Open Letter to OPIC and Cambridge Associates on the Impact Investing Initiative

Sara Olsen
Founding Partner, Social Venture Technology Group

OPIC is the US government’s development finance institution, in other words, the original American "impact investor." "It is an ‘independent’ U.S. Government agency that sells investment services… and

mobilizes private capital to help solve critical world challenges and in doing so, advances U.S. foreign policy."

With this initiative, OPIC is engaging in the new impact investing

conversation, which is about the mainstream private equity and debt markets explicitly recognizing their role in solving these world challenges through understanding, measuring and managing their impact.

1. “Impact” – What we are talking about?

2. How to tell whether something is an impact investment
3. On OPIC’s potential role
4. About impact guidelines and principles

1. “Impact” – What we are talking about?

As OPIC knows as well as any investor, “impact” means change in social, economic and/or environmental systems that would not otherwise have happened. This can be positive or negative change. What is considered to be an important or significant impact also varies based on who is judging it, and when and where they are doing so.

All businesses by definition strive to generate value for which they will be paid by its recipient. Accordingly, profit is (or is presumed to be) the result of the provision of something of value to someone who values it enough to pay more for it than it cost to provide. Beyond profit, however, all businesses also generate social (i.e. health), economic and environmental impacts for stakeholders beyond merely the owners. But not all businesses create positive social or environmental benefits above and beyond the status quo, nor are all business leaders aware of the impacts their companies create.

The result is that our economic system is extremely good at creating what it measures: financial wealth for owners. And to date it has been rather bad at creating environmental sustainability, and so-so at eradicating poverty and promoting health, particularly across the board. If these outcomes were measured, arguably the global economic system would become very good at solving these problems too.

Those businesses that consciously create or strive to create impact above and beyond the status quo could be referred to by many terms: beneficial businesses, social ventures, blended value businesses, double or triple bottom line businesses, etc. Investors that deliberately invest private equity or debt into these types of businesses are referred to as “impact investors.”

2. How to tell whether something is an impact investment

Assessing the impact of an investment is easy to say and hard to do. There are essentially two ways to gauge impact. One way is to compare the impact (social, environmental, economic) a given business or investment fund creates to an industry standard benchmark- for example, the health impacts of a given product, or the economic development impacts of a company located in a certain place. If the impacts of a company are better than the industry standard, the investment is an impact investment, and if they are worse it is not. The other way to tell is to compare the impact created to the ultimate outcome that is desired- for example, no net depletion of natural resources, or zero poverty in a given region.

Generally speaking, in the corporate social responsibility (CSR) and socially responsible investing (SRI) worlds of the past two decades, the actual assessment of net impact has been deemed too costly and too difficult to achieve at a sufficient level of confidence. So proxies for actual impact have been used, such as policies or outputs that imply certain outcomes. And funders have settled for information about whether an investment has accomplished something it set out to do, without consideration of other potentially significant impacts. Further, in the development world to date, budgets have existed to enable “measurement and evaluation” of impact by third parties, but these costs have not been internalized by the businesses and/or funds in a manner the private sector could or would adopt en masse.

However, more recently in the private equity and philanthropic worlds, and particularly the realm of relatively early stage ventures which are smaller and less complex, different possibilities to measure actual impact do exist, particularly in light of mobile and internet technologies. In the private equity context, the question is framed in terms of what value is being created with an eye to how this can be optimized going forward. Impact investors want to understand the environmental, economic or social returns on investment in addition to the financial returns- and ideally they want to know how these things interrelate.

Today, in these ventures, it is possible to assess impact with reasonable confidence at a price point the market can internalize. This is due to greater agreement about method, lower cost of data collection, more human resources willing and able to assist at all levels of the value chain, and more visibility of the information to the markets and the public—audiences who ultimately do want to know that businesses are having a positive impact and not a negative one.

But the market has not yet embraced this new reality. The bulk of investors simply haven’t asked to know what the actual impact is. The reasons are a combination of insufficient historic evidence that doing it will pay off (since it hasn’t been done before), ignorance of how to do it, cultural inertia, tall poppy syndrome, and the tragedy of the commons. Nobody wants to go first.

