Catalyzing the
growth of the impact economy
PART I
A mature impact economy would help power economic growth
while solving global social and environmental challenges. Here’s what it will
take to accelerate the impact economy’s development.
Since the term “impact
investment” was
introduced in 2007, the field of impact investing has grown and diversified in
notable ways. Impact-fund managers have amassed record sums, continuing a trend
that can be traced back at least five years. Funds have streamed money to
impact investments from a variety of sources, and asset managers are making
more investments outside the sectors that formerly attracted the lion’s share
of capital. Researchers have engineered novel ways of tracking and reporting
impact, giving investors greater confidence that their money is producing
social benefits and helping entrepreneurs make more effective decisions about
their strategies and business models.
Amid
these encouraging developments, it is possible to define a sharper vision for a
healthy, mature impact economy that involves a wider range of actors and
institutions than today’s impact-investing industry. In an impact economy, the
norms—practices, policies, and standards—that are attached to the pursuit of social
impact would be as widely accepted, consistent, and stable as the norms that
are associated with the pursuit of profit. Encouraged by the added measure of
certainty and transparency surrounding their activities, investors large and
small would allocate more capital to the financing of social initiatives, and
entrepreneurs would devise business models whose ambition and growth potential
match investor and market demand. Consumers would direct greater shares of
their spending to social enterprises, thereby spurring large mainstream
companies to measure and pursue impact. Overall, the impact economy would
achieve breakthrough increases in scale and productivity, with capital
delivering higher risk-adjusted levels of social impact than we now see in many
cases.
In this
article, which incorporates findings from our in-depth interviews with more
than 100 investors, fund managers, social entrepreneurs, and other
impact-economy stakeholders, we consider what it will take for the impact
economy to reach maturity. We begin by exploring the vision for the impact
economy outlined above. We then look at the roles that various impact-economy
constituencies—investors, asset managers, entrepreneurs, governments, and
philanthropists foremost among them—would play in a mature impact economy.
Finally, we present three potential developments that would enable the impact
economy to mature fully:
·
instituting public policies that provide
incentives and disincentives and create certainty
·
achieving a broad commitment to mutually
reinforcing operational, measurement, and reporting norms for fund managers,
social entrepreneurs, and impact-economy intermediaries
·
creating an industry body that promotes
policies and standards of excellence and moves all participants to adopt them
These
changes would enable and encourage stakeholders to reset some of capitalism’s
assumptions and rules so that two goals receive equal priority: powering
economic growth and wealth creation while also solving global social and
environmental challenges.
Envisioning a mature impact
economy
Although
some of the ideas and practices that are fundamental to impact investment and
social entrepreneurship originated decades ago, it was in 2007 that a group of
foundations and investors convened by the Rockefeller Foundation originated the
term “impact investing,” which was later defined as “investments intended to
create positive impact beyond financial return.” Extending the idea at
the heart of that definition—the creation of social or environmental impact in
addition to financial return—to all other economic activities makes it possible
to define an impact economy as a system in which institutions and individuals
give equal priority to social impact and financial impact when making decisions
about how to allocate resources.
An
impact economy is thus a very different kind of system from a traditional
capitalist economy that prioritizes only financial returns. In an impact
economy, consumers and shareholders will challenge entrepreneurs and executives
to show that they generate their profits in a manner that contributes to the
public good. This approach to doing business is already being enacted by some
organizations on several levels—in making strategic choices, in managing their
supply chains, in allocating funds to investments—and by some municipal
authorities. But we have yet to see it embraced comprehensively by entire
industries or national economies. As such, we determined the major dimensions
of a full-fledged impact economy to be investment deployment, asset management,
delivery of solutions, and measurement and reporting.
Investment deployment
The
past few years have seen capital flow into impact investments from a wide
variety of sources (Exhibit 1). Overall, impact fund managers have amassed
record quantities of assets under management: more than $228 billion, according
to one estimate.3 Yet even this amount of money is small compared
with the annual capital outlay—estimated at $1.4 trillion to $2.5 trillion of
additional spending—required to achieve the Sustainable Development Goals
(SDGs) set forth by the United Nations by 2030. To close the gap, asset owners
and fund managers will need to adopt investment strategies that put still more
emphasis on positive social outcomes, rather than strategies that merely seek
to minimize or prevent negative outcomes.
