Separating the Gold from Pyrite: Analytical Rigor and the Potential of Impact Investing
This post addresses two questions raised in the recent discussion on impact evaluation and investing: to what extent is the burden of proof lower for impact investing than traditional philanthropy, and what type of analysis does the industry itself need to separate social enterprises with goods intentions and significant social impact from those that struggle to translate the former to the latter.
Acumen Fund’s Sasha Dichter recently responded to Dean Karlan’s critique of the lack of rigorous analysis of social investments by differentiating between the social investment and the “purely philanthropic intervention”:
No matter what scale a pure philanthropic intervention reaches, the total marginal cost of delivering the nth “thing” (any intervention) is always positive, so you’re in the business of figuring out how the impact relates to that cost and how the impact relates to other similar interventions. Not so if you find the “next cellphone” – except it’s not a cellphone, it’s safe drinking water or a bio-mass powered light on a mini-grid or a safe and affordable place for a mother to give birth.
Sasha seems to be differentiating between the two because the philanthropic venture’s product or service always requires some subsidy, while the social enterprise does not. Similar to the cell phone manufacturer, the social enterprise will (at least partly) find its profit and social incentives aligned, with healthy growth and adoption signaling that it’s having a social impact without the need for a rigorous impact evaluation. Continuing with the cell phone example, Sasha notes, “Since we’re not using up grant money to pay for it, it stops being the purview of development economists to fret about this.”
From my perspective, this last point is crucial. If you are providing investors with market-rate returns without direct or indirect subsidy, I completely agree that your burden of proof is fundamentally different than that of a philanthropist.
If you are providing submarket risk-adjusted rates of returns, however, or accepting subsidies of one type or another, then you are leaving the world of cell phones and entering the world of bed nets. I believe that the majority of impact investors fall in this category, with the subsidy coming in a number of different forms.
Now if JP Morgan is correct, impact investing has the potential to be a $1 trillion market, and if just one-percent of that total is a subsidy in one form or another, we’re talking about a potential $10 billion philanthropic market.
Given this outsized potential, the fact that a large number of purely philanthropic ventures with clear-cut social value propositions and a 100-percent focus on social returns have shown virtually no impact on the lives of the poor should give pause to impact investors who are now laying the foundation for their own high-potential philanthropic market.
In addition, the microcredit industry demonstrates the damage that can be done to an industry with financial and social ambitions that allows all the players to sell a significant social impact not based in rigorous analysis but solely in the supposed benefit of providing a service “that make[s] a material positive impact on the lives of poor people.”
Microcredit surely has benefitted the poor, but would the poor have been better off if those hundreds of millions of dollars of subsidy had been put to microsavings? Or would it have been better spent subsidizing capital equipment loans for producer associations? Or, perhaps most importantly, could it have been better spent on pro-poor microcredit itself if its allocation and social investment criteria were informed by more rigorous social performance measurement before the IPOs?
Like microcredit, I’m not worried about whether impact investing will have a benefit greater than zero. I am worried that the social performance data collected will not allow impact investors to separate the gold from the pyrite, which will reduce the effectiveness of the budding industry.
Setting aside the methodological question of how to assess impact, I think the most important take away from the RCT movement is that there’s a lot of good looking pyrite.
Within the impact investing sphere, there are a huge variety of industries (e.g., irrigation systems, medical care), business models, and markets, all of which will affect the ultimate impact of a financially-successful social enterprise. That is, impact will likely vary across industry, market type, and business model (among other variables), and this presents a number of questions:
Based on the emerging impact analysis and reporting best practices…
- Are impact investors able to assess the relative social impact of these different interventions and to shift their investment focus and criteria to ensure that they are maximizing their social impact (within the constraints of their financial goals and requirements)?
- Can an impact investor who is very adept at separating the impact gold from the impact pyrite distinguish herself from the impact investor who can’t?
- Can impact investors shift the basis of “competition” for social investment from the investor’s social value proposition (e.g., financial services for the poor, rural business development) to social impact? In other words, are we seeing the birth of an impact investing industry or just the maturation of the socially-responsible investing model into a more proactive “good intentions” investing model?