Fortunately, a handful of leaders such as the largest public pension fund in the US, CalPERS, with both its California Initiative and Environmental Technology Initiative have proved over the past five years that it is possible to assess net environmental and jobs benefits at significant scale. Players such as B Lab, the GIIN, Hope Consulting and JP Morgan have established that many investors are interested in impact information, and many companies are voluntarily willing to account for their quality and potential. And the SROI method and corresponding international SROI Network of practitioners have demonstrated that there is a global appetite for the skills by which judgments can be made about what is and is not important to measure in order to understand impact.

There is proof of concept. The players are ready. It is time to scale.

OPIC has a literally historic opportunity. The time has never been so ripe for a catalytic initiative to establish the expectation that impact will be a part of accountability for performance in investments.

3. On OPIC’s potential role

OPIC has the opportunity to change the capital markets subtly but permanently, by providing an incentive for the collection and reporting of impact information in investment opportunities that bring mainstream capital together with impact-oriented capital.

Whereas international governments have created mandates that have spurred the standardization of principles for the accounting of social impact, such as the UK Office of the Third Sector, and more recently Korean, Indian and Thai policies to encourage social entrepreneurship; foundations such as the Rockefeller and Hewlett Foundations and individual instigators such as those behind SOCAP and the Take Action! Conference, have underwritten convenings and the creation of industry associations to encourage action on the part of investors and taxonomies to assist the communication of impact; still too few mainstream investors have yet done more than what amount to marketing campaigns in the impact investing space.

By mandating the reporting of net environmental, social and economic benefits of its Impact Investment Initiative, OPIC can make transparent the aggregate impact of investments that will garner dollars from name brand investment funds such as JP Morgan, Goldman Sachs, Deutsche Bank, and Bank of America. OPIC can substantially end the “tall poppy“ problem.

If hypothetically OPIC’s funds represent 10% of the total capital leveraged into a set of investments, then with $100 Million OPIC can potentially cause $1Bn in assets to have their environmental, social, and economic impacts measured. If this information is made transparent to the capital markets, we will see once and for all that the market recognizes real financial value in it—investors en masse, consumers, employees, and the public will prefer to know the impact than to fly blind. As a result, pressure will increase on mainstream asset managers to track and make transparent this information.

It is worth repeating that this has been done at large scale before. But nobody did any PR about it so that is not well known outside the churchiest of the church choir. Here therefore is a very brief summary of what has happened.

In 2000 CalPERS created the California Initiative to invest private equity into communities that rarely see PE dollars, with the goal of spurring quality job creation in those communities. In 2005 they recognized the good work of one of the investees, Pacific Community Ventures, on tracking its own jobs impact, and PERS hired PCV to capture the jobs impact of the entire portfolio on an annual basis. More than $1Bn of CalPERS money has been put into this initiative to date. When viewed in combination with coinvestors in the same set of portfolio companies, the total assets being measured probably total over $5Bn. Additionally, in 2004 PERS created the Environmental Technology Investment Initiative and included in the original side letter agreements the requirement that GPs participate in accounting for the net environmental benefits of their investments. This did not mean simply greenhouse gas emissions or any other single impact, but rather it required analysis of any and all significant and important environmental impacts, good or bad. Environmental Capital Group became the subadvisor to perform this analysis and reporting function (and SVT Group helped design the original due diligence and performance reporting system). The total dollars PERS has invested in this initiative are $600M and cumulatively the total assets being measured amount to some $9Bn. A handful of other players such as a handful of GIIN members have made some investments in which they have accounted for their impacts as well.

All told the total assets associated with these two initiatives are around $15Bn – assets for which annual net impacts have been tracked annually for several years.

This proves that impact measurement can be done at scale by mainstream investors.

4. About impact guidelines and principles

Some simple requirements established by these players allow individual companies and funds to address any particular impacts that are relevant, while meeting reporting requirements. For example, in its Environmental Technology Investment Initiative, CalPERS screened general partner groups up front for their capacity and willingness to participate in reporting net impact, and demonstrated evidence of the ability to deliver environmental benefits through their investments. Once this due diligence was done, PERS simply wrote in the side letter agreements that net economic benefits or net environmental benefits would be tracked, and they commissioned a sub-advisor to work with the fund manager to manage this process, including aggregating and analyzing the portfolio-level data and reporting it to PERS. PERS did not dictate what types of specific items needed to be tracked, but left it up to the experts within the companies, general partner groups, and the sub-advisor to exercise judgment on a company by company basis. Environmental Capital Group also had relevant experts from academic institutions peer review the selection of indicators for any given company.

