Societal Issues are Bound to Stay in the Impact Investing Space

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Interview to Uli Grabenwarter, Strategic Adviser of Stone Soup Consulting and Deputy Director – Equity Investments at the European Investment Fund.

By Pilar Balet. Posted on February 23rd 2016

1. How do you see the social enterprises sector evolving not just in Europe, but the world?

The social enterprises sector has come a long way over the last decade. It is now at a very decisive injunction point that will decide how it will move forward. On one hand, for the first time social enterprises are becoming aware of being targets of investment communities as investors move beyond the philanthropic space and use impact investing to scale the scope of their activities for doing good for society.

On the other hand, we see that the societal issues that social enterprises typically deal with have evolved a lot in these ten years. Social enterprises today need to change gears, not only do something that is basically good, but reflect on how they can make the social value that they create tangible and scalable. Those are the two biggest challenges that these enterprises are facing today, and that is what is at the base of the debate linked not only to measuring, evidencing and monitoring impact, but also to how impact is priced in the market.

2. What would you say are the main opportunities and challenges in the sector at the moment?

The opportunity is very clear and definite. Our socioeconomic system operates with assumptions that will not uphold in the future. One big element is linked to the State’s finances and how the public sector is going to fulfil its role as a welfare State.  Businesses across all sectors are facing more and more the issue of assessing sustainability as one of the factors of competitiveness. Competitiveness today is not only about the smartness of the product, but how you deal with resources that are vital for your business’ processes. It is also looking at how you deal with externalities and stakeholders. All those issues are today at the very core of successful businesses and impact investing.

“Traditional companies can learn a great deal from social enterprises”

Traditional companies can learn a great deal from social enterprises. Actually, social enterprises have a very odd business proposition, even strange from an investment point of view. They usually work towards solving a societal issue, which means that they seek to make disappear the reason why they exist. Thus, a succesful social enterprise will eliminate its business model reason of being. This might sound weird to investors at the beginning, but it is actually nothing else than what any business in today’s enterprise market environment needs to do. We are in a time where the most important feature for competitiveness is innovation. Social enterprises are bound to work at the edge of this because when they solve a societal issue they need to persist, continue and find the next issue and the solution that goes with it. Innovation is at the base of social enterprises and that is the big opportunity that we have. Not just for social enterprises, but also for society.

3. Coming down to Europe, it seems like the continent is evidencing the emergence of an ecosystem of social enterprises, incubators, accelerators and impact investors. Would you say it is something that will fade with fashion or is it here for good?

It is definitely something fashionable at the moment, yes. It is one of the risks that you may want to refer to. Social enterprises are not just about feeling good, but also about the change that they bring about. The change that can be tangibly sensed by their stakeholders, but also scaled in relation to the problem that they want to tackle. Historically, social enterprises have frequently adopted a very limited area of action and of the impact they can create. They are often limited by the scale they can reach with the funding they can attract. That has been the case due to the blurred border between philanthropic investment and for profit investment.

On the other side, even for-profit investors in social enterprises have so far not been challenging enough about scaling the impact that these businesses can achieve. We have social enterprises that grow locally, but stagnate at that level. We have incubators mushrooming everywhere and social venture funds trying to bring about that type of businesses. But there is still too little thought spent on how we can really make the value that they create tangible to society and also economically integrated, in the value that those companies have and the revenues that they generate. That is one of the big issues that we have to tackle today.

4. What is most innovative of the projects that the European Investment Fund is currently working with? What type or fields are creating the most social change?

The EIF is an investor. We invest in social enterprises directly and indirectly. But the social change and innovation is actually carried out by the social entrepreneur and the social enterprise itself. It is not something we can praise us for. We haven’t been at the origin of the brilliant idea that solves the societal issue, we merely enable it to materialise through our funding.  When we invest in social enterprises, we in a way “buy” an idea and try to bring it forward.

“the social change and innovation is actually carried out by the social entrepreneur and the social enterprise itself”

However, we are innovative in the financing tools that we make available to social enterprises in order to scale their activities. We’ve done that with our first product, the fund of social venture funds, and have spread access to finance for companies across Europe. In addition, we are currently working on payment-by-results instruments that will give different types of social enterprises access to for profit investment capital. Besides, we are also looking at implementing a co-investment scheme that will give social business angels and social enterprises access to additional capital in order to increase their reach. We value the competences that social business angels can bring to social entrepreneurs, not only by providing money but also coaching in how they can structure, organise and grow their businesses.

5. Regarding your experience creating the fund of funds for social investments, how do you foresee it will contribute to shape the sector in Europe?

