Private Capital, Public Good

A child born into poverty in the United States to a father who has served in prison has a 50 percent chance of seeing his dad return to prison by the time he turns three years old. Equally dim are the child’s chances of improving his income and lifetime opportunities, which are at less than 20 percent.

By Matt Bannick and Tracy Palandjian

A child born into poverty in the United States to a father who has served in prison has a 50 percent chance of seeing his dad return to prison by the time he turns three years old. Equally dim are the child’s chances of improving his income and lifetime opportunities, which are at less than 20 percent.

Christopher Santiago is like many of these fathers. By age 23, he had acquired a drug conviction and a prison record, but no work history, and little education.

But Christopher was both lucky and hardworking. He joined a program run by the Center for Employment Opportunities (CEO) in New York, which helped him develop life skills, and set him up with a sales job at an ice cream company. With CEO’s ongoing support, he has kept his job for over a year, and is now an involved father to his young child. The cycle has been broken. 

Christopher’s story is far from unique. Funded by a combination of charity and public support, CEO has served thousands of people like him for thirty years. 

What is unusual is a new source of financing for CEO’s programs that recently became available. The savings accrued by the state of New York, resulting from less prison time and more employment, provided the state government with an opportunity to attract investors to a Social Impact Bond (SIB). Social Finance led this landmark financing and raised capital from over 40 investors through Bank of America Merrill Lynch’s wealth management platform to fund the expansion of CEO’s services.

If it works, lives will be transformed, society will benefit, and the investors will earn a return. If it doesn’t, the investors – rather than the taxpayers – will lose money. 

Meanwhile, half a world away in rural India, Jaendra and his family did not have access to regular electricity. If they wanted to get anything done after dark, they had to rely on kerosene, which is highly flammable, expensive, and dirty – exposing his children to the equivalent of smoking two packs of cigarettes a day.

Like the 20 percent of the world’s population without access to reliable energy, Jaendra’s family had no good options until a scrappy start-up – d.light – helped solve the problem by offering an affordable solar lantern that provides a safe, clean light source so Jaendra can get things done, and his children can take a deep breath and do their homework.

There are millions of families like Jaendra’s, and companies like d.light are changing their lives.  Over eight years of growth, d.light has sold six million solar lanterns to more than 34 million people in 62 countries. It is now a profitable, sustainable business that is generating positive returns for investors and customers alike. 

These case studies are but two examples of “impact investing,” a burgeoning global movement with tremendous potential, especially here in the U.S. and in key emerging markets like India. 

Impact investing uses private capital for public good. Impact investors intentionally allocate their capital to seek both financial and social returns; and impact investments are used, in part, to meet social needs that traditional government or philanthropic efforts haven’t been able to fix on their own. 

A report released Wednesday by the U.S. National Advisory Board on Impact Investing (NAB), which we co-chair, concludes that the promise of impact investing has never been greater, while the need for it has never been more acute.

Donations to U.S. private charities have been stagnant since 2000, after adjusting for inflation, even as the population grew by 36 million, and 15 million more joined the ranks of the poor. Federal spending on domestic “discretionary” programs, as a share of GDP, is heading to record lows, even as problems of affordable housing, nutrition, and quality education grow more critical every day.  

Impact investing can help fill this gap. Instead of just finding new sources of money to throw at age-old problems, it promises an innovative way of solving them. Because investors have a stake in the success of the programs – whether they target recidivism or teenage pregnancy – they will want measurable results, and the possibility of a modest, if not competitive, return.  Providers and businesses, in turn, will have greater flexibility, and those that succeed should attract additional investment capital and reach more people. The market rewards success, while weeding out failed approaches.

Overall, $46 billion of assets under management are currently directed to impact investments, and the potential market size is estimated to be greater than $3 trillion. While off to a strong start, impact investing could be doing much more. Wednesday’s report outlines several concrete policy recommendations that can jump-start the industry, without charging the taxpayer a dime.   

For example, in 2008, the Department of Labor issued guidance that essentially prohibits fiduciaries from considering non-economic factors in selecting investments. That restriction should be lifted. The federal government should also revise outdated guidelines that are limiting foundations from making impact investments.

Changes in the tax code – such as the capital gains treatment of impact investments – could significantly stimulate this market. And the government can catalyze impact markets with small, targeted investments similar to the Department of Education’s 12-year-old program to encourage private investments in charter schools.

Anyone who doubts such policy changes can make a difference should look at the history of the venture capital industry, which was moribund by the late 1970s. The government enacted several smart policy changes – such as the clarification of the Employee Retirement Income Security Act’s (ERISA) “prudent man” rule and cuts to the capital gains tax rate – which sparked a flood of venture capital investing and an innovation boom that transformed the U.S. and the entire world. 

This needs to happen again.  Yes, capitalism often comes up short; its benefits are unevenly spread, and it is tone deaf on some critical societal issues.  But market-based principles can also be part of the solution. Done right, impact investing has the potential to improve lives for so many more Christophers and Jaendras by creating sustainable initiatives that tackle some of our toughest social challenges. We just have to give it a boost.

Bannick is managing partner of Omidyar Network and Palandjian is chief executive officer and co-founder of Social Finance, Inc.  They are the co-chairs of the U.S. National Advisory Board on Impact Investing (