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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