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The idea of using profit-seeking investments to bring about social and environmental good is slowly catching the imagination of the financial world. The new investing mantra has been termed ‘impact investing’ and the size of the market is expected to be $500 billion within the next decade. Even within this nascent sector, clear segments are emerging: there are the ‘impact first’ types—whose primary aim is to generate social and environmental good, and who are willing to give up some financial return if they have to; there are the ‘financial first’ types—commercial investors who seek out sectors that offer market returns while also achieving some good. And then, there are the yin-yang deals that combine capital from impact-first and financial-first investors.

Which of the three—impact first, financial first, yin yang—do you see gaining traction in India? And why?

In many markets, impact-first investors are taking the risks and pioneering the business models that are paving the way for financial-first investors to follow. This trend is most noticeable in microfinance, which began with substantial philanthropic support in the 1970s and 1980s and then expanded with impact-first investment throughout the 1990s.

In India, however, the demographic reality is spurring early interest by returns-focused investors in many sub-segments of the impact-investing market. Venture capitalists and private equity investors find the potential market opportunities in providing basic services like water and housing to millions of poor customers very attractive. They’re looking to put capital to work in businesses that can grow rapidly. Investors from marquee commercial firms are paying attention to this market and are conducting due diligence on social enterprises. But they often find these markets too fragmented and unproven to create a viable pipeline of investable opportunities.

In this context, yin-yang deals—in which impact-oriented investors are willing to provide seed funding to an enterprise to refine a business model, or to take a first-loss position—are especially promising in India. Early examples of this approach include the expansion of WaterHealth International’s village-based, clean-water distribution model. This was funded in India by a loan from ICICI Bank secured by a guarantee from impact-first investor Acumen Fund. WaterHealth subsequently raised a C-round of private equity anchored by Dow Venture Capital. The India School Finance Company (see story on Page 58), which is developing a model for profitable lending to private schools serving poor families, is similarly using impact-first capital to refine one that financial-first investors can expand.

How does one tackle the challenge of enhancing absorption, given that it will determine the trajectory of impact investing here? Does the government have a role?

Substantial work remains to understand, improve and expand the business models that can take impact investment and create both profit and social value. This is not simple. We do not yet have a firm grasp on the much more diverse business models (apart from microfinance) that will work in the broader social enterprise space.

In this context, enhancing absorptive capacity will require investors and entrepreneurs to be realistic and patient while confronting the inevitable setbacks and challenges. Emerging Markets, Emerging Models, released by the Monitor Inclusive Markets project, is a landmark for the type of honest assessments we will need. It also points to the role both private and public subsidy will need to play in supporting innovation and risk-taking. Investment funds like the Aavishkaar India Micro Venture Capital Fund spend a disproportionate amount of time to develop the capacity of the companies in which they invest.

The historic evolution of other industries, such as private equity and venture capital in the West, show how a government can create incentives to induce investors to enter this market. Capital gains tax breaks accorded to the information technology and outsourcing industry could also be applied to impact investments.

How soon can we see the emergence of industry-defining funds?

A handful of funds are already making impact investments in a range of geographies and sub-sectors. Some, such as the Oasis Fund of Bamboo Finance, have evolved from a legacy of microfinance investing. Others, such as Acumen Fund, have been born in the wider impact-investing industry. A series of efforts are now also underway to develop impact investing funds and fund-of-fund products that can access institutional investors as well. When global markets unfreeze there could be rapid proliferation in these funds.

Can impact investing partner with philanthropy to scale solutions?

Absolutely. For an institution such as the Rockefeller Foundation, which has engaged in philanthropy for almost 100 years, the promise of impact investing is that it offers a framework for us to partner with investors who share our focus in solving social problems. Philanthropy can subsidise the development of business models that impact investors take to scale; it can provide the risk capital to prove a business concept; it can provide subordinated investments that can entice more commercial investors to come into the market. Examples of this collaboration are beginning to proliferate.