Exhibit 1 SEE THE ORIGINAL ARTICLE
Investment
trends appear to be moving in that direction. Based on surveys showing that a
substantial number of investors, including “mainstream” investors, are seeking impact-investment
products, there may be significant latent demand for impact investments. In a
mature impact economy, then, we would expect to see more asset owners
prioritizing the financing of solutions to environmental and social challenges,
and a major increase in commitments of capital to impact-seeking investment
vehicles.
Asset management
Considering
that the 17 SDGs address a wide range of issues—from human-development
challenges such as poverty, health, and gender equality to environmental
concerns such as climate change and water scarcity—asset managers in a mature
impact economy might be expected to back enterprises with a correspondingly
diverse variety of ambitions. The past few years have seen a trend in this
direction, as asset managers have directed an increasing proportion of
investments beyond the financial-services and microfinance sectors (Exhibit 2).
Exhibit 2 SEE THE ORIGINAL ARTICLE
would
argue that a mature impact economy will also be characterized by a wide variety
in the types of investment instruments that asset managers offer clients.
Impact-investing assets under management are more evenly spread among different
types of investment instruments than they were just three years ago, with
private placements of debt and equity making up a considerably smaller share of
the market (Exhibit 3).
Exhibit 3 SEE THE ORIGINAL ARTICLE
A
mature impact economy would feature a market-clearing quantity of solutions to
social and environmental challenges. In other words, impact enterprises would
crop up to address environmental or social challenges that might be profitably
addressed, although there will remain a large set of such challenges that
cannot be solved with for-profit models. Moreover, these social enterprises
would be no more likely to go unfunded than enterprises that measure their
returns strictly in terms of profit (see sidebar, “A glimpse into the future of
the impact economy”). This is not the situation today. Impact-focused
enterprises have proliferated, and many of them operate on a modest scale,
solving a particular problem in a single locale or a small number of locales.
In the United Kingdom, for example, which has a relatively well-developed
cohort of impact investors and social enterprises, more than 80 percent of
social enterprises have annual revenues of less than £1 million.
In
addition, the “buy side” of the “market” for social impact remains
underdeveloped. Consumers are increasingly aware of the social and
environmental impact of businesses, and more consumers have stated a preference
for goods and services that help make a positive impact. This preference has
become prevalent enough that companies can no longer afford to ignore it.
Indeed, we are seeing large companies make greater efforts to align their
market strategies with their customers’ social compass, while new enterprises
are emerging that have social impact built into their business models.
At the
institutional level, though, there is only modest demand for what social
enterprises can provide. Social enterprises are not yet widely recognized as
potential bidders for public tenders or as partners for large companies, and
government pay-for-performance schemes (outcome-based contracts such as
social-impact bonds) have limited uptake. In a mature impact economy, where social
enterprises will come to be seen as reliable producers of social goods, we
might expect such pay-for-performance schemes to account for more of the
impact-investing market.
Measurement and reporting
A
mature impact economy would operate according to generally accepted sets of
standards for measuring and reporting social and environmental impact, which
would help to quantify the value of social outcomes, support accurate tracking
of progress toward the SDGs, and create the transparency that stakeholders need
to make effective resource-allocation decisions. Such standards would represent
the impact-economy equivalent of the Generally Accepted Accounting Principles
to which US companies adhere, or the International Financial Reporting
Standards used in many countries across the world. (It is worth noting that
even for financial accounting and reporting, there are still multiple sets of
standards in use.) Impact-economy standards would ideally supersede or
harmonize existing frameworks, such as the Impact Reporting and Investment
Standards (IRIS) and Social Return on Investment (SROI).
It is
reasonable to expect that even in a mature impact economy some enterprises and
investors will choose to define their impact goals in unique ways that don’t
conform to generally accepted standards and track their performance against
those goals. Such idiosyncratic approaches, however, will likely become much
less prevalent than they are today and occur only in contexts where generally
accepted standards can’t be applied easily.
Redefining the roles of
impact-economy stakeholders
Transitioning
to a mature impact economy will involve significant changes in the ways that
its various constituencies, or stakeholders, conduct their business.
Governments, for example, would pay for social outcomes that have been measured
and verified, instead of paying service providers to do work that may or may
not have the sought-after impact. Some stakeholders will find that a mature
impact economy no longer requires them to perform the same functions that they
performed when the impact economy was less developed, and so they will take on
different roles (Exhibit 4).
Exhibit 4 SEE THE ORIGINAL ARTICLE
By David
Fine, Hugo Hickson, Vivek
Pandit, and Philip Tuinenburg
https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/catalyzing-the-growth-of-the-impact-economy
CONTINUES IN PART II
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