impact objectives. Judging by the 12 outstanding funds we have had the privilege to study, we believe the 2.0 era has arrived.
In sum, in an effort to generate multifaceted financial and social returns, impact investing fund managers should dedicate resources to the following practices:
- Becoming familiar with policy issues and cultivating mutually beneficial relationships with philanthropists and government actors
- Ensuring both “soft skills” to collaborate effectively and “hard skills” needed for financial structuring are in place in order to leverage catalytic capital
- Building teams with multi-sector experiences, approaches and skill sets
- Establishing clear mission accountabilities that help align the strategic priorities of investors (and the interests of others including investees and beneficiaries), and that can be managed with unremitting financial discipline.