Impact Investing Benchmark: What’s “Impact” got to do with it?

by Paul DiLeo

Cambridge Associates and the GIIN are to be commended for introducing the Impact Investing benchmark last August. The benchmark adds to the accumulating data on impact investing, and also provokes some further thinking about how such benchmarks like this can help and hinder the realization of impact investing’s potential.

To the authors’ credit, they are careful to point out how this first iteration of the new benchmark may not be a good comparable for many impact portfolios:

• The benchmark only includes data from PE and VC funds that target “risk-adjusted market rate returns”, while, JP Morgan’s 2015 impact investor survey finds that 45% of impact investors target below market returns.
• The report notes that Cambridge tracks 392 PE and VC funds for its MRI database; the benchmark is based on data for 51, or 13%, raising the likelihood of selection, in addition to survivor, bias.
• Even in this small sample, something less than half have largely completed the typical ten year life so the results rely on – usually optimistic! — projected results.
• Over 50% of the total capital of the funds analyzed is directed towards Africa; this compares with the JP Morgan survey which finds less than 16% of total AUM of the impact investors it surveyed were directed to that region.

These mismatches likely explain some of the discrepancy between the benchmark’s realized and unrealized returns of 6.9% and those actually realized by some impact investors to date.

Grassroots has compiled data on the nine microfinance PE and VC funds launched in 2001-2005: microfinance remains the largest impact sector after housing, and these nine funds should be nearing full liquidation. Four have in fact largely liquidated on schedule; two extended under duress and the other three are only partially liquidated. Excluding the early estimates for these three, the other six are returning roughly 3%, on weighted average, to LPs. In contrast to the GIIN/ Cambridge benchmark, there is no selection or survivor bias in this data set: the nine funds encompass the entire universe of microfinance equity funds of that first vintage.

It can be debated whether the GIIN / Cambridge or the inaugural microfinance fund vintage data set more accurately reflect the financial returns impact investors are likely to realize going forward. But the more fundamental issue is the context in which financial return should be viewed, and it is from this perspective that the GIIN / Cambridge benchmark threatens to distort investor perspectives and inadvertently promote an approach to impact investing that will corrupt the concept and undermine its potential.

The GIIN / Cambridge benchmark frames a question: can comparable or greater financial value be created by applying an impact approach to a business or investment?  And it appears to confirm intuition and anecdotal evidence: of course it can! There are many examples of “impact” businesses that command premium prices and profit margins and enjoy exceptional customer loyalty and employee productivity. Can greater profitability be generated by adding impact to a product’s features? Will customers pay more, employees be more productive? Might investors offer better terms? The answer is clearly yes. In particular, positioning products to appeal to the non-financial values of affluent customers with substantial discretionary spending can increase profitability.

But this type of win-win opportunity does not always occur. Unfortunately, not all our social and environmental challenges can be solved by selling premium-priced products to affluent consumers. In contrast, if we are talking about very poor customers with limited disposable income and few choices for quality products, the idea of them choosing to pay more makes no sense. In this case, should impact investors still require that providing essential services to such clients nevertheless beat a conventional financial benchmark?

As many commentators have noted on the Stanford Social Innovation Review June 2015 post, impact investment is not an asset class, it is an approach to defining and creating value in any asset class. Conventional investment defines value solely in terms of the financial dimension – returns, volatility, correlation – from the perspective of a single stakeholder group – shareholders. In contrast, impact investing is the proposition that value should be defined in multiple dimensions – environment, community cohesion and resilience, economic justice, gender equity, as well as financial parameters – and with respect to multiple stakeholder groups – employees and customers, their families, the immediate and the global communities. Each impact investor can weight these stakeholder groups and types of value differently, but when they collapse back towards financial value to shareholders, as the benchmark seems to encourage us to do, there is a legitimate question of why we bother to distinguish it from conventional investing, other than for marketing purposes.

By positioning superior financial returns as the threshold consideration and key driver for impact investors, the GIIN / Cambridge benchmark implicitly demotes the other dimensions of value that in our view give impact investing its meaning and transformative potential.

Some impact investors see an opportunity for a high multi-dimensional return from providing poor customers with high quality essential services – health care, housing, financial products, skills training – even if the financial dimension may not match or better conventional comparables. Others might see a compelling value proposition in an investment that addresses environmental degradation or climate change, even if the financial value creation did not beat conventional benchmarks.

But by applying the conventional value lens to one dimension of value and one stakeholder group, the benchmark reinforces the tendency to ignore the core questions that every impact investor needs to answer – What kinds of value are being created? And for whom? – and instead reverts to the conventional and antithetical view that money is the measure of all things.

Prioritizing financial performance as the primary or the threshold dimension of value cramps and ultimately extinguishes the transformative potential of impact investing.

Going forward, we hope that the next iteration of this and other benchmarks will explicitly highlight the other types of value being created and for whom. Only in this way can impact investing continue to transform the relationship of values-driven investors to the capital markets, and shift more capital markets activity from enabling destructive activities to promoting solutions to poverty, economic injustice, environmental degradation and our other pressing challenges. Without including these multiple values and stakeholders in the forefront of all discussions of impact investing we risk losing its potential for good, and condemning it to a short life as a marketing fad.