The Principled Agent

Thoughts on development economics and impact measurement

Case study: Assessing the cost-effectiveness of Impact Investing

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The cost-effectiveness of impact investing is unclear due to both poor impact measurement and hidden costs. As I have addressed the former issue in the discussion note, “Cost-effective Impact Investments for the Impact Investor,” this note will explore the cost of impact investing, specifically the subsidy intrinsic in the investments.

Impact investments are generally a hybrid of equity and/or debt capital and subsidy, and likewise have two types of returns, financial and social. To understand the cost-effectiveness of impact investing it’s necessary to not only better quantify the social returns, but also isolate the subsidy. Only after clarifying the subsidy component of the investments can one assess the financial and social performance of the two components of the investments.

Within the impact investing sector, subsidy takes many forms, e.g.:

  • Grant funding for staff
  • Grant funding for technical assistance
  • Preferential access to capital at below market rates

Acumen Fund’s Best Alternative Charity Option (BACO) framework arrives at its cost basis by subtracting the management costs and principal from the returns of the investment. In their example, a $325,000 loan that returns $422,500, and costs $130,000 to disburse and manage, results in a net cost of $32,5000.

If you wanted to identify the subsidy in the deal, however, you might frame the cost differently. In this case, it appears that the management has been subsidized, and provided access to capital at below-market rates. There likely is a technical assistance subsidy as well, but that is either included in the management figure or not considered. If you incorporate the management cost subsidy[1] in the discounted cash flow analysis calculation[2] of the deal, the international rate of return (IRR) of the investment falls to    -3%. With a 12% discount rate, this investment has a net present value of approximately -$100,000; i.e., if the same capital could earn 12% net of management fees or its risk-adjusted equivalent (a conservative assumption), this investment is worth -$100,000.

This $100,000 figure represents the real cost of the subsidy, and should be considered the basis for assessing the cost-effectiveness of the impact investment.  It captures the opportunity cost of the capital, and the subsidies used to support the investment. Acumen Fund’s cost figure of $32,500 does not account for these hidden subsidies. Because we are assessing the cost-effectiveness of the transaction as a whole, the total subsidy of the transaction must be considered.

In this case, the investment appears to do justify its cost, though it’s necessary to make a number of assumptions beyond the information provided by Acumen. The investment’s sales are estimated to provide two million person years of malaria protection. Acumen Fund does not attempt to estimate how many of those people would gain malaria protection through one of the many other means, e.g., government programs, other NGOs, other small businesses, etc. Further, there is the question of alternative sources of capital for the investment. If the firm could access capital at a slightly higher rate, for example, then the impact of the firm’s investment is relatively marginal. For simplicity, I will assume that Acumen is the only source of capital.

Further, let’s assume that 500,000 to two million person years of malaria protection is a sound estimate of the range of incremental person years of protection added by virtue of this investment – in an alternative universe without this investment, this range of person years would go completely unprotected.


This investment projects 5-20 person years protected per dollar of subsidy, or $0.05-0.20 per person year[3]. With additional information, it would be possible to also estimate the impact on disability-adjusted life years (DALYs) as well.

There is significant subsidy in impact investing, and it likely varies by social fund. This isn’t a weakness in and of itself, and it should be accepted to the extent that it provides adequate social returns.  In order to support a healthy impact investing market, it’s important to be explicit about the level of subsidy in the investments (and the funds more broadly) in order to provide an accurate cost basis from which to assess the cost-effectiveness of the investments. I suspect that as we become more explicit about this subsidy, the more interested donors will become in “Cost-effective Impact Investments for the Impact Investor.”

[1] There are multiple ways to address the issue of management cost; alternative investments would also have management fees, albeit much lower.  I have assumed here that the 12% discount rate is net of fees.

[2] The analysis is based on the data supplied in Acumen’s BACO case study linked above: more information is available upon request. The negative IRR is largely driven by the annual management subsidies. While I’ve assumed a 12% hurdle rate, the NPV of the subsidy increases to $130,000 with a 25% hurdle rate (a reasonable assumption). You can also arrive at higher subsidy estimates if you discount the investment with a financial discount rate, e.g., 12% or 25%, and then discount the subsidy at a social discount rate, e.g., 3-4%. At the high end, if you assume that the market-rate hurdle rate should be 25%, and discount the resulting implicit subsidy in the investment and the management subsidy at 4%, you arrive at a much larger real subsidy cost (about $270,000.) At this extreme, the investment projects to return 2-7 person years protected per dollar of subsidy, or $0.13-0.53 per person year.

[3] For simplicity, I am not applying a discount rate to the social value, but at a standard 3-4% social discount rate, the change would be marginal, provided a five-year time horizon. If instead the time horizon is ten years, the real impact is approximately half.


Written by Chris Prottas

February 7, 2012 at 7:17 pm

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