Social investment

By Adrian Hornsby
Head of Research & Analysis, Investing for Good

Highlights

• Social investment combines social or environmental outcomes with financial returns.
• Many social businesses have achieved consistent growth, generating 2%-8% annual returns on average.
• Social investments offer an opportunity for portfolio diversification.
• Social investors should consider their risk profile and requirements for financial return, and the areas where they wish to have an impact.

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The internet, climate change, and soaring volumes of international trade have, over recent years, brought about a profoundly heightened sense of global interconnectedness. Ethical questions have come into company boardrooms, and a cross-weaving of interests and concerns has demanded more integrated solutions. Increasingly it is becoming clear that business, society and the environment are mutually embedded.

In contrast to the ‘traditional’ model of philanthropy, by which people profit-maximise with one hand to then give away profits with the other, the social investment model¹ seeks to co-align financial and ethical interests in a single strategy. The capital itself, rather than a ‘charity run-off’, is used to further the mission-interests of the investor, and produce a ‘blended return’ — i.e. one composed of both financial and social or environmental benefits. Together these elements compose a double or in some cases triple bottom line.

Blending offers a number of key advantages:

• A greater degree of congruence is achieved between investments and the values and beliefs of the investor.
• As the capital is invested not donated, it remains in circulation, thus leveraging increased social impact through successive redeployments.
• The market discipline of invested capital obliges socially motivated organisations to engage in profitable activities, encouraging sustainability.
• Conflicts between profit-maximising investments and philanthropic activity are minimized².

The practice of financial and ethical coherence has some history, stretching back to the co-operative credit organisations of the nineteenth century. Over the past three decades socially motivated banking has grown considerably, with organisations such as Triodos Bank and ShoreBank now each managing balance sheets in excess of US$2 billion. However it has been over the past decade that business-style approaches have engaged in large-scale and innovative ways with traditionally third sector issues, and the blended space has started to explode.

Many social businesses have achieved consistent and impressive growth year-on-year, delivering financial returns to investors mostly between 2% and 8%, as well as significant sustainable social and environmental benefits. As the model of for-profit, socially motivated enterprise creates stronger proofs of its viability, investment opportunities are proliferating, with new businesses starting up, and mainstream players such as Deutsche Bank and Morgan Stanley getting involved and creating funds.

However many feel we are still in the early moments of a blended space Big Bang. Given current levels of interest in tackling both climate change and global inequality, and considering the scale of the problems and the clear need to involve business in the solutions, it is likely that the sector will continue to expand rapidly.

What is social investment?

A social investment can broadly be defined as an investment in an organisation (or fund) whose primary mission is to achieve positive social or environmental outcomes, and whose method for achieving such outcomes is through profitable trading. The nature of the business may vary, but whilst trading itself is the driver for mission fulfillment, profitability should not conflict with impact. Therefore what is good for business will equally be good for communities and natural environments.

A popular example is microfinance, where the successful repayment of a loan not only allows the microfinancier to be profitable, but equally indicates that the microborrower is using credit well to grow their business. Similarly, for a clean technology company, better sales figures mean more emissions displaced. The same principles work for, among many others, fairtrade retailers and Community Development Finance Institutions (CDFIs).

However, while the mission-driven organisation should be profitable thanks to and not in spite of its mission, the size of the financial return to investors may have to compete with the organisation’s desire to reinvest in its own expansion, or to offer its services at a lower cost. This second situation can arise in particular among organisations focused on impoverished communities (e.g., those providing financial services, clean water, healthcare etc. to the excluded), where the potential for higher returns to investors is sometimes sacrificed in order to ease the burden on the poor.

On the other side, the ‘impact quotient’ of the blended return may be compromised by mission drift, whereby an organisation’s operations move subtly away from their original focus (e.g., a microfinance institution may find itself drifting toward larger loans and so away from the microborrowers it originally set out to serve). This however can and should be scrutinised. A number of organisations publish a social audit, distributed alongside the annual report, which allows investors to maintain a close relationship with the impacts being achieved, and to monitor social returns just as they do financial ones.

