There’s no shame in making money from good causes: Josh Spero on the arrival of ‘impact investing’, a third way between soft philanthropy and hard-nosed profiteering
DALSTON, NORTH OF the City, may be the chicest place in Britain, according to Italian Vogue, but it is not a natural destination for high-net-worths. Despite the hipsters who crowd Broadway Market on Saturday mornings and the clubs of the Kingsland Road on Saturday nights, Dalston is in Hackney, one of London’s poorest boroughs, and its deprivations — financial, social, educational — are critical. So why would Dalstonian poverty even cross the mind of an HNW?
Faisel Rahman is why. Rahman founded Fair Finance in Hackney in 2005 to offer small loans at reasonable rates to those whom the high-street banks would never look at (and whom rapacious doorstep lenders charging 2,500 per cent APR looked at too easily). It is a form of microfinance for London’s financially excluded, left out not necessarily because of a poor credit record but because of no credit record.
‘How do you find a way of promoting financial wellbeing to people who are either on the margins or out of sight of financial services?’ he says, sitting in Fair Finance’s second office, just opposite the new Dalston Junction rail station. This is not a calculation of pity: ‘It’s a market, it’s an opportunity. When you look at it with one set of eyes, you don’t see anything there — you just see people you can’t make money out of. Through another set of eyes you can see a group of people who really are being denied a decent service. We’ve tried to bring banking back to people who are outside the banking system.
What Rahman — and his HNW investors — see is not a simple philanthropic service nor a straightforward business, but an opportunity to create both financial and social profit. For example, Fair Finance has been making loans to women in Hackney who want to become driving instructors, an occupation which fits in with the school run and gives them a degree of financial independence. ‘A typical loan on our personal loan product is £400, and it’s for a washing machine or a cooker — it’s not for a pair of Nike trainers or a down-payment on a Lamborghini,’ he says. With a repayment rate of 92 per cent (‘from 100 per cent of people rejected by banks’), this is not a charity.
Social or impact investing has been developing in the UK since the Social Investment Taskforce kickstarted it in 2000, and as befits the world’s innumerable problems, the private-sector projects taken up range from the prevention of prisoners’ reoffending to small agricultural concerns in Africa. Importantly, impact investing — which could easily seem like philanthropy, loans made with little expectation of repayment — is starting to become an (illiquid) part of a sensibly diversified portfolio.
Projects fall into two categories along a scale of risk, return and effect: impact-first investments which emphasise the social return and finance-first investments where the profit is more important. This class of investment does not require a halo — it should not be taken solely as a moral option. There is nothing wrong with making money out of projects which do a social good, and that is an attitude which is starting to turn investors on to it.
Alexander Hoare, CEO of C Hoare & Co, has been advocating social investment to some clients, especially when some adventurous projects offer higher yields than dormant cash in today’s low-interest-rate environment. He feels strongly that it is more than a happy medium between capitalism and philanthropy: ‘It’s not traditional aid in any sense: it’s intelligent use of resources. “Happy medium” sounds like a mishmash compromise; it’s something more than that,’ a third strand ‘getting more capital where it’s needed alongside existing capitalism or existing philanthropy.’ Our abnormal economic conditions favour it too: ‘In 2008 and 2009 you saw the conventional invested universe correlated to one; it all went down the pan together. But if you’re growing trees in Uganda, that is uncorrelated, truly uncorrelated.’
The social logic is compelling, Hoare says, as investing in a bond to reduce recidivism reduces your chance of being mugged. He has personally taken part in impact investing (‘I was leant upon by my vicar, at Christmas’), supporting the (legitimate) venture of a former armed robber who went on to become Ernst & Young Entrepreneur of the Year.
If City scepticism is suspected, the imprimatur of Sir Ronald Cohen should counter: he is the non-executive chairman of Bridges Ventures, formed in 2002 with backing from 3i, Apax Partners and Doughty Hanson. Michele Giddens, an executive director of Bridges Ventures, says that impact investing is a permanent third way: ‘Historically the accepted theory about investment was that you make the maximum financial return with your money and then you might take some portion of that, perhaps much later in your life, perhaps for the next generations as a foundation, and you give it away for social purpose alone, with no financial return. Over the past decade, there’s been a seismic shift in people’s understanding and increased belief that there is a space in the middle.’
