By Nick Murphy, head of charities investment management at Smith & Williamson
This article was originally published in Smith & Williamson's Enterprise magazine, a thought leadership publication for entrepreneurs and growth companies. You can download this issue of Enterprise here.
There has been a subtle, but insistent shift in the way our investment clients look to allocate their capital. We find an increasing recognition that investment should have purpose as well as generating profit, with the charity sector – where we specialise – at the vanguard of this change.For the clients we work with, impact investing is a logical extension to responsible and sustainable investment, providing a new way to address social and environmental issues and further their charitable goals. It offers a compelling alternative to philanthropic donations. Current estimates from the Global Impact Investing Network (GIIN) put the size of the impact market at US$502bn*, growth of around 80% in the past four years.
Impact investing in the charities sector has been building since 2016, when the Charities (Protection and Social Investment) Act introduced a statutory power to make social impact investments (also referred to as program-related investment). The idea is that the charity can further its charitable aims, while at the same time potentially make a financial return. The act releases charities from the legal framework for financial investments, but in return their charitable resources must be used to further the charity’s stated aim, for public benefit and to produce some financial return for the charity.
Equally, the Pension Regulator now allows pensions to invest a small proportion of their funds in impact investments. Given the size of many pension funds, this can equate to a significant level of funding.
In this way, successful social investments expand the number and range of projects a charity can support, sometimes loans or equity are a better way of providing support and different vehicles can improve the terms on which charities are offered finance.
Mixed motive investments where the intention is not purely social and there are elements of financial motive are also possible – such as a charity setting up a trading company.
It is also possible to have some private benefit flowing to other investors provided the trustees believe it is necessary and reasonable in terms of the amount in the circumstances. However, an unacceptable level of private benefit might affect the charitable status and this is an element to which business owners hoping to attract social funding need to be alert.
Defining social investmentOne of the single largest problems with social investment is a lack of agreed definitions. The EU is compiling a taxonomy of environmental definitions and once this is complete will follow with social definitions, but this remains some years away. ‘Good’ social impact will ultimately be determined by our individual values, culture and belief system.
The Investment Association uses the GIIN definition, which see impact investments as having four key elements: intentionality, financial returns, investing through any asset class and impact measurement. As we see it, any business that wants to attract impact funding will need to be able to display these characteristics:
Impact investments intentionally contribute to social and environmental solutions
Impact investments seek a financial return on capital that ranges from below market rate to a risk- adjusted market rate
Range of asset classes I
Impact investments can be made across all asset classes
A hallmark of impact investing is the commitment of the investor to measure and report the social and environmental performance of the underlying investments
While definitions remain elusive, it is vitally important for any long-term impact investment partnership that both sides understand what is expected of them. The company looking for impact funding will need to have a clear understanding of the charity’s mission, and the charity will need to understand the company’s intended impact.
Setting clear parameters for monitoring and evaluation up front is crucial. A business will need to be clear about establishing and stating social and environmental objectives to relevant stakeholders. They will need to set performance metrics and targets where possible and then measure against those metrics over time. Reporting on social and environmental performance to relevant stakeholders will also be a key part of the process.
Other considerations may include elements such as how involved the charity will be, the definition of ‘impact’ and the establishing of a clear feedback loop. This is key to effective collaboration.
These parameters should also include an understanding of the risks involved. Liquidity, for example, may be an important consideration. Impact investments are often smaller, tightly held structures and there may not be ready liquidity. Any investor needs to understand this, or risk derailing the impact investment by trying to withdraw capital too quickly. There should be clear agreement on the time horizon for realising gains from the investment.
Ultimately, the charity sector and social purpose companies looking for capital should have a fruitful partnership ahead as long as both sides are clear on what they expect from the other. Effective control and monitoring will ensure both sides realise the potential gains from a partnership.