Several events, including the publication of excellent reports by the Monitor Group (From Blueprint to Scale) and the Omidyar Network (Priming the Pump) and the recent Social Capital Markets conference (SOCAP12, noted in an earlier blog), prompt a few reflections.

Last year I was fortunate enough to spend a week at the Rockefeller Foundation’s Bellagio Center, where a group of experienced development practitioners discussed the role of public policy in the impact investing sector. Much has evolved in the space since then, but this much remains true: According to many experts, the current efforts to invest with impact represent a paradigm shift in development financing.

For many, the question now is: How do we support the impact investing sector so that it becomes a positive force that advances the fundamental objective of reducing global poverty? This transformation in mainstream development resonates with many efforts by the Aga Khan Development Network under the leadership of His Highness the Aga Khan over the past fifty years.

Aga Khan Development Network Pamir Power Plant

The shift in impact investing resonates with efforts by the Aga Khan Development Network.

Expectations: Four Scenarios

In international development, we generally accept that when investment (or to use the conventional term, aid) produces societal benefits, it helps to boost economic growth. In the long run, a stronger economy both helps the general population’s well being and boosts profits for investors and companies in the region. However, many maintain that there is an inescapable tradeoff between social and financial returns.

Can impact investment naturally result in overall increases in both social and financial rates of return? Table 1 describes four scenarios, divided between short- and long-term. Some investors may base their choices on the belief that there are short- but not long-term tradeoffs between social and financial returns. Others may expect short-term reduction in financial returns with optimal financial and social returns in the long run. For each investor, there is an appropriate strategy.

 

Table 1: Expectations about Investment Returns
No Tradeoff Tradeoff
Long-Run Financial returns may need to be lower in the short-run to increase social returns, but will eventually be recouped through improved economic growth Financial returns need to be lower in the short-run to increase social returns, and long-term growth effects will not result in full profit recovery
Short-Run Both social and financial returns can be increased simultaneously in the short-run Financial returns must be sacrificed to achieve higher social returns in the short-run

As discussed at SOCAP12, the investment mix in Table 2 advances this idea that investors can choose their investment vehicle to achieve their desired returns. As the sector matures, it should become possible to assess returns by sector, country, or vehicle.

It may prove true that investments in certain sectors will fall into one short-run and the other long-run quadrant. It may be possible in agriculture or urban telecommunications, for example, to make short-run increases in both social and financial returns.

 

Table 2: Examples of Targeted Investments by Expectation of Return
No Tradeoff Tradeoff
Long-Run An investment in secondary and tertiary education leads to improved quality of the regional workforce that can be employed by local for-profits. An investment in healthcare systems leads to a healthier workforce, but over the long-run does not increase investor financial returns enough to cover the cost of the initial investment.
Short-Run Seed funding for a technological innovation in telecommunications benefits farmers, and creates significant local demand and profits for investors. An investment in franchising a new clean water delivery system increases health outcomes within 6 months, but the first 3 centers operate at a deficit.

At this time these decisions are based on limited information. Practitioners agree on the need for astandardized method of measuring the social or combined social and economic benefits produced by impact investments. With measurable social benefits, impact investors will become better able to make decisions when allocating among investments. The Rockefeller Foundation, the Global Impact Investing Network, and B Lab have efforts underway to create such standards, though a universally accepted method is some way off.

In cases where there is no tradeoff, simply improving awareness of these opportunities will increase socially responsible investing. For investments that involve some trade-off, many mainstream commercial investors need extra encouragement to pursue social impact. That means some combination of:

  1. Self-enlightenment: Decision-makers need the inner conviction that improving livelihoods is the right thing to do.
  2. Consumer demand pressure: In the past, negative social marketing for some goods (e.g. furs, tobacco) helped shrink demand and signaled that those forms of investment or production were not acceptable to the public.
  3. Peer Pressure: Religious and community-based groups have shown how peer pressure can increase consumer demand or influence legislative/regulatory policy.
  4. Legislation: National and international standards have helped to reduce, for example, child labor. This creates an environment that enables progress.
Roshan Telecom Afghanistan

Current efforts to invest with impact represent a paradigm shift in development financing.

Advance rigorous standards of measuring social returns;As our work deepens in the field, we at AKF USA, along with our colleagues in AKDN, see a need to:

  1. Strengthen civil society institutions that support local impact investing in certain countries;
  2. Foster an enabling policy framework to align incentives between for-profit entities and the populations where they operate.

 

These three strands align with AKDN’s longstanding approach to civil society and the creation of enabling environments for improved livelihoods. This is an area in which we hope to engage further with many innovative individuals.

Dr. Mirza Jahani is CEO of the Aga Khan Foundation USA.