A few key principles are de rigeur.

• Impact means impact. The goal should be to understand what changes compared to what would have happened otherwise in the issue areas that matter to people- both those the investor intends to address, as well as any important, significant others that may arise intentionally or unintentionally. No matter what approach is used, whether GIIRS, a randomized control trial experiment, or something in between, this must remain the goal or the approach could lose its purpose. If actual impact is not explicitly assessed, then the way in which the rating is a leading indicator of impact should be made explicit. If the net impact— meaning any significant and important externalities, not just the intended outcomes—are not tracked and verified by a third party, the analysis will lend itself to greenwashing.
• Stakeholders must be involved. If key stakeholders – including employees, customers, suppliers, and the community– haven’t been consulted about what is important about a given investment’s impact, it is all too easy to settle for the view on the part of an investor that everything is good as long as profit is made. We can see that this is insufficient.
• Analysis must be comprehensive. Instead of picking something that’s working and leaving out what is not, the analysis should include the whole shebang.
• Results must be transparent. With appropriate confidentiality safeguards, companies should report to their investors, and investors should aggregate and report results. What is left out should be stated. Assumptions and sources should be stated. It should be possible for a third party to replicate the analysis based on the documentation of it and get the same result. Ideally the analysis has been performed or verified by a knowledgable third party.
• Context matters. It is harder to create a stable job in rural Ghana than in San Francisco. The qualitative and quantitative context should be provided to inform consideration of the “difficulty of the dive,” as well as understanding of how much of the problem may exist or remain globally.
• Invite innovation. While this has been done, it is still early days, and many issues have yet to be resolved, among them: what should be within the scope of analysis, what constitutes an impact significant enough to track (materiality), what is a reasonable degree of credibility to meet in the measurement of impact and its proxies, etc. Furthermore, how to measure in a manner that is both accurate and cheap enough that it does more good than harm deserves a lot more innovation. As such, a sixth guideline could be to invite parties to suggest the best ways of measuring something credibly and at low cost, and to explain why that way is better than some other way.

OPIC can make a big impact by simply asking the funds in the impact investment initiative to account for their impact, in whatever way they deem best, as long as it adheres to a few key principles. We believe the principles above would be a good start.

But OPIC’s impact would be infinitely larger and more lasting- indeed transcendent of government administration or OPIC leadership tenure- if it partnered with some PR resources. Those players from the private sector who are interested in helping to catalyze impact investing could make the results of impact analysis visible to the public. This final step, of making the results visible to the public, will reveal the value of this information. Once that is done, mainstream investors will buy it, literally.

A Caselet: Tesla

Arguably Tesla Motors is an impact investment. It has received investments from funds with an explicit goal of creating jobs in California, and from funds designated for Environmental Technology Investments, among other investors. In both cases, the net jobs and environmental benefits have been measured.

Tesla has both direct and indirect benefits- it reduces fuel consumption and inspires people that electric cars don’t have to be lame. Yet a new model and make of car also implies the creation of a new production line, and this is highly resource intensive when contrasted with the per-vehicle impact of an existing production line. Furthermore, while the all-electric Tesla uses no gasoline, and emits no CO2e when running, it does use batteries to store electricity, and these have significant negative upstream and downstream environmental consequences. Lithium, a key material in batteries, is found in a few places in the world among them the Bolivian Altiplano, which to date has been a pristine natural wonder of the world but with the shift to a more electricity-powered economy it faces growing pressure to submit to mining—and there aren’t many impact-oriented mining companies yet.

When the environmental ramifications upstream and downstream are understood, it becomes possible to do projections and scenario planning to improve the design of the product, hold suppliers to certain environmental and labor requirements, and inform investor-company dialog. This means a truly greener company, fewer problems with the society’s ‘license to operate’ down the road, and potentially better financial returns as a result.

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What do you think? We’d love your comments!