A multitude of players are involved in the impact investing market. Its great diversity is one of the key findings of the study conducted by the Global Impact Investing Network (GIIN) in 2023. Insurance companies and banks, fund managers, individual investors and family offices invest in the same way as foundations. What unites them all is the idea that the investments will have a measurable positive social or environmental impact. However, they differ in their return expectations.
There are investments where returns are deliberately waived, or at least the return expectations are not the main focus,’ says Professor Markus Frölich, Professor of Economics at the University of Mannheim and Director of the Center for Evaluation and Development.
But there are also impact investments that certainly can generate a return. As an example, he mentions insurance products for smallholders who bear the risk of crop failures. These products improve the social security of farmers. At the same time, there is the possibility of a small return, but there is no commercial market, as the risk is very high. According to the GIIN survey of 307 investors, 12 per cent expect a below-average return on their impact investments, which has an impact on the preservation of capital. Although 14 per cent also accept a below-average return, they expect it to be closer to the market return. The majority of investors aim for a risk-adjusted market return.
Intended impact
The idea of making an impact with investments is not new. ‘The development banks were the first to create these kinds of investment pots,’ says Sabine Döbeli, Managing Director of Swiss Sustainable Finance (SSF). The aim was for them to specifically contribute to poverty alleviation. In the early 1990s, they helped existing NGOs become commercial microfinance institutions.
Today, impact investing is carried out in both emerging and industrialised economies. In addition to social concerns, impact investing is primarily aimed at environmental protection issues. Thematically, they therefore come under the heading of sustainable investment strategies, i.e. investments that take into account environmental, social and governance (ESG) factors. ‘For us, impact investing is a sub-area of sustainable investment,’ says Sabine Döbeli. In general, impact is an issue. ‘More and more investment products are geared towards making a positive impact,’ she says. The simple way is to invest in companies that are already achieving the desired long-term impact. A distinction must be made between this and an investment where the investor deliberately influences the company. The latter is a concept known as ‘investor stewardship’; in such cases, investors play an active role. By exercising their voting rights and in dialogue with management, they influence the course of the company in order to achieve improvements. This mainly applies to equities and bonds. By contrast, traditional impact investing takes place in the private market, i.e. in investments that are not traded on the stock exchange. ‘It is crucial that new capital is made available for innovative solutions that contribute to a sustainable world,’ she says. In impact investing, the investor defines what the intended impact is. We need measurement criteria and therefore proof of what has changed as a result of the investment. ‘These are the factors that set impact investing apart,’ says Sabine Döbeli. ‘Today, impact investments are usually carried out by specialists who are primarily involved in private markets and thus make new capital available.’
The precise definition of impact and how impacts are measured
There are different views on how to define and measure impact. ‘In the field of economics, however, the term is very precisely defined,’ explains Markus Frölich. Impact is measured at the level of the people who are ultimately affected, he says; in other words, those for whom an impact is to be achieved. This must be determined in comparison with a control group. Three Nobel Prizes have been awarded for defining and measuring impact: in 2000 to Professor James Heckman; in 2019 to Professors Banerjee, Duflo and Kremer; and in 2021 to Professors Angrist, Card and Imbens. The three economists Esther Duflo, Abhijit Banerjee and Michael Kremer provided key insights into this topic. In 2019, they were awarded the Nobel Prize in Economics for their work in poverty research. They managed to demonstrate the varying impact of financial aid. To this end, they went to Kenyan villages and put together different groups, which all received different kinds of support. This allowed the researchers to determine which types of aid were useful based on their impact. According to Frölich, the trend towards economists being strongly oriented towards medicine and the natural sciences when it comes to measuring impact began as far back as the turn of the millennium. He also talks about the credibility revolution, as described by economist Professor Joshua Angrist. In economics, social and political sciences, there was a move to introduce standards in medicine and the natural sciences and to demonstrate impact by means of empirical comparison groups. Frölich compares this approach to pharmaceutics: when a medication is introduced, its effect is tested and verified against that of a comparison group that has been treated with a placebo. It should be essential for impact investing that an impact is clearly demonstrable. Together with transparency, this creates credibility. It’s absolutely key. This evidence enables impact investing to hedge against accusations of greenwashing. This suspicion can arise, especially with investments that promise an impact that is difficult to measure. After all, the marketing aspect of sustainability is appealing. An investment may appear more attractive if it promises a long-term impact in addition to a return, but these promises are often not fulfilled. ‘Overall, it’s probably a continuum,’ says Markus Frölich. A continuum that ranges from return-oriented investments, which make sustainability promises primarily for marketing reasons, to impact investments, which have a demonstrable impact and accept below-average returns. Transparency, traceability and measurable objectives could provide guidance, but are unfortunately very often not achieved.
More and better jobs
The SECO Start-up Fund (SSF), an initiative of the State Secretariat for Economic Affairs (SECO), has a clearly defined objective. Its aim is to promote job creation in emerging and transition economies (ETEs) by supporting the founding of new companies with successful business models. To this end, the SECO Start-up Fund grants long-term, interest-bearing loans to investors/borrowers who are domiciled in Switzerland and are seeking co-financing for a start-up in an ETE.
