What it takes to build dreams – Part 2

Paula Goldman, Omidyar Network’s Director of Knowledge & Advocacy and co-author of the excellent “Priming the Pump” blog series made a very helpful and clarifying comment on the last post (emphasis added):

Sasha, excellent post. I agree with you that as a field we need to get a lot smarter about the risk/social impact equation — this will make or break the field. I also agree with you that the path to scale here isn’t just about making this an asset class. Commercial markets are already incredibly good at allocating capital efficiently, including to businesses that generate positive impact and solid financial return. The risk is that by pumping up the industry in this way, there will be nothing incremental or new about investments labeled as impact investing.

I would ask you though to reconsider the use of the term ‘crummy’ economics. While the economics in many cases for impact investing are sometimes different than traditional investing, taking on additional and different types of risk doesn’t necessarily mean lowering financial returns.

This comment shines a light on exactly the distinction I’m trying to make, because, for this conversation, I’d like to take a pass on the whole discussion of what the returns are in “impact investing” (and whether or not they are “crummy”) since I don’t believe you can answer that question without better defining which segment of impact investing you have in mind.

Instead I’d like to ask whether, as I observe anecdotally, there are sectors/project outside of impact investing that attract huge amounts of capital that have “crummy economics.”

To recap the sorts of conversations I’d love to redirect:

Question 1: “What is the risk/return profile for impact investing?”

My current answer: “It really depends on what you mean by ‘impact investing.’  For some (significant) part of what could broadly be defined as impact investing, the financial returns may well compensate an investor and her LP well for the financial risk she is taking.  However, there are also big and important parts of impact investing – including those segments where the non-negotiable is impact; and those segments focused  on the poorest, hardest-to-reach populations – where the financial returns likely won’t fully compensate the investor or her LPs for the risks they are taking.”

Question 2: “But if the returns aren’t there, doesn’t that mean that the sector will never grow? Doesn’t that mean that capital will never flow in in significant ways, in which case the sector will never scale and reach its potential?”

AHA!  THIS is the question I’m aiming to dig in to, not the prior one.   This is why I said that I’d observed that “increasingly across sectors I meet more and more people who acknowledge that most of the most important (dare I say the most “impactful”?) work they do has crummy economics.”

Namely, I’m finding the discussion on “what the returns are” to be circular, because it hinges on how you define “impact investing” and what particular niche/sub-segment you are in.  The dead-end I’m trying to break through is the one that says “IF the returns aren’t there versus the risks people are taking, then capital won’t flow in.”

My hunch – and the thing I’m looking for data on – is that this statement might be empirically incorrect.  My hunch, informed by conversations with people in sectors far away from impact investing, is that the overall NET returns for huge swaths of projects that create public good (and have an underlying long-term economic logic) might be low (aka “crummy”).  But these projects and the people backing them find a way to make them happen at scale – whether by layering capital, layering risk, layering returns, bringing in philanthropy….. in such a way that lots of stakeholders and lots of stripes of money get what they want.

And so, my non-empirically-proven hunch is that the fundamental net (total project, total portfolio) return being low doesn’t inherently limit the ability of billions, even trillions of dollars, to find its way to meaningful project that have a blended return.   That’s the data I’m looking for.

One reader kindly pointed out the Kauffman Foundation’s recent report that revealed that 78% of their traditional venture capital funds “did not achieve returns sufficient to reward us for patient, expensive, long-term investing.”   And yet $22 billion a year still flows into venture capital.

Not exactly what I had in mind, but that seems to be a pretty great data point showing that failing to compensate LPs adequately for the risks they take doesn’t mean that money won’t flow in.

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2 Responses to What it takes to build dreams – Part 2

  1. Paula Goldman, Omidyar Network says:

    Hi Sasha,
    Really glad you keep digging here.
    I would see it a little differently. I do in fact think commercial capital needs to enter many of the markets in which impact investors play in order for them to reach massive scale — and that therefore market rates of return are important. But what people seem to be missing is the question of time and sequencing. After all, if phenomenal high impact high financial return investments already existed in many of the sub-sectors of impact investing, the commercial markets would already be all over them and there might not be any need for impact investors.

    To us at ON the whole promise of impact investing is to be able to catalyze the growth of new models that can have massive social impact — to be able to derisk these generic models so that they can grow and tap commercial capital to scale. We believe more capital needs to go in at the early stages of testing these models. And while the economics here are sometimes (definitely not always) different, it’s important that impact investors choose businesses that they believe *will* eventually become viable enough to scale through commercial capital seeking market rates or return.

    Certainly happy to continue the conversation; it’s an important one!
    Paula

  2. carl fischer says:

    Nice to follow two ” heavy weights” in this space in a rather academic discussion.
    The issue of returns has been hyped up because Impact Investment has frequently been called an asset class. It is not. Rather it is present in many asset classes. And as returns in those classes vary so they do here. The main issue in terms of attracting capital is that the major investor so far has been excluded. It is the same investor that has made SRI so big: the unaccredited investing public ! This industry us preaching to the converted. The public at larger doesn’t even know that Impact Investing exists and if it did it had no way of investing in it.
    As long as we continue meeting each other at expensive events or academic discussions it won’ t have an impact at all. Histiry tells us that change only happens once adopted by the people ( cars, phones, internet etc.). If the people dont’t know – keep talking.

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