Matt's Investments Blog

The path of future market development: from social investment to impact investment?

Joe Ludlow and Jo Casebourne - 19.11.2012

The UK's comparative advantage in developing the impact investment market, together with the relatively small size of supply relative to present and future demand, provides an opportunity for the UK to lead the world in investing in public and social innovation, and in developing innovations in ways of financing for impact. The Impact Investment industry could be a great British success story.

But it is becoming clear there are competing views on how the market should develop.

We think these competing viewpoints are broadly clustered into three main visions of the role of impact investment:

1. 'access to affordable capital for the social sector' - this view focuses on the demand for finance from social sector organisations and holds that the social sector needs 'affordable' finance because there is a market failure in both the price paid for the social sector's outputs reducing profitability, and a market failure in the provision of capital by mainstream financial institutions to the social sector. Together this puts social sector organisations at a comparative disadvantage compared to private sector organisations e.g. social sector organisations struggled to compete with the private sector for contracts from the DWP's Work Programme, and struggled to access working capital to deliver on those contracts that were won[1].

Whilst, there is no doubt that the social sector needs access to finance, this traditional sector-based view of demand can see finance as being an end in itself, or at least the only barrier to greater impact.

2. 'the lack of finance is a problem of perceived not actual risk' - this view considers that it is possible to make attractive financial returns from impact investments, but that the mainstream market does not yet understand the risks and returns of impact investments and so does not provide finance. It is hoped that by demonstrating impact investments further new mainstream investors will be attracted into the market to supply finance. This view assumes that investors are primarily motivated by financial return and see impact as a differentiator between assets. 

3. 'creating a different type of investment market' - this view:

• is focused on impact and emphasises the centrality of achieving positive social outcomes (and evidencing their achievement) as the key factor in allocating impact investment capital
• is neutral on legal form and sector of organisation seeking to achieve social outcomes - whether an organisation is in the private sector, public sector or social sector if they are aiming to improve social outcomes the impact investment market should serve their needs. 
• believes specialist impact investment intermediaries are needed who understand the needs of impact investors and investees and who have built business models around serving these needs. Demand and supply of impact focused capital exists but intermediation is not easily delivered via the existing financial market infrastructure. There is growing evidence that a segment of individual investors are motivated to invest to achieve a positive impact on society (see Nesta 2011[1] and Worthstone 2012[2]) and are prepared to take risks to stimulate innovation and to achieve positive social outcomes (with financial returns actually being secondary). 
• sees finance as only one tool in the tool bag, not an end in itself. The supply of finance is seen as necessary, but not sufficient, to enable organisations to develop successful business models that deliver positive impact on social outcomes. In this view, the primary focus is on finance for innovation, rather than innovations in financial mechanisms.

Nesta's work on impact investment is built upon the last of these market viewpoints. This is not to say our view is right and others are wrong. However, we find this view most consistent with

• our wider work on public and social innovation;
• our experience of social ventures operating across the public, private and social sectors; and with 
• our experience of individual investors - for whom impact investment is a new and different way of deploying their wealth, distinct from both philanthropy and their existing investments.

In this series of blogs we've sought to discuss some of the dynamics of the impact investment market in the UK as we see them. We hope you've enjoyed them and welcome your comments and own experiences. 

Much of this thinking is reflected in the approach of the Nesta Impact Investments, the new early stage social venture investment fund managed by Nesta Investment Management.

See the full impact investment blog series:

• Impact investing - a very old idea
• Rather than feast or famine, we need a balanced diet
• Who wants impact investment? part A
• Who wants impact investment? part B
• Focusing on impact
• The path of future market development: from social investment to impact investment?

[1] Nesta (2011) Investing for the good of society: why and how wealthy individuals respond. Nesta http://www.nesta.org.uk/library/documents/BSFFGoodofSocietyprint.pdf

[2] Worthstone (2012) Financial planners as catalysts for social investment. Nesta http://www.nesta.org.uk/library/documents/Financialplanners2.pdf