Three Fallacies of Impact Investing

Updated: Jun 21, 2020

Many believe that it is impossible to invest in something that provides good financial returns, as well as positive social and environmental benefits. For them, it is one or the other – impact investing may lead to positive social change, but it won’t provide market rate returns. However, this blog post will go through the three most common misconceptions of impact investing, and attempt to debunk all three myths.

Fallacy #1: Impact Investing firms cannot deliver market rate returns

Impact investing is often associated with below-market returns. This is misleading and is certainly a misconception. Many impact investors look for top-tier venture capital returns, and achieve them. In 2015, a Cambridge Associates’ study discovered that impact investing returns are comparable to traditional funds. Yet, in order to build trust in impact investing’s potential to generate market returns, the industry requires a sizeable cohort of successes.  For example, California’s Kapor Capital, a venture capital investment and social impact firm, recently published its latest performance metrics for the year 2019. It recorded an IRR (internal rate of return) of  29.02% (net of fees) and 3x Total Value to Paid in Multiple, which ranks them in the top quartile of venture capital firms.

Fallacy #2: Opportunities for Impact Investing firms is too limited

The second misconception, or myth, is that the opportunity set for impact venture capitals is narrow;  that there are not enough firms out there that can be considered as socially or environmentally focused companies. In reality, most, if not all businesses have some type of positive and negative social/environmental effect, but only a small percentage of them are concentrated on measurable, long-term results through their products or services. As Melina Sánchez Montañés claims, this is “a unique opportunity for investors — by migrating startups to the impact camp, the opportunity set and quality of social/environmental startups could increase exponentially. In Israel, 35% of startups surveyed by Social Finance reported having a social/environmental mission. This is no small gig.”

Fallacy #3: Impact firms have no real or meaningful impact

The third misconception is that small startups and impact investing firms do not actually have any meaningful impact. Brad Harrison of ImpactAlpha says the following: “The impact outcomes for an investment can vary widely. Consider that for many investments, the impact component may not be realized for several months if not years after the initial investment is made. This is especially true of investments in sectors like education or healthcare where the biggest outcomes may not be easily visible for a decade or more. For example, an investment in a company that provides affordable contraceptive devices for rural villagers in sub-Saharan Africa may have a transformative impact on those individuals and the communities in which they live. But measuring this social impact is challenging without deep, on-the-ground research comparing health and economic outcomes in a village that receives contraceptive devices versus a village that doesn’t. Such a study would likely need to last for many years to generate reliable data.” 

Although it may not always appear as if impact firms are truly having a positive social or environmental impact, the likelihood is that they are. This is even more the case following the introduction of new methodologies and ways in which impact can be measured. For example, the Rise Fund undertakes a qualitative assessment of potential investments to screen for and remove any deals that are unlikely to pass the Impact Multiple of Money (IMM) metric obstacle, just as it eliminates deals that are not financially promising. Businesses with a social purpose and a potentially measurable impact get the go-ahead for IMM evaluation. Rise will only invest in a company if the IMM calculation suggests a minimum social return on investment of $2.50 for every $1 invested. Companies that adopt this metric can set their own minimum thresholds, depending on their aims. 

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