SSIR recently posted a piece by Paul Brest and Kelly Born entitled “When Can Impact Investing Create Real Impact?”
The article highlights a much-debated issue in the impact investing arena. In summary, “Although it is possible for impact investors to achieve social impact along with market rate returns, it’s not easy to do and doesn’t happen nearly as often as many boosters would have you believe.”
The authors called for responses to their thought-provoking article. Read our response below:
“How do you know if a social investment is really creating impact? In a time of lively conversation about “impact investing,” market participants continue to debate the definition of an impact investment and the nature of the impact we seek to achieve. At Social Finance, we have taken a deliberate effort to direct capital to areas with market frictions and to work where investor returns are contingent on the achievement of social outcomes. In this context, we are gratified to see the Brest and Born article (When Can Impact Investing Create Real Impact?) and the valuable framework the authors put forward for evaluating the impact in impact investing.
Core to our work at Social Finance is the Social Impact Bond (SIB), an innovative outcomes-based financing mechanism that mobilizes private capital to drive social progress. By funding the expansion of effective, prevention-based social services to underserved individuals and communities, SIBs create unique value for taxpayers and generate sufficient benefit for government to repay investors for their upfront investment. While the SIB market is still young and largely untested—the first US SIB was launched in 2013, and participants in this market are still absorbing the lessons of other impact investing sectors—it provides a useful paradigm to explore the model that Brest and Born outline.
The authors describe three types of impact: enterprise impact, nonmonetary impact, and investment impact. A well-designed SIB has the potential to effectively generate impact in all three categories.
• Enterprise impact: Brest and Born define enterprise impact as “the social value of the goods, services, or other benefits provided by the investee enterprise.” As SIBs channel funding to enterprises that deliver valuable social outcomes for populations in need, they should create enterprise impact by definition. The SIB delivers both product impact (“the impact of the goods and services produced by the enterprise”) by funding scaled-up services, as well as operational impact (“the impact of the enterprise’s management practices on its employees’ health and economic security”) by achieving valued outcomes and enhancing the well-being of the community. In a SIB this impact is not simply theoretical but estimated a priori as part of the contract structuring, and assessed independently post hoc to evaluate the actual impact. SIBs incorporate the use of rigorous statistical models to measure this social value as expressed through outcomes rather than outputs. For a SIB aimed at tackling prisoner recidivism, for example, the basis of measurement would not be the number of prisoners served by SIB-funded interventions (an output). Rather, measurement would focus on the achievement of a reduction in recidivism or another socially-valuable outcome associated with an improvement in the prisoner’s life. Accordingly, government payment would not be based on services rendered but on government’s valuing of – and the providers’ achievement of – these outcomes. Government’s value would likely be based on the reduced costs of the criminal justice system when prisoners do not recidivate, as well as the increased value to the macroeconomy from ex-prisoners who are productively employed.
• Nonmonetary impact: SIBs provide enterprises and the community with more than funding. The SIB structure encourages greater focus on the use of evidence in government decision-making. Based on the principle of pay-for-success, SIBs make government’s requirement to pay for programs contingent on the successful achievement of predefined outcomes. As a result, government performance risk is reduced, taxpayers’ resources are used more efficiently, and increased transparency is brought to the use of taxpayers’ money. Moreover, SIBs shift attention and resources to prevention rather than remediation in the provision of social services. Key to the SIB market are intermediary organizations that help identify high-quality providers and interventions, negotiate with government, and structure and raise the capital. In the Brest/Born framework, financial intermediaries like Social Finance achieve nonmonetary impact by:
o “Improving the enabling environment for social enterprises and investor” – SIB intermediaries facilitate investment opportunities by connecting social enterprises, investors, and the government and by articulating their common social and financial goals. Intermediaries in the SIB market have helped shape SIB-enabling legislation and the government’s procurement of SIBs.
