A New Epistemology of Solving Complex Problems

I’m in India, spending the week with the Acumen team and with the Acumen India Fellows for their fourth seminar. Last night, at the end of the first day of seminar, we were joined by Vijay Mahajan, one of the most esteemed social sector leaders in India. Vijay is the founder of Pradan, which he ran from 1983 to 1993, and was then the founder of BASIX which grew to be one of the largest microfinance organizations in India prior to the microfinance crash in 2010.

Vijay is a truth-teller, who speaks plainly and without adornment about his experiences. Our conversation was an intimate one – just us (20 India Fellows, me, Jacqui Papineau and Bavidra Mohan, together with Vijay and his colleague, documentary film-maker Girish Godbole), with Bavidra interviewing Vijay before an open Q&A.

Upon hearing Bavidra’s first question, around lessons about leadership, Vijay paused and thought hard for what must have been 20 seconds before responding. Just watching such an esteemed individual, who must have been asked a similar question hundreds of times, really stop and think before giving an honest answer was a display of humility and respect for our group that itself spoke volumes.

From that moment on, everyone in the room was silently hanging on Vijay’s every word, with most scribbling furious notes of Vijay’s pithy insights. My single biggest takeaway stemmed from a comment Vijay made early on in the discussion, when he said:

Anything that could be solved with single variable maximization was solved in the 20th century…we need to create a new epistemology of complex problems for the 21st century.

I’ve always felt that impact investing and social enterprise are something brand new. If this work is going to realize its true potential, we are going to need to think about two-variable approaches – or, better stated, leadership that embraces opposable mind thinking and sees potential where others see only contradiction.

I must admit, until last night I had not aspired to creating a “new epistemology” but I think Vijay is on to something. Ultimately we need a strong theoretical and analytical grounding to explain what it would mean to take truly new approaches to solving centuries-old problems, problems that are based as much on caste, social exclusion, geographic marginalization, and politics as they are on simple microeconomics. And, as Vijay reminded us, such a theoretical underpinning is not entirely new. Indeed, in 1956 economist Herbert Simon developed the notion of “satisficing” rather than “maximizing” behavior as being a more accurate description of how individuals and firm managers behave. Perhaps we need more satisficing firms of we are to solve this new batch of problems.

Indeed, the more I think about it, the more it strikes me that Vijay’s statement summarizes the core fault line within impact investing and social enterprise: is impact investing just about extending the market, a chance to extent single-variable (profit) maximization to areas where it hasn’t yet reached? Or is single-minded profit maximization (versus profit achievement), as a binding constraint, anathema to the real task of tackling social issues?

There’s no doubt that there is work to be done on both sides of this fault line. It is an overstatement to say that all single variable maximization problems were solved in the 20th century, and there are huge emerging swaths of the population – hundreds of millions of people – who are optimally situated to benefit from the extension of 20th century approaches to them. However, I believe that impact investing will fall far short of its potential if it limits itself to this approach (indeed, isn’t it just “investing” to find businesses that fit age-old criteria and invest to help them grow)? What I am seeing after nearly eight years doing this work is that that, outside of narrow verticals (e.g. financial services on mobile platforms), the social sector leaders who are working to reach marginalized populations do not act as if single-variable maximization is enough.

By the way, it bears mention (lest anyone jump to conclusions) that just because one agrees that a narrow profit-maximization mindset is not enough does not predetermine anything about what business models need to look like, what form an organization should take (for-profit, non-profit, or some other form), or even about financial returns. Rather, this is a conversation around what sort of problem one believes one is working on, and an assessment up-front of whether the tools that we created in the 20th century are up to the task of tackling the problems of the 21st century.

Vijay’s closing thought, with which I heartily agree, was that “we cannot build great theory if we keep on reporting practice wrong.” Our challenge, from the outset, is to have the audacity to imagine the world as it could be, and the humility to share the real lessons of what it takes to create large-scale social change. Vijay certainly shared his real lessons with us, and I know that I and the Acumen India Fellows will follow his lead in continuing to take problems head-on, and honestly share what we are learning with other practitioners, so we can all build a better future.

