Investment Criteria 2: Financial Return
Regarding financial return, traditional investors look to maximize IRR (internal rate of return) balanced with factors like time horizons, diversification needs, and appetite for risk. To this list, Impact Foundation also adds considerations of the impact sought by a particular investment.
This balancing act creates a tension between maximizing financial return in the short term and maximizing social and spiritual good. We have explained in this post that the interplay between impact and financial return inherent in impact investing can be represented simplistically on a continuum from impact only - as with grants - to financial return only - as with traditional investing.
Sometimes achieving our social, spiritual, or environmental goals means delaying or sacrificing financial return. We refer to these investments as Impact First. In other instances financial return may be commensurate with traditional investments of the same type while also providing significant impact. These enterprises offer Finance First investments.
Consider an example of an impact first investment. In the context of creating sustainable solutions for rural poverty in Northern India, we would do a disservice to the mission and the long-term health of the business by insisting on large short-term financial returns. As our friend Steve Garber is found of pointing out "you ask a different set of questions if you want to make money for 100 years than if you want to make money for 5 years." Sometimes those questions produce plans that pay greater dividends of social, spiritual, and environment impact in the short run.
Why invest knowing we might make less than market-rate returns? Let's think about it a different way. What if we could achieve the same impact as with a grant to a charity while also getting some of the capital back to be able to reinvest or grant again? A grant offers a 0% return. Compared to that, a low-interest loan to a charity looks quite attractive.
Our commitment to earning a social return on all of our assets does not replace our intent to invest our capital prudently for financial return, even though guidance for our investment policies emanates from our public purpose and mission, first and foremost. In our case, time horizon and investment choices, for example, primarily align with our mission to maximize the amount and impact of charitable giving. So while tax and fiduciary laws regulate our operations, they do not determine our investment policies.
This interplay between impact and financial return does not always mean sacrificing financial return. The first Impact Investing Benchmark study supports this idea:
"Impact investment funds that raised under $100 million returned a net IRR of 9.5% to investors. These funds handily outperformed similar-sized funds in the comparative universe (4.5%), impact investment funds over $100 million (6.2%), and funds over $100 million in the comparative universe (8.3%)."
Early data suggest that investors can achieve risk-adjusted, market-rate return alongside impact in certain instances. When looking for financial return, Impact Foundation applies the disciplines of a capital investor in making both grants and investments. In all sectors, we seek to invest in strong enterprises with reliable revenue.