Michael Green, co-author of Philanthrocapitalism, agrees: ‘I get frustrated in the development world when people have this idea that there’s giving money away, which is doing good, and there’s making a profit, which is taking money away, and that just isn’t true. People are just hostile to profit, and we have to change that debate.’
A study by the International Finance Corporation shows that the fast-developing frontier markets are not just suitable but also profitable for impact investing. Investments under $2 million have a high write-off rate (between 20 and 30 per cent), but this immediately drops to 5 per cent above $2 million. Companies in the $500,000–$10 million range are known as the ‘missing middle’, too big for microfinance and too small for most international banks and private-equity firms, suspected by all yet evidently investment-worthy above a certain point.
UBS supplied the example of a West African agribusiness, focused on sugar, flour and animal feed, which operated within a strict social, ethical and environmental framework, providing healthcare to its employees and employing thousands of local people. As well as these social benefits, it brought investors an IRR of nearly 40 per cent: $9 million invested turned into $38 million on exit. The horizon stretches beyond Africa, of course: networks of thousands of inexpensive private schools for the poor in Hyderabad, as Professor James Tooley of Newcastle University has studied, could be expanded with impact investing, and environmental projects around the world are gaining favour.
Jacana Venture Partnership, co-founded by Stephen Dawson, invests in fund managers who in turn invest in and support SMEs in Sub-Saharan Africa. Dawson, who is the sector’s most respected figure, having also co-founded Impetus Trust, an impact-first venture philanthropy charity (applying private-equity techniques to help charities), says there is a long spectrum between finance-first and impact-first projects to suit most investors. ‘It’s not guaranteed,’ he says, ‘but it’s not a stupid investment.’ What stops private clients investing in greater numbers is the uncertainty of wealth managers and private bankers about which opportunities to take, so Jacana is trying to establish ‘a seal of approval’ to make this easier.
Bridges Ventures concentrates on British projects in the impact themes of underserved, inner-city areas, education and skills, the environment, and health and well-being; the projects have to meet both financial and social criteria, and the Venture Funds’ investors, who have typically invested from £500,000 to £10 million, are equally institutions and HNWs, families or foundations. Giddens says their track record reflects exits from 12 per cent to 216 per cent per year.
The latter was from Simply Switch, a call-centre-based business saving people money on their gas and electricity bills which employed ‘80-plus individuals, many women, many ethnic minorities’. It was sold for £22 million and investors walked away with 22 times their investment. These businesses can thrive today, despite our general slowdown: ‘If you can contribute to the country’s skills agenda, or to other pressing social and/or environmental needs, you’ve probably got a growth opportunity even in a flat economy.’
ITS RECENT HISTORY of innovation does not do it great credit, but it seems the City of London may be about to embark on a positive path. Donna St Hill and Michael Green are determinedly optimistic as we talk over coffee at the Lanesborough about I4D (Investors for Development). Put simply, I4D’s goal is that ‘the UK investment community will allocate 0.7 per cent of assets under management, £25 billion at current market values, to development investment’, meaning the full range of projects with financial and social returns.
It will also help philanthropists spot investment opportunities, allowing private money to be leveraged against theirs, and advise the government on stimulating impact investing. It is a macroeconomic approach to very local issues, and it is refreshing that this type of investing is not covered in pieties and platitudes.
At first glance, this seems like shooting for the moon, an enormous sum (0.7 per cent is the government’s target of GDP going to development aid) from some recalcitrant parties, but St Hill has been a patient advocate for I4D and the City is close to signing up.
St Hill, whose background is in development finance and who is executive director of development advisers Equity Strategies International, received endorsement from Stephen Dawson and spoke to Parliament’s Development Select Committee before ‘unveiling the idea in front of 50 prominent philanthropists, corporations, bankers, investors, convened by Sir Richard [Branson]. There was such enthusiasm. Those people who’ve made their money through risk-taking and investment, they got it,’ but they did not want a government-led approach, like all good capitalists.
The financiers were persuaded both by reaching important markets — Africa is a bright prospect — and by the reputational benefit: ‘Now, when the whole world is saying how socially useless the City is, what if we could get them to focus a little time, a little money on using capital markets for good?’ The banks are not unaware that the government will be watching, and they approve of investing in the private sector rather than underwriting the public sector.