(And maybe, just maybe, we will eventually find a way to develop a PhD 21st in the Epistemology of Solving Complex Social Problems…)

Give Impact Investing Time and Space to Develop

Note: this piece originally appeared on the HBR Blog.

Impact investing has captured the world’s imagination. Just six years after the Rockefeller Foundation coined the term, the sector is booming. An estimated 250 funds are actively raising capital in a market that the Global Impact Investing Network estimates at $25 billion. Giving Pledge members described impact investing as the “hottest topic” at their May 2012 meeting, and Prime Minister David Cameron extolled the potential of the sector at the most recent G8 summit.  Sir Ronald Cohen and HBS Professor William A. Sahlman describe impact investing as the new venture capital, implying that it will, in the next 5 to 10 years, make its way into mainstream financial portfolios, unlocking billions or trillions of dollars in new capital.

As this sector moves from the margins to the mainstream, it’s important to consider: What will it take for impact investing to reach its full potential?  This question is hard to answer because, in the midst of all of this excitement, there aren’t clear success markers for the sector.  Without those, the institutions managing the billions of sector dollars won’t be able accurately to assess the risks they are taking and, more important, the returns, both financial and social, they hope to generate.

Impact investing is not just a new, undiscovered corner of the investing world. It has the potential to join traditional investing and government aid and philanthropy as a third way to deploy capital to address social and environmental issues. A fully developed impact investing sector will incorporate the best features of markets—rigor and speed; quickly evolving business models; strong revenue models; and access to capital as ventures show signs of success—with the best features of government aid and philanthropy—serving unmet needs; reaching populations that are bypassed or exploited by the markets; investing in goods with positive externalities; and leveraging public subsidy to extend the reach of an intervention—to solve social problems.

Impact Investing_Time to Develop_1

Because impact investing really is something new, the old ways of assessing risk and return are not enough.  And yet, like a moth to a flame, those in the sector are endlessly drawn to discussions around what constitutes the “right” level of expected financial returns.  There is no single right answer to this question.  Under the broad umbrella of impact investments lie myriad sectors, asset types, and investment products, most of which still need to be developed and understood.  It looks something like this:

Impact Investing in 2014: Colorful, full of potential, and highly disorganized

Impact Investing_Time to Develop_2Note: Each circle represents a business and each color represents a business vertical (e.g. sanitation, housing, mobile banking).

To make sense of this kaleidoscope, three things need to happen.

First, impact investing needs time to develop. This is a nascent sector where entrepreneurs and investors are still figuring out business models, developing new financial products, and proving exit strategies and exit multiples, and only a handful of players are using agreed-upon metrics for assessing social impact.  Whether it’s solar lighting, mobile authentication, micro-insurance, mobile banking, drinking water, urban sanitation, low-income housing or primary health care, entrepreneurs need time to test, modify, and refine business models.  These entrepreneurs are looking for support from risk-seeking investors who have an appetite for failure, are willing to be pioneers, and who value the social returns they’re creating.

As the sector grows through this period of creative destruction, models that don’t work will die out, models that survive will attract copycats, operating costs will go down, and winners will rise to the top.  The sector will organize itself across the spectrum from philanthropy to investing, and the resulting clusters will demonstrate the differences in risk, financial returns, target customer, and social impact across the various sub-sectors of impact investing.

Impact Investing in the Future: Developed clusters across the spectrum

Impact Investing_Time to Develop_3

Second, in addition to time, the sector needs a framework to measure success, one that makes sense of the sector’s inherent diversity.  Akin to the Morningstar Style Box, such a framework would allow an investor to easily identify best-in-class social and financial performance across and within the various sub-sectors of impact investing.

Third, the sector needs practical, widely-adopted, and standardized tools to measure social impact.  This is easier to describe than it is to do.  Although investors value both financial and social return today, the sector only measures financial return well. The big, unspoken risk is that we’ll end up ranking and sorting impact funds by the only thing they can be ranked and sorted by – money – without assessing or valuing the different levels of social impact these funds have.

The future of impact investing depends on our ability to embrace what we’ve learned over the course of economic history: solving social issues requires both private and public capital, a combination of risk-seeking investors and incentives and subsidies from public actors to make it easier and more attractive to reach underserved segments of the population.  Hospitals, parks, educational systems, sanitation infrastructure, low-income housing — globally, risk-seeking investors build these solutions in partnership with the public sector, which plays its part to adjust incentives, act as a major customer, and provide subsidy where needed.

