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Global, June, 08 2018 - How do we make sure that the blossoming impact investment movement — especially as it starts to supplant traditional aid — actually leads to improvements in outcomes for the people and communities it is supposed to benefit?
The impact investment industry is growing rapidly, a fact that many of us in the field celebrate. In 2010, J.P Morgan projected up to $1T in investment would be deployed this decade — which would make impact investing twice the size of official development aid to the world’s less develop countries (as defined by the United Nations), presuming historic levels of aid stayed constant since 2010. Many of us are starting to envision a day where we can drop the “impact” moniker and just assume that investments take into account social and environmental factors.
But are we scaling the right model? How do we make sure that the blossoming impact investment movement — especially as it starts to supplant traditional aid — actually leads to improvements in outcomes for the people and communities it is supposed to benefit?
Impact investors over the past decade largely focused on proving that impact investments could achieve a “market rate” or above return profile. Making something wildly profitable will of course attract the attention of financial markets, and thus increase the chances it will scale effectively.
Often, however, the elements that make something profitable work counter to those that maximize positive social impact. So it’s important to recognize that if we expect to expand impact investment based primarily on its profitability, we should expect to get just what we set out to create: a tool that has maximized profit over impact.
In my view, the pursuit of scale must be accompanied by a litmus test to make sure we are equally scaling impact, in a way that is both accountable to and transformative for beneficiary communities.
Impact investing can learn from the history of microfinance — the provision of debt and other financial services to the poor — an industry that was at a similar stage 15 years ago. In that case, the industry achieved financial scale, while impact at scale was largely left behind. Fortunately, impact investors have the opportunity to think more creatively over the next decade, as long as they learn from past mistakes in microfinance.
Lessons from Microfinance
There are two major debates in particular about microfinance that are relevant for the impact investment industry.
First, does microfinance help people, and if so, how much? Depending on who you talk to about microfinance, it is either the solution to global poverty and deserves to be included in the basic list of human rights, or it’s a complete rip-off of the global poor that only serves to concentrate more resources in the hands of the wealthy. A long line of studies has been unable to conclusively prove the point for either side. Still, the question is important to ask.
Second, should microfinance make money, and if so, how much? One school of thought held that, for microfinance to scale and attract and maintain commercial capital, it needed to show that it could achieve market rates of return. Others believed that, if it was truly a social intervention, perhaps it shouldn’t make money beyond enabling institutions to sustain themselves, especially if the owners of those institutions are primarily wealthy people outside of the communities being served.
If our starting place in defining successful scale-up is a certain expected return for the investor, then the tail is likely to wag the dog in terms of the financial services offered and who ultimately benefits. For example, many microfinance institutions have promoted loans far more than they have promoted savings, as loans produce much higher margins — and in the case of some less scrupulous institutions, people have been flat-out prohibited from opening savings accounts if they are not taking out a loan as well. Prioritizing profitability over impact can also lead institution to provide activities and services according to which ones are most profitable, rather than which best support poor people and ultimately eliminate poverty.
Scaling microfinance through financial market adoption became the predominant preoccupation and ambition for the industry before the questions of “Does it actually work to reduce poverty, and under what circumstances does it work best?” were fully answered. The assumption became, “Microfinance works, so let’s scale it” without acknowledging how scaling through the prioritization of profits could change the nature of the industry and have consequences for the people being served.
Early adopters of microfinance wanted to prove that it was a commercially viable product, deserving space in an investor’s portfolio alongside real estate and the stock market. By 2010, they had succeeded. Compartamos Banco, a Mexican microfinance institution largely owned by Accion International, had been able to undertake an initial public offering in 2007 with a valuation ultimately reaching $1.5 billion, implying a 250x return on the initial $6 million put in by founding shareholders, a roughly 100% annual return compounded over eight years. It was one of the world’s highest-grossing IPOs in a year when the market was otherwise in chaos due to the mortgage lending crisis.
In 2010, in India, the microfinance institution SKS also went through an IPO that generated millions in profits — along with an impressive amount of scandal and intrigue. In both cases, a large number of shares (and in the case of Compartamos, the majority of shares) were owned by nonprofit institutions, which presumably plowed this profit back into more development work.
Globally, some $38 billion in investments and 624 million “beneficiaries” later, microfinance had indeed grown up as an industry. But while the industry was scaling, it had a rougher time justifying its popularity based on the idea that it was actually helping poor people. A 1998 study by Mark M. Pitt and Shahidur R. Khandker that inspired elation about microfinance’s impact on poverty was later discredited by David Roodman, a well-known research scientist in the field, as having been based on faulty methodology. Additionally, Grameen, the bank founded by Muhammad Yunus that had pioneered microfinance, issued a literature review in 2010 of the most thoroughly conducted randomized controlled trials at the time. The report concluded that “collectively, these three studies suggest that microfinance had impacts on business investment and outcomes, but did not have impacts (positive or negative) on broader measures of poverty and social well-being” (my emphasis). The only positive impact, according to the study, was that people who already had higher incomes and established businesses were able to benefit from access to financial services.
How do these challenges apply to impact investment? First and foremost, we need mechanisms to insure we scale impact alongside financial return. These mechanisms should include the three principles suggested by the nonprofit Transform Finance: engage communities in the design, governance, and ownership of enterprises; ensure that those running institutions and structuring transactions, add more value than they extract; and balance risk and return between investors, entrepreneurs, and communities so that everyone benefits.
Many organizations are already adhering to these practices. For example, LendStreet helps highly indebted consumers pay off their loans such that the majority of the economic savings is passed to consumers. The Working World, which provides loans to worker-owned cooperatives in the U.S. and Latin America ensures that those who have contributed their sweat equity and accepted high levels of personal risk accrue fair economic benefit alongside investors.
Making sure that the impact investment industry follows these mechanisms may slow down growth, especially as it will require investment in infrastructure and deeper relationships with beneficiary communities. But, in my view, one of the key lessons from microfinance is that when we come together as an industry in pursuit of a goal, we can achieve it — we just need to make sure to choose our goals wisely.
Advocating for a more cautious approach to scaling can sometimes feel like being the enemy of the good — a tough role to play in an industry where everyone is motivated by the idea of doing good and wants to scale. My hope is that by creating new models that are focused on transformative social change, and can also scale, we can realize our greatest aspirations for the field. In this last decade, we proved that impact investment can maximize financial returns — perhaps this next decade should be committed to maximizing impact.