We are in a period where the market is shaping and we are instrumental in the emergence of a new investment space. The fund of funds is the first fund in Europe dedicated to social venture funds investing in social enterprises. What is innovative about it is that we understand ourselves not only as a capital provider, but also as a sparing partner for fund managers that want to dedicate their investment strategy exclusively to social enterprises. We help them make their business model institutionally investable, and that is an important intake.

6. How do you manage that?

If you look at the space for social investments that took place ten years ago, you will see there were zero institutions interested in it. It was exclusively driven by philanthropic organisations, foundations and alike. Meanwhile we have acknowledged that we will never tackle social issues at the scale that they are growing today with the philanthropic capital we can mobilise. Hence, there has been a need to increase capital efficiency. Philanthropic money is preserved for those areas that can only be dealt with a philanthropic approach; investment capital is brought in for those social issues that can be dealt with in a market-based solution. In order to develop that space, social enterprises needed to make the move from non-for-profit businesses that collect grant money, to businesses that collect investment money and adopt business models.

“we will never tackle social issues at the scale that they are growing today with the philanthropic capital we can mobilise”

At the same time, there is a need for fund managers that accompany those enterprises in the process. In our fund of funds we have taken on the role of becoming a catalytic investor for creating this ecosystem. As an example, for the first time in financial market history, we have introduced the link between financial incentives and financial performance of fund managers to the impact that they create. We link the profit share that they get from their financial performance to the impact performance they can materialise in their portfolio. If they fall short of the set impact objectives, or if they create a financial return with activities that are not impact-driven, then this will have an impact on the carried interest that they take away from their activity.

7. We seem to hear a lot lately about impact investing. It seems like there are more people looking for impact projects around Europe than people with solid impact businesses.

We don’t necessarily have a shortage of investment opportunities, but we definitely have a shortage of competent intermediaries. If you look at the private banking market universe, there are plenty of high net worth individuals eager to access investment opportunities that combine financial return with social impact, but they get very little offer. The reason is that the requirements to the intermediaries that operate in that space have changed dramatically over the last five to ten years. Before, a private banker was nothing else than a salesperson that collected products from a centralised development unit within a private bank, and merged them with the portfolio composition designed by one office’s clients.

“there are opportunities for those banks that move fast and change fast”

Today, the client has become much more demanding in terms not only of what return is achieved by an investment product, but also how this return is achieved. There is a kind of consciousness about the purpose of the deployment of the money that is given to private bankers. Suddenly, the account managers that private banks have been operating with are over challenged because they are not used to clients asking questions. There is a whole education process and there is a need to reshape the client interface that private banks currently work with. During this period of change we are in, there are opportunities for those banks that move fast and change fast. The challenge is to catch up with this opportunity at hand.

8. Would it be possible to create a platform that could link and check deals for social investors and enable them to enter new markets?

There are plenty of those initiatives going on and platforms creating impact metrics standards. The market is very much in motion at the moment. Unfortunately, there is still a great deal of fragmentation. Not only geographically, but also in terms of investing mentality. The definitions of what impact investing, social enterprise or market space mean are very different. In terms of the development of the market space, the activity is definitely there. The question is how long will the process last until it can consolidate into a bigger critical mass that can attract also investors in a meaningful number to become a mainstream market.

“there is one thing in the impact investing space that is bound to stay which is the presence of societal issues”

Today, impact investing is still too often used by many mainstream market players as a twist in their traditional activities because it feels sexy and it is easy to sell in the market. But unlike the previous hypes that we have seen in the financial markets, there is one thing in the impact investing space that is bound to stay which is the presence of societal issues: the fact that they cannot be solved purely by distributing tax money to a few actors in the market because we lack resources to fund it all. The societal issues are growing at a pace that is overtaking us. Hence, no matter how much of the current market environment is linked to a fashionable approach of market development, those two issues are bound to stay. It means that we will have to keep looking for solutions no matter what the casualties are amongst those that have not been taking that market segment seriously.

9. In a past interview you mentioned that you wished a world where social impact is seen as an opportunity rather than a constraint to business development. Could you tell us more about this world you envision?

Being optimistic, this is probably the first wish of mine that will materialize. In the very beginning, social impact was a constraint in doing businesses, something that you actually needed to comply with. Today we are beyond the time where people saw that as a burden, but see it now as a necessity to remain competitive. Competitiveness is an opportunity; you can differentiate yourself by being more responsible to societal challenges.