What the sector needs is enthusiasm about the future and patience around the time it will take to get there.  In traditional investing there is a premium on liquidity, low beta, and lower risk, all of which justify higher or lower returns. In impact investing, we need to find a way to place that same premium on social impact by valuing the public good being created – just like we do in early stage R&D in science, IT, health, and biotechnology. We allowed microfinance and the venture capital industry the time and space to develop over a few decades. Surely we can do the same for impact investing.

Quantitative Social Metrics for Impact Investing

I have this nagging feeling of an elephant in the room – in the room of impact investing, I mean.

On the one hand, we’ve made tons of progress.  I don’t just mean progress in terms of more funds being raised and more mainstream attention – though those are both good things.  I mean that it’s become increasingly accepted, conceptually at least, that for an investor to be an impact investor, she must actively intend to create impact, and she must actively measure the impact she is creating.

(E.g. the World Economic Forum report’s recent definition of impact investing as “an investment approach that intentionally seeks to create both financial return and positive social or environmental impact that is actively measured.”)

While we’ve made progress on the language, I’m not sure how far we’ve come on the “actively measured” bit – mostly because it’s really, really hard to measure impact.

Let’s not forget what’s at stake here though. We value what we measure.  And what we are able to measure today is financial return.

Think about it:  we have hard, objective measures on the financial side – or we will, as soon as more impact funds realize their returns.

And we have a framework for measuring impact (in the IRIS standards, and in GIIRS ratings) but no agreed-upon standard of what social impact data should be collected and shared by impact funds.  This means that, despite the incredible work of building IRIS and GIIRS, we continue to build an impact investing sector without agreement on what constitutes impact and what minimal data should be collected by impact funds.  If we continue to walk this path, my fear is that (say what we might to the contrary) we’ll inevitably end up ranking and sorting impact funds by the only thing they can be ranked and sorted by – their financial returns.

It strikes me that part of the way forward is by constraining our path.  What if what’s holding us back is too many options, if the Achilles heel of the 400+ IRIS indicators is that they leave even the most well-intentioned impact investor overwhelmed and a bit mystified?  What if part of the way forward is to narrow our search to the most important, most universal, most quantifiable data we can find that will give us one-level-deeper insights into what’s going on underneath the hood.  Quantifiable because this is the only thing that might start to balance the scales and be weighed equally with the financial returns we hope to realize.

For example, wouldn’t it be nice to understand who impact investors are actually serving?  To understand who the end customers are for the companies that make up various impact portfolios?  If this could be objectively assessed, and if we could gather this data easily, this data might start to tell us something beyond what we can find in the glossy prospectuses of impact funds.  We know, of course, that reaching the emerging middle class in urban sub-Saharan Africa and reaching the poor in rural sub-Saharan Africa are two completely different balls of wax, yet gathering data on who a given fund is actually serving has been, so far, nearly impossible.  And until we gather this data, we’ll never begin to properly understand how far market-based solutions can go to reach poor and underserved populations.

This is just one of the areas I’m excited to be exploring with our impact team led by Tom Adams at Acumen – using cellphones and text messages to quickly and reliably understand who end customers are, so that we’ll have the real data capturing who is actually being served across different geographies and sectors.  We successfully piloted this work last year with a Kenyan firm called Echomobile, and we’re rolling it out more broadly across the full Acumen portfolio.  The idea is to use technology, married with smart frameworks like the progress out of poverty index, to make it easier to get data and insights about real impacts on the ground.

I don’t know what these data will tell us, but I do know that the pursuit of easy-to-collect, quantitative data will be a first step towards differentiating the social impact strategies of the myriad impact investors in the marketplace.  And I think this will be part of the way forward.

This video of a talk I recently gave at Acumen’s Investor Gathering explored this idea in more detail, and it starts to outline what the end state of impact investing might be.  Let me know what you think!

How do I get a job in impact investing?

