Making a difference with social impact investing

The 1970s had the energy crisis and consequent stagnation; the 1980s had the free market revolution and subsequent explosion of greed; the 1990s saw booms and busts, pushing some into prosperity and many into poverty. As we settle into the 21st century, the new generation can do little else but clear up the mess.

The millennial generation is creating a new and different world amid past destruction. While generations past have made great advances, some reckless behaviour has caused deep and worsening wounds. Says Sir Ronald Cohen (pictured), founder of Big Society Capital, and head of the G8's Social Impact Investment Taskforce: "The time is now. For venture capital and private equity to take off, a number of things had to come together at the same time. The same is happening for impact investing. First, the millennial generation is looking for meaning beyond reward and there's also a ‘grey wave' of people that want to give back. Then, investors are seeking to achieve more than just financial returns. And finally, governments need innovation and appropriate capital to tackle social issues more effectively."

The swelling gap between rich and poor causes a host of worrying consequences. According to the Joseph Rowntree Foundation, rising levels of poverty lead to poorer health, putting more pressure on healthcare services; more crime, creating heavier burdens on the justice system; and lower levels of education, meaning fewer skilled people, which in turn chokes growth and innovation. Says Philip Newborough, co-founder and managing partner of Bridges Ventures: "There are a whole raft of social issues that remain as a result of wealth inequality and lack of access to services. The private sector has a role to look at its impact, and go one step further to think about how it can solve these issues."

Millennial generation
The millennial generation comprises entrepreneurs wanting to build better and more sustainable businesses; wealth inheritors seeking to invest responsibly; and consumers demanding goods that create a positive impact.

As the responsible, sustainable and ethical revolution takes hold, private equity is in a unique position, not only to support impact investments, but also to generate healthier returns. Impact investing is about bringing in a third dimension, it is not just about risk and reward anymore. 

The new generation of entrepreneurs is focused on creating responsible businesses. According to The Millennial Survey 2014 by Deloitte, young entrepreneurs' number one priority is to change society by creating responsible businesses. For private equity, this requires a new approach to sourcing deal opportunities. Bridges Ventures' investment in The Gym Group is a perfect example of an opportunity found by focusing on social impact, using the firm's "impact lens". "By approaching origination through looking at societal challenges we find opportunities others might miss," says Newborough.

While it is commendable that entrepreneurs are increasingly focused on tackling social issues through business, it is vital that these businesses attract consumers and are able to grow. Fortunately, the millennial generation as consumers are more and more concerned and aware of how businesses behave. The success of companies including The Body Shop, Tom's Shoes, Warby Parker glasses, and a whole host of fair trade goods retailers is clear evidence of how consumer behaviour is changing. Consumers want to feel good about their purchases and the businesses they transact with - not just for buying a quality product, but buying one that has a positive impact.

In line with evolving consumer demands, wealth managers are also witnessing rising demand for responsible investment products. "Younger people have a heightened awareness of the world and our impact," explains Bruno Bertocci, managing direct and Global Equity Portfolio Manager at UBS Global Asset Management. "This takes on different forms, whether it's shopping in Wholefoods or driving electric cars - it all feeds back into sustainability. So it makes sense that individuals are concerned about their personal investments - they want them aligned with their own views. Wealth managers have to meet these needs to keep clients and attract new ones."

Funds of the future
For private equity, this indicates a shift in investment allocation. "There is evidence already of investors focusing on both financial returns and impact. The process has been going on for several decades, but it is coming into sharp focus now because of impact measurement. We can expect investors to prefer managers that can deliver measurable social and financial returns at the same time," says Cohen.

Indeed, rising demand from all forms of institutional investors for social impact investments will inevitably affect fundraising. "Pension funds are starting to allocate into sustainable and social impact investment vehicles; both of our recent funds received investment from pension funds. Now our investor base is mainly institutional, which is a complete change to when we started," says Newborough.

From speaking to various pension funds around the world, Bertocci believes that impact investing is the future of investment. "I have been speaking to large pension funds in Colombia, Iceland, the Nordic countries and Japan, all of which are signatories of the United Nations Principles of Responsible Investment (UNPRI). The feeling is that it's not good enough to just sign up - you have to do something. You have to provide returns for members while looking for ways to embed sustainability in a sound way. All pension funds are looking into this."

Measure for measure
As Cohen points out, advances in how to measure impact is a major catalyst for social impact investing. The introduction of standardised accounting mechanisms for measuring social impact, from organisations including the Global Reporting Initiative (GRI), the Sustainable Accounting Standards Board (SASB), and the Global Impact Investing Network (GIIN), will enable investors not only to better track and understand impact investing but will cause a shift in allocation to those able to report in line with new standards. Governments are also pushing for standardised accounting methods with the development of the EU Standard for Social Impact, and the UK's 10-year programme labelled "Inspiring Impact". These collaborative efforts are transforming the space and are now gathering real momentum.

