Social impact investing has emerged as one of today’s most intriguing investment approaches. Investors of all ages and types are looking more closely at opportunities to invest their dollars in ways that generate solid financial returns, while also generating desired changes in the world at large.
But for many investors, questions remain. Do these forms of socially conscious investing actually have the desired impact? And do they deliver the returns they promise? Given that it’s a relatively new field, some investors have been hesitant to commit while they await definitive proof.
A recent report from McKinsey & Company sheds light on the potential of social impact investing by analyzing a number of such investments made in India between 2010 and 2015. The authors find that many impact investors are seeing both healthy returns and promising social outcomes, concluding that “this nascent asset class can meet the financial challenges as well as achieve the social returns sought by providers of capital globally.”
The full report, “Impact Investing: Purpose-driven finance finds its place in India,” was published in September 2017 by two of McKinsey’s senior partners: Vivek Pandi in Mumbai, India, and Toshan Tamhane in Jakarta, Indonesia.
First, a matter of definitions: “impact investing” belongs to a much larger category of “sustainable investment,” which covers a broad array of practices and strategies that rely, at least in part, on using environmental, social and governance (known as “ESG factors”) in allocating funds.
The Global Sustainable Investment Alliance defines impact investing as “targeted investments, typically made in private markets, aimed at solving social or environmental problems.” As a more directed form of sustainable investment, impact investing might be thought of as more targeted and forward-leaning, since the investor seeks to achieve financial returns and social change by directing capital toward a specific enterprise. So, for example, an investor who backs a for-profit social enterprise dedicated to bringing clean water to underserved communities in emerging countries would be engaging in impact investing.
In their study, Pandi and Tamhane set out to examine the real-world outcomes of a number of impact investing projects in India, an emerging economy that has benefited from substantial levels of such investment. They examined 48 impact investments, analyzing the returns at the time of investor exit—that is, when the investor would have realized his or her gains or losses. The median holding period until exit was about five years.
As another example, an investor who chooses to avoid investing in companies that manufacture tobacco or alcohol products, because he/she is concerned about the health or social consequences of smoking or alcohol abuse, is practicing an individualized form of sustainable investment. Likewise, larger institutional investors like pension funds may elect to direct their funds toward companies and investment opportunities that align with their own ESG priorities.
The projects included enterprises dedicated to financial inclusion (banking and microfinance), health care, education, agriculture and clean energy (primarily wind, solar and hydropower).
The researchers found that impact investing projects overall were competitive in generating returns for shareholders, comparable to what other venture capital and private equity investments might generate. Among their findings:
- Impressive returns: The 48 investor exits from 2010 to 2015 “produced a median internal rate of return (IRR) of about 10 percent. The top one-third of deals yielded a median IRR of 34 percent, clearly indicating that it is possible to achieve profitable exits in social enterprises.”
- The size of the deal may matter: In terms of size, midsize deals seemed to be the sweet spot for the best returns with less volatility: “The larger deals produced a much narrower range of returns, while smaller deals generally produced better results,” Pandi and Tamhane conclude. “The smallest deals had the worst returns and the greatest volatility. These findings suggest that investors (particularly those that have been hesitant) can pick and choose their opportunities, according to their expertise in seeding, growing and scaling social enterprises.”
- Not just returns, but also results: “Impact investments touched the lives of 60 million to 80 million people in India,” the authors estimate. “To be sure, India has vast populations of people in need. But then again, as social enterprises scale, so will their impact, reaching a critical number of at-risk people in smaller populations.”
These initial findings, while promising, are not definitive, and some caveats do apply. First, this study was necessarily limited to a relatively small number of projects in one country, so more research is certainly warranted to replicate these findings.
Moreover, the authors point out that consistent returns were not found across all investment sectors. Investment in some targeted areas (financial inclusion, clean energy, agriculture) resulted in better returns than in others (health care and education returns lagged by comparison). Those findings may be helpful to both social entrepreneurs and investors in determining how future projects can be better designed to generate an improved return on investment.
Ultimately, the McKinsey report is a solid step toward addressing what the authors describe as “the mistaken rap” on social impact investing: the assumptions that returns on social investing are substandard and that they take too long to achieve. Moreover, Pandi and Tamhane suggest that focusing on combining financial and social returns can help strengthen the contract between the business world and the society it serves.
While these findings focus specifically on the results of impact investing in one emerging economy, they offer a useful framework for thinking through the potential for change in other environments. Those with an interest in social impact investing should pay heed to the McKinsey report as they seek to better understand this promising strategy for “doing well while doing good.”
*SIFMA does not provide investing advice. As always, discuss your goals and strategy with a financial professional before making investing decisions.