WSIC2013I had the chance to speak at the Wharton Social Impact Conference this past Friday.  It was fun, engaging, and energizing to see so many students so immersed in this space.  Indeed Wharton’s Social Venture Fund – I met the team while on campus -has 35 members (selected from more than 100) who give 5-10 hours a week to source, diligence and recommend potential impact investments across numerous sectors; and they have just raised enough funding to make early stage investments in a number of these companies for the next few years.  Great stuff.

Inevitably, one of the questions one gets asked in these sorts of settings – directly and indirectly – is: “how do I get a job in impact investing?”

I found myself answering the question two ways.

If the question meant, “if I want to be the person doing the impact investing (in the developing world?), how do I get that job?”  in which case the answer is pretty straightforward: build experience both in deploying capital directly in private transactions (e.g. in private equity or venture capital) and have direct operational experience in the geography where you’d like to deploy that capital – ideally working in the sector in which you’d like to invest.

And then try really hard to get picked for the job that you want.

The problem is, I think it’s way too early to be asking that question, because it fundamentally overestimates where we are in the evolution of this industry.  “Impact investing” is a nascent, messy, ill-defined space that’s somewhere near late toddlerhood.  We can barely agree on definitions of what is and is not an impact investment, and we’re a long way off from being properly organized as an industry.  For something so new, with so many talented people excited and looking to make an impact, the orientation cannot be around how to get picked for the tiny number of jobs that exist for the massive number of amazingly qualified applicants.  Instead, the opportunity is to create a job, a role, a set of experiences that will allow you, over time, to help us all shape and move and define this new space.

Ultimately, letting go of the notion of a job search broadens your opportunity set in two ways.  First, it forces you to recognize that the odds of getting picked for that 1 in 1,000 job you think you want are not good enough odds for someone as capable as you are.  And this is good news, because the moment you realize it is the moment you can take on the work of shifting your orientation from job-seeking to job-creating, which I’d rather you do sooner than later because it keeps you in the driver’s seat.

Second, once we recognize how early it is in the creation of this new ecosystem, we can begin to understand that people who will define this new space won’t just be investors, they will also be entrepreneurs and company-builders and thinkers and connectors and fundraisers.  They will be troublemakers in big institutions who can bend a big operation in a new direction, and free agents who are skilled at connecting ideas with people with money to make things happen.  Mostly, they will be the kind of people willing to do the hard work of creating something new.

This sector doesn’t need people who are looking for jobs – and it won’t for a while.  What it needs are people (like the folks I met at Wharton) who have a 10 year head start on those of us who are already in the industry, people who are willing to take the whole sector to another level and, I hope, to a better destination.

More shapers and visionaries and big thinkers, please.  We are still just at the beginning.

Impact Investing – From the Margins to the Mainstream

[Note: this post originally appeared on the Acumen blog]

Today, the World Economic Forum (WEF) is releasing a new report titled, From the Margins to the Mainstream: Assessment of the Impact Investment Sector and Opportunities to Engage Mainstream Investors.  The report aims, in the author’s words, to “provide an initial assessment of the sector and identify the factors constraining the acceleration of capital into the field of impact investing.”WEF Impact Investing Report

The report serves as a field guide for anyone looking to allocate capital into impact investing, targeting in particular the mainstream providers of capital (e.g. pension funds) that are, by and large, sitting on the sidelines.

Unlike some of the previous comprehensive reports on impact investing, the WEF report avoids the temptation of contributing to the hype around impact investing.  Rather, the authors, Michael Drexler and Abigail Noble, working in collaboration with Deloitte Touche Tohmatsu, provide a clear-eyed assessment of the state of the market today, collecting and clearly presenting much of the available aggregate data for the sector and also speaking directly to those who are managing mainstream institutional capital to understand how they view impact investing and what it would take for them to deploy capital into the space.

Clarifying Definitions

This report will serve as a powerful jumping-off point for the next stage of conversations within impact investing, and also, I hope, will accomplish the not-so-small goals of putting behind us the definitional questions of “what do we mean by impact investing” and “is impact investing an asset class?”