o “Finding and promoting investment opportunities” – Intermediaries identify best-in-class service providers that meet key SIB criteria, including the ability to produce monetizable outcomes within a reasonable time horizon. For example, Social Finance has teamed with Collective Health to launch a demonstration project in Fresno, CA that aims to prove the concept of up-front investment in asthma education and management services for low-income families of children with asthma. This project is designed to find and promote an investment opportunity, and pave the way for issuance of a SIB.
o “Securing and protecting the enterprise’s social mission” – For a SIB to be successful, it must meet the interests of all three sets of stakeholders (government, investors, and service providers). Effective intermediaries assure that SIB metrics align with an enterprise’s theory of change, are valuable to society, and are likely to be achieved, as determined by a rigorous assessment of past performance. A SIB contract should explicitly ensure that metrics meet these three objectives and ensure that the program remains true to its core mission.
• Investment impact: Brest and Born define investment impact as “a particular investor’s financial contribution to the social value created by an enterprise.” SIBs have the potential to achieve investment impact by funding the scaling of social services to a quality and/or quantity that otherwise would not have been achieved. SIBs were developed because of a dearth of funds from philanthropy and government to scale up social services, so by definition SIBs provide more capital than the enterprise would otherwise received. Brest and Born draw a line between concessionary and non-concessionary investments, arguing that the return sacrificed by a concessionary investment by definition creates impact. Under this framework, it is clear that concessionary capital provided through SIBs provides investment impact. Indeed, most SIB funding has been on concessionary terms, with early projects involving grants, credit enhancements and/or guarantees from philanthropic backers.
On the other hand, the authors argue that if the impact investor does not provide capital on concessionary terms, “what can [the impact investor] contribute that the market wouldn’t do anyway?” We could rephrase this question: Do SIBs simply repackage grant money that would otherwise have funded social service providers, or do they actually tap into new pools of capital to fund the sector?
We believe that SIBs have the potential to attract non-concessionary funding, i.e. investment impact in the Brest/Born framework. The SIB market is born of what the authors term “perspicacity – discerning opportunities that ordinary investors don’t see” – and creates formerly unseen or unarticulated connections between market returns and social impact.
As Brest and Born explain, market frictions can obfuscate potential investment opportunities and create unique opportunities for enterprising investors to create impact. Therein lies the appeal of SIBs.
o Imperfect information and skepticism, for example, may create the perception that the risk of investing in social programs is greater than the reality. This perception would lead many commercial investors to avoid instruments like SIBs. Moreover, as a connection between the value that social service providers generate and the opportunity for investment still needs to be articulated on a case-by-case basis, capital would not be directed to these investments but for intermediary organizations and SIBs.
o The small deal size and illiquidity of early SIBs may deter some investors.
o Inflexible institutional practices and governance problems, such as silos within government and the tendency to continue entrenched social programs despite a lack of data on their efficacy, may prevent the scaling up of effective, preventative programs.
These frictions make the market for funding social programs imperfect – and that is the opportunity that SIBs address. Investors who can “see something that you don’t” can look beyond the perceived risk and illiquidity of the market, for example, to discern a viable investment opportunity. In particular, investors may find the SIB’s lack of correlation a very appealing characteristic. Government officials who can overcome long-standing practice to embrace the principle of pay-for-success, similarly, can create those viable investment opportunities. Intermediaries can help these parties see the connections and opportunities and as a result create investments that otherwise would not exist.
Well-designed SIBs have the potential to increase both the quantity and quality of investment in the social sector beyond what would otherwise have occurred, creating investment impact under the Brest and Born rubric. Quantity is achieved by driving investment capital to the social sector on both concessionary and non-concessionary terms, thanks to investors who have the perspicacity to divine opportunities that others fail to see. Quality is achieved by emphasizing outcomes and performance-based programming, which enhances the efficiency and effectiveness of social interventions.
In this article, Brest and Born put forward an important rubric for active impact assessment that fits well with the SIB framework. We believe that this rubric will also be valuable in exploring other sectors within the impact investing space, and in spurring further initiatives for the benefit of investors, government, and society.”
Entry by Jane Hughes, Director of Knowledge Management