A business today that deals with societal issues in a proactive manner has definitely a greater degree of resistance to macroeconomic cycles than a company that ignores them. Of course, you can still make money with models that disregard these challenges like the oil industries, and that will remain possible for years to come. But today you also have companies that act proactively in alternative energies and others. They survive because there is investment capital for them, and they are revenue generating businesses. The same things apply to social enterprises dealing with societal issues. We have got plenty of business models that ten years ago were nothing else than an outsourcing from the public sector to the private sector of social service delivery. Today, we see the State becoming more and more a market player that buys from social enterprises the delivery of social value. That is a very encouraging evolution.

Interview by Pilar Balet, Communications Coordinator, Stone Soup Consulting. @pbalet

sirronaldcohen

Merida, Mexico — On his trip to Mexico last week, the Pope called for a more ethical capitalism. “The flow of capital cannot decide the flow and life of people,” he said during a packed mass in the border town of Juarez.

A few thousand miles southeast, here in Merida, hundreds of investors, entrepreneurs and social justice advocates gathered to advance just such a financial system. The conversation at last week’s Latin America Impact Investing Forum, or FLII, tackled the challenge of redirecting capital towards businesses solving problems in the region’s poorest communities.

What we’re doing is going to change financial markets. It’s going to begin to allocate resources not on the basis of just risk and return, but on risk, return and impact.Sir Ronald Cohen

Now in its sixth year, the FLII is the largest impact investing gathering in Latin America. Discussions ranged from the potential of new social impact bonds and other pay-for-success models now popping up across Latin America; to the burgeoning interest of the region’s millennials trying to bring talent to the growing sector; to Brazil and Mexico’s entrance into the Global Impact Investing Steering Committee, the global body charged with promoting impact investing around the world and pushing for policy support in national markets.

For Latin America, a big question is how much support governments and big institutions are prepared to give the growing sector. Sir Ronald Cohen, often regarded as “the father of British venture capital,” was in Mexico to support the homegrown movement.

Cohen, who leads the Global Impact Investing Steering Committee, joined the conference to meet with impact investing leaders from Mexico, Brazil and Colombia. Cohen told the crowd that impact investing represented a revolution, disrupting business, philanthropy, government and civil society as we know it. In the future, financial markets will consider impact, alongside risk and return.

ImpactAlpha sat down with Cohen to discuss Latin America’s impact ecosystem, Wall Street’s role, and the threat of “rogue” impact investors. We were joined by Juan Del Cerro from Disruptivo.tv.

ImpactAlpha: As you travel around the world to conferences like this, what’s the level of enthusiasm you are seeing for impact investment?

Sir Ronald Cohen: The response has been great. Here at the Latin America Impact Investing Forum, for instance, there are people from more than 20 countries, all thoughtful, dynamic people, who’ve gone out of their way to come here. You realize this matters to a lot of people. And you can feel the atmosphere changing, country by country.

Disruptivo.tv: Can you explain the role of Global Impact Investing Steering Group?

Cohen: The U.K. government set up, on behalf of the G8, a task force to catalyze the global impact investment market. It did this in 2013 and we published our report a year later. The feeling was that we should not just stop. But if we wanted to continue we needed to broaden the group beyond the task force countries, the G8. So we decided to created a Global Steering Group, which would take the baton from the task force and push the implementation of impact investment across the world. The question was how many countries we would accept as members, because there’s a limit to how many new members we could absorb. We said we’ll take five, and the criteria is you’ve got a functioning task force in your country. This shows you are serious about impact investment. So we had invitations to join. We picked five countries from those who applied – Mexico, Brazil, India, Israel and Portugal – where a lot is happening in the country and a task force exists.

ImpactAlpha: Why was it important to add new members? 

Cohen: So each country has a shot at becoming the leader in impact investing. It’s not like tech, where you need an ecosystem that is complicated to put together. There are social issues everywhere across the world and there are entrepreneurs everywhere across the world. We’ve just been in a discussion with Colombia about post-conflict issues. Colombia could well innovate in this area if the right people pick it up and put the effort behind it and from there it can spread to other countries in the world.

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The social issues differ and there are some things in common, so I’m interested in helping anybody serious who wants to try to get impact investing going in their country. So from here I’m going to Silicon Valley. Then I’m off to Washington D.C., where the Brooking Institute has a whole meeting scheduled with 250 people on social impact bonds. A couple of weeks later I’m going to India, I’m visiting three cities in India. And it’s all demand. Demand is pulling me rather than my having to go around pushing it.

What interests me, is just as with tech, as you began to discover that tech can happen anywhere in the world–I mean the United States dominated it hands down but there were great software writers in Sweden and Finland and elsewhere. I think with social it’s going to be the same. If we want to improve people’s lives we have to do things at scale. It has to be global from the get-go and we have to think in terms of interventions that can be scalable. Which is why we’re thinking about very large outcomes funds for specific issues.