Let’s start with the definition of impact investing.  The WEF working group on impact investing, of which I was a member, started by wrestling with this core definitional question, and, as usual, the group was split between debate on the substance of the definition and fatigue that we still, as a sector, are stuck returning to first principles.  Indeed, between the GIIN, ANDE, leading practitioners like Pierre Omidyar and Matt Bannick, JP Morgan Social Finance, and the G8 Social Investing Forum we still don’t have an agreed-upon definition of impact investing.  Hopefully, with this report, those days are behind us.

The report defines impact investing, simply, as “an investment approach that intentionally seeks to create both financial return and positive social or environmental impact that is actively measured.”  The notable words in this definition are “intentionally” and “actively measured” – for how can we be impact investors if we do not intend to create impact, and how can we know if we have created impact if we do not actively measure what we have accomplished in both financial and social terms?  What unites impact investors is a shared purpose (“intention”) in creating social impact, and all the diversity of investment theses, sector focus, and expected risk / return profile should not obscure this fact.  And, as a sector we must set minimum standards around social impact measurement, and continue to drive the practice of assessing the social impact, in order to demonstrate to ourselves and to the world where and how we are making a difference.

The WEF report also quickly and elegantly dismisses the notion that impact investing is or should be an asset class, stating that impact investing “is a criterion by which investments are made across asset classes. An asset class is traditionally defined as securities or investments that behave similarly under varying market conditions and that are governed by a similar set of rules and regulations. Under this definition, it is clear that impact investing is an investment approach across asset classes, or a lens through which investment decisions are made, and not a stand-alone asset class.”  Hopefully this succinct statement, and the supporting arguments in the report, will put this question to bed once and for all.

The Perspective of Mainstream Investors

To date, according to the WEF report (sourcing 2012 data from GIIN and JP Morgan), the largest providers of capital into impact investing to date are Family Offices/High Net Worth Individuals and Development Finance Institutions (DFIs) – which is surprising since together Family Offices and DFIs hold just 2.5% of all global assets.  The goal of the WEF report is to demystify impact investing for the holders of the other 97.5% of global assets, and the authors started by talking to these holders of capital to see what they think of impact investing today.  The results of these conversations are quite sobering.  For example, in surveying representatives of US-based pension funds the authors discovered that:

[The WEF] survey results indicate that US-based pension funds are generally unfamiliar and confused by the term “impact investing.” Almost all (81%) of the respondents have heard of the term before, but most feel that it is another term for responsible or sustainable investing (36%) or that it is a noble way to lose money (32%). Only 9% felt that impact investing is a viable investment approach. As such, only 6% of respondents are currently making impact investments today.

The question, of course, is whether these U.S.-based pension fund managers are missing something or if, instead, we are in the early days of impact investing and it is appropriate for mainstream capital to, by and large, be sitting on the sidelines.

One telling piece of data from the report is that of the 242 impact investing funds assessed in April 2013, 62% of these funds had less than a three year track record, indicating that it is very early days in this market.  Furthermore, much of the capital in the market today, especially capital outside of microfinance funds, is deployed in long-term, illiquid investments, so it should not be surprising that mainstream investors are taking a wait-and-see attitude since financial returns for most fund managers are largely unrealized.  On the flip side, these data reinforce that, for those who are willing to take on risk and be first movers in this space, there are tremendous opportunities.

Recommendations

The WEF report ends with a series of recommendations around what it will take to accelerate the growth of the impact investing ecosystem and, in turn, bring more mainstream capital into the space.  These recommendations – three each for impact investment funds, impact enterprises, philanthropists and foundations, governments, and intermediaries – are the most actionable part of the report for those of us in the sector, and they should be taken seriously.   The recommendations that strike me as the most important are:

