Impact Investing Can’t Deliver by Chasing Market Returns

May 17, 2023

To be successful, impact investors need more realistic expectations and to be part of a larger and community-based pool of capital, including philanthropic investments that lays the groundwork for impact.

Posted in SSIR on May 17, 2023
By Jim Bildner
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In 2012, more than a decade ago, in response to a growing wave of impact investing obsession, Kevin Starr warned that impact investing was doomed to fail: “Few solutions that meet the fundamental needs of the poor will get you your money back,” he observed, and “overcoming market failure requires subsidy.”

These realities have not changed since Starr wrote “The Trouble With Impact Investing.” In fact, if anything, the cost of solving for inequity has only increased. Yet the fascination with impact investing has only gotten stronger, even as achieving true impact—let alone a market investment return—remains vanishingly rare. To be blunt, the data is in: Few problems have been truly solved by impact investing, and returns have been nominal at best. Proof of this abounds, like the so-called “Opportunity Zone” investments, which research has shown to be “costly and poorly targeted and (have) done little to create jobs or improve conditions in poor communities while providing massive tax benefits to wealthy investors”; intended to spur investment in low-income and undercapitalized communities, they have instead subsidized investments in communities with relatively higher incomes, home values, and educational attainment as well as stronger income and population growth. Most practitioners working in community development have accepted this as the reality of impact investing: The harder you drive for social impact in disadvantaged communities, the farther away you get from unbuffered full market return. But the hype persists.

After 20 years and more than 220 investments made supporting early-stage frontline social organizations, Draper Richards Kaplan Foundation—the organization I have the privilege to lead—we have adopted a simple true north: What matters most is creating an impact in the lives of the most vulnerable populations—whether it’s addressing food insecurity by providing meals where needed, providing housing to the homeless, making medical care accessible, making social justice a reality for all or providing pathways to employment opportunities, to name just a few of the problems our portfolio organizations are trying to solve. And while the majority of the investments we have made have been grants, roughly a quarter of our investments have been Program Related Investments (PRI) in for-profit entities, so we know a thing or two about impact investing. By definition, PRI regulations ensure that there must be an “impact” in investing.

Our experience has been crystal clear—just getting our principal back (and being able to recycle any return into another social enterprise) is a huge win—one we are absolutely comfortable with. Why? Because the impact from these for-profit investments is exactly the same as the impact from our nonprofit grants: More than half of the organizations are directly impacting more than 10,000 lives, more than 40 percent are impacting 50,000 lives, a quarter are impacting 500,000 lives and more than a fifth, millions of lives. We attribute the similar impact from our for-profit PRI investments as our nonprofit organizations to the fact that we never compromise our focus on social impact, regardless of the form of the entity. Without the pressure of seeking market returns, we are free to focus on true impact in our for-profit investments. And without the pressure to deliver market returns, these for-profit entities do not have to compromise their focus on those most in need.

And yet, the noise in the funder ecosystem remains fixated, some would say obsessed, on the notion that it’s possible to achieve both market returns and full social returns. We recently pulled data and transcripts from impact investing conferences and what did we see? Equivocation. Asked whether it’s possible to achieve both market returns and meaningful social returns, panelist after panelist kept saying, “It depends”: It depends on how you measure social returns and over what time frame; it depends on your definition of impact; it depends on which population the investment focuses on.

The implication was clear: The more aspirational the impact goal, the harder it is to achieve market returns.

In looking at multiple data sources that aggregated philanthropic inflows as proxies for investment capital inflows, the data shows us two things:

  1. No market return-based capital that attempts to address a single placed-based societal inequity—employment, wages, housing, or educational attainment, to name just a few—can have more than a hyper-local effect, in the long-term, until other tools are brought in.
  2. Placed-based “investment” capital directed for social returns, outside of housing, has been unable to achieve the impact investing goal of full market economic returns and high-impact social returns. The most common characteristic we saw in social finance or capital market investments targeted at these focus areas was the need for massive tax subsidies provided by governments or “loss reserve” coverage most often coming from philanthropic sources. This, by definition, is not a market return, but a return made possible by philanthropic capital or government tax subsidies that artificially de-risks the investment and enhances returns based on external subsidies—in short, just what Kevin said in 2012.

Some might ask, what is the harm of this false investing narrative? It’s simple: While there is demand for impact investments that create full market return and true social impact, these simply do not exist at scale. Pools of capital that chase it either quickly evaporate, or, worse, give up on making a positive social impact at all, depriving communities in need of precious capital. And even worse yet, realistic and viable deals that can absorb multiple forms of investments with more realistic economic expectations go unfunded. That’s the harm.

However, it’s a different story when multiple forms of capital are pooled together, with realistic economic expectations, and including targeted philanthropic capital to ensure the ability of a community to absorb the investment. One of the best examples of this is the Kresge Foundation’s social investment team’s work in the Woodward Corridor in Midtown Detroit through the Woodward Corridor Investment Fund (WCIF). Created in 2013 as a multi-investor fund designed to provide permanent financing for mixed-use projects in Detroit’s Midtown neighborhood, the Fund was capitalized at $30.3 million and provided fixed-rate loans and forward commitments based on up-to a 120 percent loan-to-value ratio, 15-year term, 30-year amortization, at 5 percent interest. The multi-investor collaboration included senior lenders (MetLife, Prudential, PNC, and the Fisher Foundation) and subordinate lenders (Kresge, NCB Capital Impact (now Momentus Capital), and the Calvert Foundation). In its structure, the fund blended grant capital in the form of general operating support for the fund administrator and as funding for a loan-loss reserve, PRI capital (first low-cost debt and later an unfunded guarantee) that set up the conditions for a conventional senior lender to come in, not as an impact investor but as tried and true market capital.

That’s the key: using true impact investing dollars to set up the conditions on the ground to be investable for conventional market capital. Impact investing is not its own thing. It’s part of a coordinated effort to attract market capital, not be the market capital.

And by the way: For those skeptical about impact, the results wildly exceeded all expectations. The Midtown district dramatically overperformed the city on virtually all measurable statistics, including a decrease in unemployment rate, an increase in median property values, and an increase in rental rates. Both quantitative and qualitative analyses show that this capital mix—realistic impact investment paired with grant capital dramatically accelerated the foundation’s goals in the neighborhood.

Data fails to capture just how important the grant (and concessionary) capital was in laying the groundwork for the success of the impact investment and, in particular, the capital channels through which the fund operated. For several years in advance of the fund formation, Kresge staff worked with other local foundations to support the growth of the local community development organization, Midtown Detroit, Inc. (MDI). MDI was instrumental in assembling project teams, providing technical assistance to developers, taking possession of publicly owned (blighted) assets, curating retail amenities, and housing down-payment and rental assistance programs to jumpstart the market. Kresge alone provided $3.6 million in general operating support to MDI from 2008-2013 and another $1.4 million in project support grants for work in the Corridor.

For a community to flourish, it needs coordinated capital inflows from all sources: business capital, real estate capital, mission capital, nonprofit funding, and often federal, state, or local community development funding. Isolated forms of capital with return expectations disconnected from the totality of need are destined to fail, disappointing those in need and making the next attempt that much harder. The last thing these communities need is an impact investor trying to achieve market returns on their backs. Coordinated capital, intentionally focused, using existing community-based channels and utilizing all the investment tools in the “toolbox” (and driven by local project management) will, over time, produce better returns—social for sure, but economic as well if expectations are appropriately set.

It’s time to change the definition of impact investing to this kind of investing and change the narrative to make it the rule, not the exception. All impact investors welcome.