In India, the ambulance service 1298 was launched with a combination of philanthropic support and impact investment and is ready to scale with public and private investment capital. In the US, the Rockefeller Foundation worked with other foundations and the City of New York to create an investment vehicle that led to more than $160 million of commercial bank lending in the low-income housing market.

Is it possible that the rise of impact capital will compress the pipeline of philanthropic capital that is already addressing a host of societal challenges? After all, not all societal/social problems can result in business models…

There is not enough money in philanthropy to address the magnitude of basic social problems such as insufficient healthcare and inadequate housing. At the same time, the market cannot solve every problem. So, we need to partner with impact investors who can unlock the much greater sums of capital available in the for-profit capital markets. With the advent of a strong impact-investing market, philanthropy’s more limited resources can be focused laser-like on where we are most needed. That involves funding crucial activities that the markets never will—such as movements for social justice, human rights campaigns, and outreach to the most poor and remote communities. And also to take the risks that investors cannot—backing ideas that could prove transformative.

Do you see the possibility of impact- or financial-first investors influencing social entrepreneurs to focus more on profitability, unwittingly diluting the latter’s social purpose?

This question assumes that there is an inherent trade-off between financial return and social purpose. In some cases this is a false dichotomy. Great social entrepreneurs are developing businesses that create both substantial profits for investors and social good. However, in other cases this trade-off is real. Thoughtful social entrepreneurs with whom we work are increasingly facing tough strategic decisions about how to pursue growth strategies while sticking to their social mission. As the industry develops, we will be able to learn from examples of pioneers who have successfully navigated this tension—and those who did not—to get a better understanding of this trade-off.

As businesses big and small begin to acquire a social hue and character, certain experts argue that in a decade or so, there will be little or no distinction between a ‘social venture’ and most major businesses. What is your view?

For many people, especially young graduates, the mainstream view that treats ‘business’ and ‘charity’ as completely separate spheres of activity is increasingly arbitrary and unconvincing. These people are developing social enterprises and bringing concepts of social engagement to mainstream companies. This trend will likely continue and the lines between business and charity will blur.

But I do not envision that impact investing and social enterprises will necessarily take over the world. A substantial amount of commercial activity will continue to be directed toward creating and selling products and services whose primary motive is the creation of profit. The good news is that we can live with this.

Do you envisage a situation where investing for impact becomes too easy—where the definition of social/ environmental impact is diluted to become virtually meaningless?

No doubt there are forces in the financial services industry that will seek to lower the standard of what an impact investment is. Lower standards will make it easier for institutional investors and wealth advisors to meet their clients’ growing interest in impact investment without developing radically new business models or skills.

This is where credible metrics become important. Without standards for measuring and reporting on social impact, it is increasingly becoming difficult to distinguish enterprises that are great at creating real social impact from those that are just great at telling stories about their work. Fortunately, a major effort is now underway to create a common language for reporting on social impact. The Impact Reporting and Investment Standards, housed in the Global Impact Investing Network, have the potential to help investors understand—and importantly, compare—the social and environmental impact of investments they make.

Would you like to see governments catalyse innovative business entities like the Community Interest Company (CIC), as in the UK? How do you see the policy environment shaping up in this regard?

Impact investors and the social enterprises they support often find themselves force-fitting their operations into tax and regulatory systems that do not understand what they do. Having to convince a sceptical tax authority that an investment can have a primarily charitable purpose, or to explain to a charity regulator why your non-profit organisation is generating revenues through product sales, can be exhausting and distracting.

Governments are slowly catching up to the innovation occurring in the impact-investing space. Legal recognition of the corporate form of a for-profit company with a social mission, such as the Community Interest Corporation in the UK, is an important step. Similar efforts are underway in the US. In Holland, the tax authority recognises the social benefit of ‘green’ investments with a special tax break. In France and South Africa, the government mandates institutional investors to set aside a small component of their assets for impact investments. These changes take time. The Global Impact Investing Network is an endeavour to create a platform to accelerate similar developments around the world.