  1. For impact investing funds: be clear and transparent about financial returns and standardize impact reporting.   In this next phase of development of our sector, we have an urgent need for segmentation, and this will not be possible without real data.  It is up to all impact investors to build the systems to collect data on financial and social performance, and take the steps to share it, so that the world can develop a much better understanding of actual rather than targeted performance.
  2. For impact enterprises: proactively measure and report on social and environmental impact.  It is up to the sector as a whole to standardize measurement practices and to bring the costs of measurement down, and up to leading impact enterprises – especially those first movers who have reached scale – to show what is possible in terms of measuring and sharing social and environmental impact data.  We need these success stories to show us the way.
  3. For philanthropists and foundations: Help lower risk by providing grants to early-stage enterprises and anchor investments to impact investment products and funds.  Given how much capital is still sitting on the sidelines, as well as the fact that philanthropists and foundations have been the first movers in this space, we need continued deployment of risk capital (grants and subordinated capital) – to companies and to funds – from those who understand the space best.
  4. For governments: Help de-risk the ecosystem through innovative financing mechanisms.  Whether through guarantees (like the New York Acquisition Fund), subordinated positions in funds, or other mechanisms (e.g. Social Impact Bonds or Development Impact Bonds), governments can use their capital to accelerate the growth of the sector and attract mainstream capital.  Impact investing is creating public goods and governments should be comfortable using public monies to accelerate the growth of this ecosystem – including by luring in mainstream financial players.
  5. For intermediaries: aggregate data on impact investing and publish the findings.  This is the clear corollary to the first recommendation.  Our sector urgently needs real, available, public data on financial and social performance across different investment strategies, sectors, stage of investment and geography, in order to better discern the realities on the ground.

This WEF report is comprehensive, clear, and actionable, providing a tremendous opportunity for all actors in the space to accelerate the development of the impact investing ecosystem.  It is exciting to see how far we have come, as well as to have a better sense of the next building blocks we will need to put in place to continue to grow and deepen the impact of our sector.

When Can Impact Investing Create Real Impact?

Paul Brest and Kelly Born recently published a fascinating article in Stanford Social Innovation Review called “When Can Impact Investing Create Real Impact?”   In additional to this article being very much worth the read as a major contribution to the theoretical underpinnings of impact investing, SSIR took the step of framing the piece as “Up for Debate” and they asked a number of leading thinkers in the space to share their perspectives on the article.

The combination of the original article and the responses serves as one of the most up-to-date, unvarnished perspectives on where impact investing is today, what different leading players see as the strengths and fault lines within the space, and where people come out on the core questions of what is (and is not) investing for impact, how social impact and financial returns are either complementary or in tension, and the role of measurement (assessing impact) in creating long-term change.

For those of you who are in impact investing or want to understand the space, I highly recommend the full suite of responses by Audrey Choi (Morgan Stanley), Nancy Pfund (DBL Investors), Amit Bouri (GIIN), Beth Richardson (B Lab), Brian Trelstad (Bridges), Mike McCreless and Catherine Gill (Root Capital), Matt Bannick and Paula Goldman (Omidyar), Sterling Speirn (Kellogg Foundation),  Nick O’Donohoe (Big Society Capital), Antony Bugg-Levine (Nonprofit Finance Fund), John Goldstein (Imprint Capital), Harold Rosen (Grassroots Business Fund), David Wood (Hauser Center), Alvaro Rodriguez and Michael Chu (IGNIA),

My own take on the article was this:

Paul Brest and Kelly Born’s article brings a welcome analytical framing to the emerging field of impact investing. The sector has been growing exponentially, with a large number of new funds being raised and increasingly mainstream visibility. In June 2013, UK prime minister David Cameron kicked off a G8 session in Lough Erne, Northern Ireland, on impact investing.

The irony is that despite the increased attention and funding for impact investing, there is still considerable debate about what actually constitutes an impact investment. Indeed, some of the most aggressive claims about the size of the impact-investing market—generally agreed to be a few billion dollars today, and predicted by some to grow to anywhere between a few hundred billion and $1 trillion by 2020—hinge on loose definitions. For example, much of the predicted hundreds of billions in impact investing comes from the microfinance sector, capital that effectively has been rebranded “impact investment.” And a considerable amount of private capital that was already being invested in developing countries seems increasingly to be called impact investments.

This lack of clarity about what impact investing is and isn’t makes it harder for investors to understand the landscape, harder for funds to raise money, and harder for entrepreneurs to navigate a sea of new investors describing themselves in similar ways but behaving very differently in terms of return expectations, risk appetites, and long-term objectives.

Brest and Born’s article bravely takes on many of these core definitional issues, and it is meticulous in defining the types of impact an investor could have: enterprise (the product or service makes a difference), investment (provision of capital that would otherwise not be available or be more costly), and nonmonetary (supporting the ecosystem) impacts.