ImpactAlpha: Will the outcomes fund be tied to the new Sustainable Development Goals?

Cohen: Not necessarily. Because there are 17 goals, I’m not sure we can go all the way through them. But education clearly is a major, major way of improving people’s lives. If you can prevent someone from dropping out of school or university, it’s probably the single biggest influence you can have on how their life goes after that. So why I am going around all these different countries? Because all of these different countries have got people there that deserve to be helped and there are people who want to help them.

Disruptivo.tv: What are a couple things that the rest of the world can learn from Latin America?

Cohen: I think each country has its own ecosystem. When I went to visit Brazil, I found everybody rather depressed by the inability of the government to tackle social issues because of budgets, because of the functioning of the government, and so on and so forth. When the idea of impact investment was developed by their task force and they began to speak to people, a coalition of people began to come together, including big corporations and big banks. It turns out that the big banks, for instance, have very big charitable foundations and that these charitable foundations could pay for the outcomes, instead of the government. So all of a sudden, in a place like Brazil, if you say I want to improve the dropout rate in schools where kids from the favelas are going, my bank foundation would pay on the outcome.

I’m interested in helping anybody serious who wants to try to get impact investing going in their country.Sir Ronald Cohen

So you can go raise a social impact bond, sign a contract with me, I’ll pay you if you make sure that the number of kids that drop out of school is reduced. So I think what’s interesting about that is obviously if you can impact somebody’s life early on in their education you have massive improvements in the lives they would lead. But it’s also a way of supplementing what the government can do, so that countries don’t just depend on government.

Wherever I go there in Mexico there seems to be people interested in impact investment. There seems to be a groundswell of support in Mexico for impact investment.

ImpactAlpha: How specifically does the Global Steering Committee support its members?

Cohen: Mainly through the transfer of knowledge and experience and expertise. Like in the U.S., which just changed its regulations around trustees of foundations and pension funds, it’s because of the National Advisory Board that this happened. In the U.K. you’ve got parallel legislation that just made it through parliament to do the same thing for foundation trustees. It can be very powerful for other countries as a precedent. They can say look, it’s been done in the U.K., it’s been done in the U.S., why shouldn’t it be done here?

We are looking at the possibility of creating a platform for connecting leaders in impact investment across the world. So you want to start a recidivism social impact bond, you send out the message, you create a roundtable, you can discuss the issue, you can move forward. On diabetes, you get together and move forward. So whoever just issued the social impact bond could spend time talking about the metrics for a diabetes bond. The U.S. has a huge diabetes issue, India, the whole Middle East.

ImpactAlpha:  Impact investing seems to have embraced Wall Street and the big financial institutions. Was this an intentional strategy and do you believe Wall Street can be, and be seen as, as a force for good?

Cohen: So I like to say: money’s like water, you can live without it and if it drowns you, it’s not such a good thing. From my perspective what we’re doing is going to change financial markets. It’s going to begin to allocate resources not on the basis of just risk and return, but on risk, return and impact. It’s a process that could take 20 or 30 years.

A lot of financial institutions have people in them who agree. It’s not easy for the financial institutions to change their models. But it seems to me what we want to do at this early stage of development of the field is focus on the people who believe this can work, not focus on persuading the skeptics. If those people are in the financial services business they may well come back with amazing ideas for reducing the cost of finance for certain parts of the population. When you begin to see the challenge of fintech entrants now into finance, reducing the cost of personal finance, or the cost of finance for businesses (that) has a big social impact in itself — quite apart from the support that they can bring to aggregating money from investors in social impact bonds of one kind or another.

I think it’s very important for us to focus on all those who are interested in impact investment, and those within financial organizations should be no exception.

ImpactAlpha: Say we set up this structure of risk, return and impact. Are you concerned at all about the accountability of wealthy individuals that might not share our values, let’s say Vladimir Putin, for example, who might claim to be an impact investors?

Cohen: I think you have to very strict on measurement. I don’t accept that anyone who creates impact is an impact investor. That’s investment with impact. An impact investor is somebody who has the intention of achieving objectives, set objectives in the social or environmental area, and measures their achievements alongside financial return. People will try to call themselves impact investors. Everyone will be an impact investor as some stage, just as in the tech bubble everybody jumped into it and hoped for a high valuation. We just have to be very strict about saying, ‘If it’s not measurable, it doesn’t qualify as impact investment. It’s investment with impact, good luck to you.’

This article by Dennis Price first appeared here.