Criteria and risks

Social investors are likely to be self-steering in terms of their appetite for risk, their requirements for financial return, and the particular area where they wish to see impacts being delivered (e.g., developing world or UK focus, social or environmental projects). At present, social investment opportunities tend to be medium-to-long-term (five years or more), with little or no liquidity, and are more likely to be debt than equity based.

Not infrequently an investor will be expected to take on a level of risk not compensated to a commercial standard by financial return, and in such cases the investor may need to consider the impact aspect of the blended return in order to rationalise that risk. However, increasingly sophisticated structured offerings are emerging, whereby subordinated layers of debt are taken on by foundations and highly socially motivated investors in order to offer well cushioned senior debt, with fully commercial levels of financial return, to more mainstream investors. As the nascent universe of social investing continues to expand, it is expected that greater liquidity and more innovative financing will develop.

Due to the immense diversity of social investments, risk comes in many different forms. However broader categories of risk can be identified which do apply to large parts of the sector. These include:

• Early-stage risk: Many social businesses are early-stage companies with unconventional business models, representing innovative approaches or new technologies, which are largely untested. Companies may have limited financial histories or experience of debt, and market data for comparable operations may not exist.
• Developing country risk: Many social investments are made in developing countries, and so are subject to a wide variety of risks including potentially unstable political environments, less solid legal and financial structures, and currency risk.
• Policy risk: Business plans of mission-driven companies are sometimes predicated upon sympathetic policy environments (e.g., renewables targets for green energy providers), which may be subject to changes in political mood.

A significant upside for investors comes however in the form of diversification. Because social investments tend to focus on new or underserved markets, often with little correlation to mainstream markets, they offer investors the opportunity to spread investments across a broader range of interests, and thus lower overall portfolio Beta. Moreover, mission-driven organisations often tap into vast and vastly underdeveloped resources, such as solar power, or labour forces in emerging economies. The best social investments are able to present strong growth potential regardless of wider economic downturns.

Next steps

A considerable variety of options is available to social investors, ranging from a growing number of social impact funds through to hands-on venture philanthropy. The key distinguishing features are the levels and types of risk, financial return, and social or environmental impact involved, which taken together form the social investment profile.

The Ethical Investment Association opens a number of avenues for related advisory services, and some regulated IFAs and wealth managers are beginning to offer advice in this area. Still, pressure from clients will be crucial in driving forward the realignment of investment practices with the interests and values of investors.

Recommended resources

• Investing for Good is the UK’s first FSA-regulated social enterprise offering investment advice, data and market expertise across the social investment sector in the UK and internationally. 
• Triodos Bank is an ethical bank which uses deposits and investment banking services to finance companies, institutions and projects that add cultural value and benefit people and the environment. 
• Charity Bank is the UK’s only regulated bank that is also a registered general charity. Charity Bank uses depositors’ savings to support charities, voluntary organisations and social enterprises that address society’s needs. 
• The Community Development Finance Association (CDFA) is the trade association for community development finance institutions (CDFIs). CDFIs are sustainable, independent financial institutions that provide capital and support to enable individuals or organisations to develop and create wealth in disadvantaged communities or underserved markets. 
• The Ethical Investment Association (EIA) is an association of financial advisers interested in the promotion of ethical and socially responsible investment. 
• The UK Social Investment Forum (UKSIF) is the UK’s membership network for sustainable and responsible financial services.   
• Ethical Investment Research Services (EIRiS) is a global provider of independent research into the social, environmental and ethical performance of companies. 

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¹ Social investment offers social investors an opportunity to combine financial with social returns. As with any investment decision, we advise you to consult an investment professional in evaluating your options.  

² The reality of such conflicts was notably flagged up in early 2007, when it was revealed that investments made by the Bill and Melinda Gates Foundation were frequently in companies whose activities (chiefly through pollution) were contributing to the very problems which Foundation grants were attempting to address.

About the author

Investing for Good provides investment advice, data and market expertise across the social investment universe. We believe that investment portfolios can and should be better aligned to investors’ core values and motivations. Our mission is to incorporate these values into management practices.

Adrian Hornsby heads Investing for Good’s pioneering social impact ratings system, which is supported by a unique structured framework of assessment criteria. He is an expert on emerging economies, and is co-author of The Chinese Dream (010 Publishers, 2008). He writes and speaks regularly on issues relating to Chinese and global development as well as on ethical investing.