"By tying financial returns to social outcomes achieved, you give social enterprises the key to the capital markets. Capital will begin to flow to those doing the best job and to those who are able to do it best at scale," says Cohen, who notes that there is a whole raft of social impacts that can now be measured

Bridges Ventures has created a set of tools to measure impact, which combines existing metrics hailing from the US, including GIIN's Impact Reporting and Investment Standards (Iris). Says Newborough: "Measurement is a key part of the evolution of impact investing - if we can measure and even price the impact of these investments - that takes us to the next level."

The Bridges Ventures Impact Scorecard acts as an important guide during due diligence processes in understanding the potential impact of an investment, and then as a clever portfolio management tool throughout the life of the investment. Using The Gym Group as an example, Bridges' key impact themes for the investment were health and wellbeing and underserved markets. For instance, to measure its impact, the investor counted the number of first-time gym users and the proportion of those in deprived areas. It also counted the number of jobs created and supplier spend in deprived areas.

Turning tides
Advances in how to measure impact has seen the launch of Social Investment Bonds, of which there are now 30 around the world, 20 of which are in the UK. Of the UK's 20, 10 are supported by the Department of Work and Pensions, highlighting government's increasing willingness to tackle social issues at an early stage - an awareness that prevention is cheaper than the cure. Where youth charities can demonstrate their outcomes (for example, getting young people into work), when matched against the cost of a young person not working, a clear cost advantage can be seen.

The UK government has taken an encouraging step by publishing the cost per year of social issues including those caused by reoffenders, children in care homes, care for the elderly, homelessness, education, drug misuse and domestic violence. By making these costs pubic, social enterprises are able to clearly demonstrate the cost savings they can provide - making a neat case for investment.

While parts of the UK government may have made some positive developments, one area of advancement has not been as smooth. The G8 Taskforce has strongly recommended that governments use their purchasing power to support the development of social enterprises. In October, the Ministry of Justice's contracts announcement was expected to see social enterprises taking on government contracts. However, in the end the work went to large multinational corporations because of a requirement for bidding companies to have a parent company with £15m on the balance sheet.

"It has been disappointing," says Cohen. "I don't think it was because social sector organisations were incapable of winning - at least two were - it was because of the rules set for qualification. The problem was these organisations - even with Big Society Capital support - were unable to meet the £15m requirement and this didn't seem fair. It is hard to understand why the rules were framed in this way if the aim was to give social sector organisations a chance."

However, Cohen sagely points out that it takes time to change cultures. "We were trapped within the traditional commissioning rules. The aim should have been to create greater competition from social sector organisations, because their social motivations and skills can be superior to those of businesses."

Building momentum
Cohen is optimistic that there is momentum within government ministries to include social sector organisations in the future, and he hopes they will react differently following this most recent round of tendering. "The forces of the status quo will always be forces of inertia - it takes effort to move them. It may take several tries," he says.

One major development for the UK is likely to occur following the 2015 election. The BVCA has been lobbying for enhancements to the Social Impact Tax Relief (SITR), which has already seen positive results in the UK Chancellor's Autumn Statement. The limit has increased to £5m for one year and £15m over the organisation's lifetime.

Furthermore, the BVCA is morphing its citizenship committee into the Impact Investment committee. "We are broadening that committee to include investors and advisers already involved in the sector. This group will become the focus for the lobbying process," explains Tim Farazmand, chairman of the BVCA. And beyond this, the association is also drawing up its manifesto in the run-up to the election. "The social impact investment manifesto will be a key plank in the broader document," says Farazmand.

Education, education, education
The case for social impact investing, or a socially responsible attitude to investing, has been made clear - the question now is what to do about it. Farazmand believes that the asset class is, for the time being at least, in a good position: "In terms of where we are in this evolution, which is still relatively immature, private equity is alerting itself and trying to understand the opportunities.

"My advice to private equity firms would be to start with education: read at the G8 report, understand the momentum, what is meant by profit with purpose. If they don't act now there is a chance LPs might get ahead of them, or they might miss deal opportunities. And, arguably those funds that get their first will more likely have a first-mover advantage."

Whatever the causes or reasons behind today's situation, the basic fundamentals of capitalism and economics still apply. Businesses make profits by meeting needs. However, our needs are no longer fuelled by a greedy consumer mind-set, rather our very basic needs for housing, healthcare and education need to be readdressed. While these may appear issues to be dealt with solely by governments, business and markets have crept into every facet of every person's life - from water companies, food producers and suppliers, schools and prisons - bestowing an important social responsibility on all those profiting from social services.

The millennial generation is tearing down the walls between public and private and taking matters into its own hands. By bringing entrepreneurial excellence and innovation as well as best practice to organisations wanting to make a difference and tackle social issues, we could, very shortly, live in a world where tabloids no longer decry private businesses from profiting through social services. We may even see a day where the private sector is more celebrated and trusted because of its social contribution. To not think seriously about this future now would be to miss out on future fund commitments, future employees, future deals and future growth. 

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