I recently had the privilege of attending the first-ever investor day of the HCT Group, a high-impact enterprise involved in public transport. This was the first occasion the company had met a group of investors at a time when it was not seeking capital; the purpose was to explain itself and discuss progress against both financial and impact targets. We expect to have more of these events in future.
An award was meant to be given to the best question from the audience, but when it turned out to have been asked by Dai Powell, the chief executive of HCT, the award was given to someone else instead. What was Powell's question? He asked whether any of the social investors who had backed impact investment funds varied their required rate of returns based on the social impact achieved.
Just to clarify, impact investment funds are backed by underlying impact-oriented investors such as Big Society Capital and commercial investors such as banks and pension funds. These investors commit capital to fund managers, who in turn invest this capital in social impact companies in the form of equity or loans. The social enterprise pays dividends or interest on the investment to the fund manager and it pays a performance-based return to the underlying social investor.
HCT recently closed a £10m financing deal with a range of impact and mainstream investors. ClearlySo advised on this offering and it had several interesting features, such as a reduction in the interest rate paid by HCT to investors if HCT matched or exceeded certain impact targets. This is understandable, because IIFs exist to increase the social impact, as well as to earn a satisfactory rate of return. We are aware of a few other notable transactions that also have this feature, but it is the exception rather than the rule in impact investment. If we wish to increase the social impact achieved by entrepreneurs, surely it is sensible for the fund managers to put in place incentives for social enterprises. This is obvious and straightforward.
But if we follow the logic, it makes sense for IIF fund managers to be similarly incentivised by their underlying investors. All IIFs measure the impact that their investee social enterprises make. So, in theory, the IIFs could be incentivised by underlying social investors accepting a lower rate of return if the fund managers generate more impact with their investments than originally targeted.
But not a single case comes to mind of an IIF whose returns to investors are adjusted for the impact achieved. I cannot think of any funds backed by BSC, for example, that have such a "ratchet", nor is BSC itself held to account in this way. I should add that our agreements with BSC require us to report about impact.
I think that most people involved in impact investing would agree that economic incentives are a useful mechanism for adjusting organisational behaviour. Impact investors recognise this as a matter of principle, we speak out in public on the importance of this issue and we work with entrepreneurs to try to put such incentives in place. For the sector to get to the next level, it might be interesting to reward the providers of capital like this.
Rodney Schwartz is chief executive of ClearlySo, which helps bring impact to investment