How to open the black box of impact investing?

Those pushing impact investing need to address at least three key questions if it is to grow its relevance and fulfil its supposedly transformative potential. In the final of a three-part series, Gorgi Krlev – whose research at the University of Heidelberg’s Centre for Social Investment focuses on social enterprise, innovation and impact – asks: what makes impact investing markets special and why do we know so little about them?

According to conventional thinking, there's a typical order in which different types of investors engage in impact deals: high net worth individuals – mainly accountable to themselves and willing to take high risks – commit first, and foundations or family offices who may accept low returns and tolerate potential losses come after that. Some have underscored the need to take risks to achieve high impact. However, only when the risk decreases do we see the larger, more institutionalised players such as social venture funds enter the scene.

As a consequence, many of the deals in the first two stages may remain hidden from the public eye. That is an issue because firstly, other potential investors lack knowledge and might therefore make suboptimal investment decisions; and secondly, regulators will find it hard or even impossible to create a supportive environment that encourages high levels of private sector impact investments.

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One reaction to this would be to demand more transparency. When someone engages for the public good, they should also embrace the principles governing that public good, among them openness, trust and transparency. Ultimately, individual investors should also allow the public to hold them accountable.

In commercial financial markets we seem to accept secrecy quite willingly

Or should they? In commercial financial markets we seem to accept secrecy quite willingly. Business angels keep their pre-seed deals confidential. Equity investments by wealthy individual investors usually remain under the radar until the company hits public attention by being a commercial success – if it ever does.

Acumen founder and CEO Jacqueline Novogratz has outlined how individual deals may unlock a huge potential for collective benefit. If we do not want to withdraw the operating license from all philanthropists and other investors who are not fully transparent, which may be considered essential parts of a functioning impact investing market, we need to leave the black box of impact investing untouched.

The downside of this is that we increasingly hear of more social enterprises being ‘investment ready’ than of deals being struck. The exact causes of this are unclear, but a mutual lack of knowledge about the investor and investee landscape and of other successful deals is likely an important issue. This highlights the critical role of intermediaries that link investors and investees, so that pivotal meetings between them – such as the one described by private equity fund manager Robert Manz – are less dependent on luck. Despite their proliferation, we still seem to have too few of these market brokers.

On the other hand, it must be in everyone’s interest to make the big, public deals more visible. This is particularly relevant in foreign aid, where investors are often acting on behalf of a government. However, more transparency would also help best practices spread in developed economies. Estimates of the impact market are so volatile partly because we have no systematic way of identifying and classifying deals.

Estimates of the impact market are so volatile partly because we have no systematic way of identifying and classifying deals

Part of the problem is that we don’t even know who the actors are, and looking closely may offer quite a few surprises. For example, Caritas (a 122-year-old charity) now engages in building real estate in Stuttgart – as of 2019 the most expensive German city to live in – under the condition that private investors (for example foundations) fund the construction and give Caritas the right to manage the buildings for at least 10 years.

Caritas then charges below market-rate rents, which are paid by the city through social benefits for those otherwise unable to find any housing at all. The return generated is enough to compensate the charity’s own costs and pay a premium to the investor for a low-risk investment, since rent payments by the city are guaranteed. The city in turn benefits from the below market-rate return expectations of the investor.

Considering the shortage of affordable housing and the limited capacity of the municipality to meet the demand, most would agree that this deal can be considered an impact investment. Yet, few would expect impact investments in real estate and most would not think of Caritas as a potential deal intermediary. The challenge therefore is that to get a better understanding of national impact investing markets, we may need to investigate and map the field on a ‘deal-by-deal’ basis rather than by organisation.

This example also outlines that if investors aim to fund solutions, not just organisations, as Uli Grabenwarter of the European Investment Fund advises, first loss guarantees can be key and the state may play an important role in providing those. Foundations, if they act more strategically and innovatively could play their part here too. And as Cliff Prior, CEO of Big Society Capital, has commented, future impact investing markets should and likely will incorporate complexities that do not find their match in mainstream financial markets. Market shapers will need to find a delicate balance between individual discretion and transparency, invest substantially into market intelligence, cultivate brokers, and support the development of innovative funding vehicles.


What this all means for the future of impact investing

The three questions raised in this series were prompted by a panel discussion about the future of impact investing, given its increasing prominence in public debates and its global evolution, paired with our continued inability to define it clearly.

We need to take specific actions on all three levels to move the field forward

I think we need to take specific actions on all three levels to move the field forward. First, impact investing is a fashion and we should embrace rather than reject that fact to provoke broader systems change in the financial world. Second, impact investing is not a uniform phenomenon. To better understand and shape impact investing markets we need to take national welfare conditions into account, and to promote actual impact we need to let go of our fascination for market size and instead investigate market structure, market actors and potential for transformational change. Third, a certain lack of transparency at the individual deal level might be an essential part of a functioning investment market. However, to create a favourable ecosystem we need to get a better overview of major deals that form part of the new industry, but are easily overlooked. These can serve as blueprints for new partnerships.

The issues impact investing means to address almost by default demand unusual constellations of actors. Traditional market rationales alone will not be enough to spur innovation and urgent action in view of pressing social needs. This suggests a set of tools that market shapers will need to employ to unfold the potential of impact investing: marketing, data and integrated actor coalitions. No easy task ahead.

The post is inspired by a panel discussion at the Social Innovation Summit 2019. I owe credit for impulses to the speakers and commentators of the event: Lena Gansterer of Impact Hub Vienna (panelist) on (in)transparency in the market, Volker Then of CSI Heidelberg (panelist) on hidden deals, Leon Reiner of Impact Hub Berlin on the importance of first loss guarantees, Michael Wunsch of SEND e.V. on mismatch between demand and supply.

Catch up with Gorgi's first and second piece in this series – and let us know what you think, by tweeting us and .

Header photo by Caleb Oquendo on Pexels.