Nonmonetary impacts are the clearest and least controversial—providing technical assistance, building the enabling environment or the ecosystem, even bringing in more mainstream capital. Most of these activities are familiar forms of enterprise support (though grossly underdeveloped within impact investing). Investment impact, in Brest and Born’s view, hinges on the concept of additionality—to be an impact investor, one must be making something happen that otherwise wouldn’t. For example, one can be an impact investor seeking high rates of financial return if one is exploiting frictions in the market (such as small deal size or misperception of trade-offs between risk and returns) that keep others from deploying capital. Appropriately, return expectations alone tell you little about who is in and who is out.

In effect, this definition narrows the field of impact investing. By asserting that an investor in a highly developed subsector of the market—where people compete for deals and capital flows freely—is not an impact investor seems to imply, for example, that much of the capital going in to microfinance today is not impact investment. This is an interesting assertion (nothing happened that wouldn’t have otherwise) but it also feels like analytical parsing: it is true that an investor is not having impact if she is doing something that would happen anyway, but that tells you little about whether the investment has created enterprise impact, which seems like a more important question.

This brings us to the central question of enterprise impact. Ultimately, what we care about is whether, how, and why impact investments improve peoples’ lives. Yet unfortunately, besides a broad framing, the article does not dig deep into enterprise impact outside of the wholly accurate, if nearly clinical, observation that “the absence of data and analysis makes it difficult for impact investors to assess the social impact of the enterprises they invest in.”

As such, the article reflects the current state of dialogue in impact investing, which I hope marks the closing of the first chapter of sector-formation and the start of the second. Nearly all of the discussion in impact investing currently is focused on the capital-formation end of the value chain: Who is an impact investor? What are returns? And yet the things that matter the most happen at the other end of the value chain, at the level of customers and the enterprises that serve them.

We must continue to push further and faster in our work to analyze how people’s lives are or are not improving as a result of our work. This begins with the simple expectation that one cannot be an impact investor if one cannot articulate the impact one aims to have and assess whether or not that impact occurred. The IRIS taxonomy and the GIIRS ratings system serve as strong foundations for these efforts, but they are just a starting point. We need to continue to push for better, more cost-effective forms of data collection—including integrating technology into our measurement efforts—to learn more about who customers are, what their needs are, how those needs are or are not being met, and, at a minimum, what outcomes occurred.

Without this type of information we risk creating a Potemkin village, one that looks nice from the outside but crashes to the ground the moment you knock on the door to peek inside.

An underdeveloped market for risk

So much of the conversation in impact investing is about returns: what are they, what should they be?  Now and in the future?

Not so much talk about risk, though.

It strikes me that in traditional investing, people are rewarded for risk-taking and the most successful investors are those that become good at taking the right risks, good at discovering information asymmetries, good at making the well-placed bet early.

My hypothesis is that our biggest ability to create impact is going to come from finding the “next big thing” business models, the ones that solve problems that haven’t been solved yet – whether in energy distribution, sanitation, water, education, healthcare, etc.  And it feels to me that it’s unlikely that, in most cases, betting on new, untested business models – meaning creating new markets with huge amounts of friction (bad roads, poor ports, unreliable distribution, corruption) serving customers who are, by and large, new consumers of whatever you’re selling (so high acquisition costs, etc.) – is going to fully financially compensate investors and entrepreneurs for the risks they’re taking.

[To be totally clear, I’m differentiating between “good” and “astronomical” returns here, and arguing that if we’re clear-eyed about the risks you have to take to solve problems that have never been solved before, then “good” financial returns aren’t good enough, if your yardstick is a simple financial risk/return analysis.]

Of course the whole point is that there are funds and investors that are willing to accept lower returns because they DO value social impact.  And I hope that space continues to grow.  But what keeps me up at night is whether there’s a strong reinforcing mechanism that rewards risk-taking in that part of the capital curve?

Meaning: are the kinds of people who place real value on social returns, by disposition and in terms of feedback loops in the marketplace, likely to be rewarded and culled and selected for their ability to take big, well-calculated risks?  Or is it easier to soft-pedal on risk when the upside is mostly non-financial?  And, if that’s true, are we systematically under-investing in the highest-potential opportunities, because we shy away from risk?