‘We always work on a subsidiary basis to other market participants,’ says Susanne Grossmann, a partner at fund management firm FINANCEcontact. For every loan granted by the SECO Start-up Fund, it defines impact targets.
The number and quality of jobs that a borrower or start-up should create is an important objective. ‘Where possible, the positions should be formal long-term employment contracts,’ she says. ‘This is because these positions are usually better covered by social security and generally longer lasting than temporary contracts.’ This corresponds to SECO’s primary objective of creating ‘more and better jobs’. In addition to the jobs created directly in the start-up, other impacts are also assessed, such as the generation of income opportunities for self-employed persons who have a formal employment relationship with the start-up, such as smallholders who supply a processing company. Grossmann points out that these effects are less directly verifiable.
Risk of unfair competitive advantages
Sometimes, these requirements prevent the fund from getting involved. In general, FINANCEcontact has noticed a decline in demand over the past few years. This is no doubt due in part to the pandemic, which practically brought demand for loans to a standstill for two years. In addition, the impact financing scene has developed significantly over the last two decades. It often operates on the basis of non-repayable subsidies (in Swiss law: à fonds perdu), favouring organisations that execute projects. Grossmann, on the other hand, considers it important that they allocate public funds to finance commercial business models in the form of loans rather than grants. She is fundamentally critical of non-repayable subsidies being used to finance the private sector, because they can give companies unfair competitive advantages in a market. Commercially financed competitors with potentially more financially sustainable business models may suffer as a result. Grossmann believes that there are still too many non-repayable subsidies being allocated in the private sector at the moment. Although she does see that mixed financing can make sense in specific cases, such as for companies that provide services that offer a ‘public good’, or agricultural projects that take a long time to generate income. ‘But you have to apply such financing almost homeopathically, as you might say,’ she says, ‘because you can also do an awful lot of damage.’
Role and responsibility
One advantage of a loan, in her eyes, is its binding nature. The borrower has greater personal responsibility. Because the SSF only provides part of the finances required, the borrower must also make an investment themselves. Susanne Grossmann is convinced that if capital has a price, it promotes business models that are sustainable – not only socially, but also financially. In addition to financing, the fund supports borrowers with advice and assistance, if desired: ‘We work more or less as a sounding board or as a coach.’ But there are limits. The important thing is that everyone sticks to their roles. Because the loan has to be repaid in the end. As a lender, the SSF is careful not to influence business decisions. Because the lender cannot be responsible for the business’s success or failure: in the end, they will want their money back.
Selecting an impact
Before impacts can be measured, an investor must define the desired objectives. In answer to this question, Markus Frölich notes that different questions are often mixed up together. On the one hand, the effect of impact investing can be measured: the support of children in socially difficult environments can be measured in the same way as the impact of support for gifted children. But when it comes to comparing these two effects, the organisation must decide which objective it feels to be more important. Neutral, reliable data helps with this. What can happen in the absence of such data becomes apparent during discussions in society when, in a political process, supporters and opponents of a measure use different expert assessments to arrive at different results. A standard of rigorous scientific impact measurement can prevent this. Credible measurement results give security to a project and its objectives. Markus Frölich cites the example of PROGRESA from Mexico. There, the government introduced conditional cash transfers: social assistance was paid to mothers on the condition that they could prove that they sent their children to school and ensured their health was taken care of. A comprehensive, independent study provided objective evidence of the impact of the programme. This meant that the new government could not stop the scheme after the elections, although on principle it would have liked to have stopped programmes brought in by the previous government, on the pretext of their ineffectiveness. Transparency and measurability also enable comparability between countries. Frölich notes that the independent scientific measurement of social projects is more developed in emerging economies than in industrialised countries. As he puts it: ‘Projects in emerging economies are often financed by the Global North, which then demands objective proof of their effectiveness.’
Soft factors also count
The GIIN study shows that most impact investors today take steps to measure the effectiveness of their investments: 46 per cent examine their impact every year, 22 per cent measure it even more often, while only 5 per cent do so on an ad hoc basis. Only 1 per cent never check their impact. The SECO Start-up Fund reviews the impact of its loans at least once a year, as well as once every five years after funding has come to an end. Borrowers report on their impact by means of a questionnaire. The soft factors examined also include compliance issues (environment, social and governance) and the corporate model per se. The idea is to find out whether borrowers have brought a whole new type of business model into the market that others can adopt or even copy. The effect on other investors is also of interest. ‘We look at what further investments the Start-up Fund’s loan has triggered,’ says Susanne Grossmann.
180 billion Swiss francs
For the autumn, Swiss Sustainable Finance has announced a new study that will examine the impact investing market in Switzerland. The previous data on all sustainable investments shows that the share of impact investments accounts for around 11 per cent of sustainable investments. Investments worth around 180 billion Swiss francs now apply an impact approach in Switzerland. ‘There are various forms, which also include the real estate market, for example,’ says Sabine Döbeli. In relation to the overall investment market, this is likely to amount to three to five per cent. The potential for impact investing must be assessed correctly. It remains only a supplement to an investment portfolio. She says: ‘But you also need to consider how you can achieve an impact with the rest of a portfolio, and investor stewardship is an important tool in this respect.’