Tuesday, December 18, 2018

ECONOMY/INVESTMENT SPECIAL .....Catalyzing the growth of the impact economy PART I


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 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 ORIGINAL ARTICLE

We 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 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 ORIGINAL ARTICLE

Asset allocators, such as foundations and pension funds, would gradually progress from screening companies or sectors out of their portfolios depending on whether they fail to meet specific thresholds for social or environmental performance (a “no negatives” requirement) and toward actively targeting companies that intend to help solve social and environmental challenges (a “positive” or “positive offset” requirement).
Fund managers, responding to the needs and expectations of asset allocators, would devote less time and effort to seeding and nurturing early-stage impact models and more time to financing the expansion of organizations with large-scale impact potential. Some fund managers would also consider financing carve-outs and major transformations of organizations that can have a disproportionate impact on social or environmental opportunities. For fund managers, the ability to help impact enterprises scale up their activities to a significant degree would become an enduring source of what might be called “impact alpha”—social and environmental performance that consistently exceeds industry benchmarks.
CONTINUES IN PART II
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?cid=other-eml-alt-mip-mck&hlkid=10a31f62ef46493893d9616341f8d822&hctky=1627601&hdpid=4d19f8e2-c2d2-4ea9-80cb-90cd01ea7500

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