Green, whose new book The Road from Ruin (once more co-written with Matthew Bishop) advocates revolutionising capitalism with a culture of long-termism, thinks that the banks should see this as an opportunity to develop themselves: ‘It’s a much more productive thing for the banks to be doing. Rather than tossing a few hundred million quid around as an extra tax payment, here’s something which uses their skills and is sustainable. It’s about them doing better business themselves. It’s win-win-win.’
St Hill adds, with commendable candour: ‘I4D’s mission is unashamedly self-interested. It isn’t going to be investments in our traditional Western economies that are going to generate the returns, but rather investments in high-growth emerging and frontier markets. Socially and environmentally sustainable investment opportunities in those markets practically guarantee enormous goodwill for the UK, courtesy of the City of London, and that £25 billion annual investment target will also contribute substantially to UK trade, jobs and growth. By the time other advanced donor nations commit to this idea, we’ll have PM Cameron’s Big Society writ global.’
There has also long been the promise of the London-based Social Stock Exchange, which will trade only in companies with social and environmental aims, allowing them to raise capital and thus expand much faster. This has failed to materialise so far, but the government’s social investment strategy of February 2011 includes it as a priority.
ALTHOUGH BRITAIN IS leading the development of impact investing, with firms like Bridges, Impetus Trust and Jacana, the idea has been taken up elsewhere. Chandran Nair, author of Consumptionomics (about why the developing world should not be allowed to consume like the West), set up Avantage Ventures ‘to create a marketplace for social capital’. Nair speaks with scorn of banks’ attitudes to impact investing: the head of a major European bank’s wealth-management division told him: ‘What you’re doing is great, but please don’t expect us to help you, despite the rhetoric. We don’t make any money on the deal.’
Certain banks, notably JP Morgan and UBS, have been active in making impact investing part of their offering. Andreas Ernst, who is developing a social investment fund for UBS, says it was client-driven: ‘We received feedback from clients that they’re interested — in addition to the giving side — in opportunities to align their investments with their philanthropy.’ If the emphasis on making returns from, for example, small-scale agricultural projects in Africa sounds inappropriate, it is exactly this reaction which is being conquered: squeamishness, although no one is being taken advantage of, advances nothing.
The accelerating growth of impact investing — I4D would be a tipping point, and there are rumours that the PM supports it — will not be without casualties or failures. Like every asset class, it has its star performers and its busts. Indeed, because it is still developing there may be systemic problems or massive blow-ups, as microfinance in India and Bangladesh testifies: the Indian state of Andhra Pradesh took action against several microfinance banks which had been charging usurious level of interest, driving dozens of borrowers to suicide in despair.
One of the reasons microfinance has become unpopular with governments within whose borders it operates is because it has disrupted the market, says Michael Green: ‘If it gets to scale and gets disruptive, the biggest risk you have is political. That’s the story of microfinance — why do we have all this fuss in Andhra Pradesh? Because microfinance providers are challenging traditional state banks and establishments with interests linked to the money-lenders. If you think about investing going into healthcare or energy or all those areas, there’s a real potential in developing countries that vested interests are going to be disturbed.’ This is why a partnership with the government, like I4D, may succeed.
A problem applicable to any sector is that the faster it expands, the laxer the quality control becomes. Andreas Ernst points out that only big banks can afford to do proper due diligence, and Michele Giddens says the concern that ‘too much capital gets thrown at a relatively young sector too quickly’ is widespread. Investors, desperate for a piece of the impact action, may encounter less scrupulous intermediaries who do less research and pick worse investment opportunities; just like many people now are trying to claim the mantle of ‘family office’, so ‘impact investor’ sounds similarly dynamic.
As everyone interviewed here points out, however, impact investing is far from reaching this careless or disruptive point, and the few organisations in the sector are well respected.
THERE ARE NOT just opportunities for HNWs in impact investing — they may even see themselves reflected in it. Faisel Rahman points out that the tailored service Fair Finance offers, despite occurring in what may seem deeply non-U postcodes, is not in fact new to Spear’s readers: ‘What we’re carving out is a new market of a new type of lending that can only be successful in this way. It exists already in the United Kingdom. There is a group of people who need this type of relationship, a flexible, bespoke financial service: it’s the very rich. There’s a similarity between the type of products that the very rich want and the way they want it and what we’re doing, which I guess you could call private banking for poor people.’
Illustration by Vince Fraser