Post written by Tania Carnegie, Leader, KPMG Impact Ventures
Momentum around impact investing continues to build. There is an increase in both investment opportunities and funds committed by impact investors. Last month, BlackRock, the world’s largest money manager, announced a new business unit dedicated to impact investing.
Critical success factors
KPMG interviewed a select group of leaders in venture capital, wealth management, banking and capital markets, and other areas of traditional finance. We wanted to understand their perspectives on impact investing and opportunities for government policy to stimulate the investment of more private capital in achieving positive social outcomes.
Three themes emerged that are relevant to policy makers, financial institutions, investors and ventures.
1. Attention to detail
Audrey Choi, CEO of Morgan Stanley’s Institute for Sustainable Investing,recently commented: “If we want this market to really grow, we have to make sure we go into this in a ‘best in class’ way.” Robust implementing agreements and comprehensive due diligence are therefore critical.
Implementing agreements for social impact bonds must address the allocation of commercial risk. However, this does not mean that all risks can be allocated to intermediaries and investors. For example, funding agreements that provide the government with the unilateral ability to reduce its level of fundingor terminate the agreement altogether should provide for a minimum reimbursement to investors.
Service agreements must include standards and measures so that the agency or service provider are incented to deliver the intervention, or face recourse. Investors will demand that the agency or service provider have sufficient “skin in the game” to achieve the intervention and outcome.
Finally, in the case of larger, more complex social projects, including affordable housing, the financing and direct agreements should include step-in rights for lenders or investors. These rights can be exercised in the event of non-performance by service providers, or events of default.
Significant due diligence is required to understand a social impact opportunity, business model and associated risk. Investing for both impact and financial return adds a level of complexity that is not generally part of standard term sheets or due diligence procedures. Non-financial risks, such as reputation and political risk, also require careful consideration.
For example, the due diligence procedures with Australia’s social benefit bonds– the Newpin Bond and the Benevolent Society Bond – included assessing the level of downside risk relative to return and the efficacy of the program. If the right factors aren’t properly considered, there’s a risk of negative experiences that could tarnish future impact investment opportunities.
2. Clarity around investor motivation
A number of factors may motivate an investor to enter this space – such as the desire to be an early adopter, to extend existing philanthropic efforts, or to seize a good investment opportunity – as well as the pursuit of financial returns.
KPMG in Australia’s evaluation of the planning and development of the country’s first social benefit bonds revealed that the bonds attracted new impact investors. Over 70 percent of investors in the Newpin bond indicated they would have otherwise used their funds for commercial investment, not philanthropy.
Investors in The Benevolent Society bond indicated that four factors of equal weight influenced their decision to invest: level of risk, financial return structure, reputation of the service provider, and government involvement.
Achieving risk-adjusted returns is important to most investors, and the recentImpactBase Snapshot published by the Global Impact Investing Network provided some interesting insight into the pursuit of market-rate returns.
The study demonstrates that investors’ general return philosophies and expectations vary with asset class and impact theme, making generalizations about impact investing problematic. Investors should be clear about their motivations and investment objectives – and whether they might want to take on a broader role in the initiatives they’re investing in, should the need or opportunity arise.
3. The role of government
Government involvement made a difference to investors in The Benevolent Society bond; our discussions with executives from financial institutions confirmed that the way government engages also influences investor behavior.
With the perception of risk generally high among new impact investors, the leaders we interviewed expressed interest in short-term government interventions that would help mitigate risk, in order to draw in new investment, help establish a track record, and increase the viability of the market. However, they raised concerns about programs that would be deemed a subsidy or would artificially support the market over the longer term.
Government initiatives to stimulate the flow of private capital should embrace a longer-term vision of engaging the private sector and exploring fundamental shifts in funding and service delivery models. This may require initiatives that span government departments or portfolios to create scale and momentum, rather than taking a siloed approach.
These critical success factors – attention to detail, clarity around investor motivation, and government involvement – should be high on the list of considerations when structuring or assessing impact investing opportunities. Addressed properly, these factors can help draw in new sources of private capital, establish a track record of successful interventions, and create a viable market.