At best, data help us predict the future and understand the past. At worst, they mislead us and obscure the truth. Investors—in the business of predicting the future—know this better than most. Data are the coin of the investing realm: economic data; industry data; company performance data; and now, increasingly, social and environmental data—information that some investors use to gauge the impact of their investments. These “impact investors” are using these data to invest “into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return,” according to the industry trade organization Global Impact Investing Network (GIIN). These investors may target a particular sector like Fair Trade agriculture, for example, or companies with explicit social or environmental missions such as those committed to sustainable supply chains (Ben & Jerry’s), hire disadvantaged employees (Goodwill Industries), or dedicate business revenue to a social cause (Ethos Water). These investments all have an expected financial return (or at least an expected return of principal) and, crucially, measurable impact.
Challenge: Investing is a Blunt Instrument
At root, impact investors are motivated by the belief that the market can be both a source of economic growth and a force for good. The challenge they face, however, is that this pathway to impact is indirect; investing in companies (or funds, which invest in companies) is uncertain to lead to impact, much as investing in a promising company is uncertain to lead to profit. In truth, an impact investment may not create the desired impact given any number of changing or conflicting business and market conditions beyond an investor’s control.
Consider an investment in Walmart. The largest retailer in the world, Walmart may seem like an unlikely place to look for impact. But the data tell a different story. According to the Solar Energy Industries Association, Walmart is a global leader in solar energy production. For years, the company has been installing solar panels on store roofs, generating two times more renewable energy than its closest commercial solar power competitor, Kohl’s. To put this in context, Walmart’s solar power generation is more than 35 states and the District of Columbia combined. And Walmart is just getting started: the company plans to double its solar panel installations by 2020. On this basis, an investment in Walmart would seem to be spectacularly impactful.
But this underscores the difficulty of using impact investments to affect social or environmental change. It quickly becomes messy. An investment in Walmart, for example, creates two extreme impacts: a decrease in carbon emissions and, potentially, an increase in low-wage jobs (a negative impact many investors with social impact preferences would have a hard time accepting). And Walmart is by no means alone. Many companies create both good and bad impact, even those committed to sustainability and corporate social responsibility.
Impact Data and Analytics are Key
The complexity and unpredictability of the market require investors to arm themselves with sophisticated impact data and analytical tools to help guide their decision-making and maximize the chances that positive impact will flow from a targeted impact investment. While there are a number of public and proprietary systems that measure impact, the gold standard in impact metrics is IRIS. Conceived by a group of impact investors convened by the Rockefeller Foundation in 2008 and now maintained by GIIN, IRIS was created to serve as a free centralized repository of generally accepted impact metrics.
IRIS also serves as a cross-sector glossary of common impact terms and definitions to encourage the standardization of language across the impact investing field so that investors, companies, fund managers, grantmakers, government, and nonprofits can better communicate their activities and impact preferences. The U.S. Small Business Administration (SBA), for example, recently announced that all fund managers applying to the SBA’s Small Business Investment Company (SBIC) Impact Investment Fund “must commit to measure their social, environmental or economic impact” using IRIS-compatible metrics.
IRIS is also designed to feed a number of impact investor tools. The Global Impact Investing Ratings System (GIIRS), for example, turns company and fund-specific positive social and environmental information into impact ratings for investors. These ratings are intended to make the process—usually very labor-intensive—of identifying and comparing investments based on their impact potential, easier.
Another investor tool, B Analytics, is a customizable platform used by impact investors to measure, benchmark, and report on their impact. The platform, maintained by the nonprofit B Lab, includes searchable impact information on over 1,600 companies and 90 investment funds. Investors use B Analytics to evaluate their investments against a customized set of IRIS metrics and metrics of their own choosing.
A third tool, the B Impact Assessment, evaluates the social and environmental impact of small- and medium-sized businesses. It includes 60-200 IRIS-compatible questions on company leadership, employees, consumers, community, and the environment. Companies that score a minimum of 80 out of 200 possible points on the B Impact Assessment are eligible to become certified B Corporations. Like a GIIRS rating, B Corporation certification acts as an industry stamp of approval signaling to the company’s investors, customers, and stakeholders that it is committed to positive social and environmental impact. Over 5,000 companies have completed the B Impact Assessment and 900 of them have become B Corporations. Impact data from B Impact Assessments and B Corporations are compiled for investors on the B Analytics platform to allow for industry-wide impact benchmarking and market trend spotting.
Case Study of an Investor: KL Felicitas Foundation
The KL Felicitas Foundation was created in 2000 to support global social entrepreneurship, particularly in rural areas. The foundation invests a significant percentage of its corpus in impact investments—55 percent in 2009, well beyond the 5 percent grant or program-related investment minimum required to maintain their nonprofit tax status. Historically, the foundation measured its impact largely by counting the number of people served by its investments. This proved inadequate to the foundation’s founders—Charly and Lisa Kleissner, however, who asked for a baseline against which to compare the foundation’s impact.
To that end, the foundation adopted five IRIS metrics in 2009—two social, three financial—as common core impact indicators to measure the impact of its impact investment portfolio. In 2011, the foundation added five more sector-specific IRIS metrics related to health, energy, water, land conservation, and restoration. These ten metrics were further enhanced by six proprietary qualitative metrics developed by the foundation to capture anecdotal data related to company innovativeness and scalability.
Combined, these sixteen impact metrics are used to evaluate and compare the impact performance of the foundation’s impact investments and to “deepen the foundation’s understanding of whether, how, and why its investments helped social enterprises gain scale and increase their respective social impact.” The foundation intends to integrate the metrics into its traditional due diligence process to ensure that in the future, 100 percent of the foundation’s corpus aligns with its mission.
Case Study of an Investee: Etsy
Etsy is the largest online handmade craft marketplace in the world with over 40 million members and $1.35 billion in total sales. In an effort to more fully integrate impact in the company’s core mission, Etsy completed a B Impact Assessment to become a certified B Corporation. Initially, the company scored just above the minimum certification level. The process, however, was a worthwhile one, revealing several impact areas in which the company excelled—such as composting and community engagement—and several opportunities for it to increase its potential impact in the future.
Committed to boosting its initial score, the company organized a “Hack Day” for employees to brainstorm ways to improve its impact on the community and the environment. Several ideas from the brainstorm session became official company policy, including “an updated volunteer leave policy and program, carbon footprint tracking, Etsy School (admin-taught internal school), IdeaCraft (an internal speaker series), living plant walls, and female-driven learning and development workshops.” These ideas and others implemented by Etsy increased the company’s B Impact Assessment score by over 25 percent in one year.
Etsy considers these efforts to be consistent with its core social and environmental values. They also make the company more attractive to impact investors. Etsy’s B Corporation certification allows investors to more easily evaluate the company’s impact potential and the additional impact data now regularly collected by Etsy as a result of its B Impact Assessment make it easier for investors to monitor Etsy’s impact on an on-going basis.
IRIS metrics and the analytical tools they support are state of the art. Many social enterprises, such as Etsy, depend on them to track and communicate their impact to investors and other stakeholders. That said, companies don’t operate in a vacuum; they are subject to global forces outside of their control. Even a data-driven impact investment may not be sufficient to keep a company on track for impact. This is the downside to harnessing the market to affect change: it can be difficult to predict the outcome. But what if impact investors could be more surgical in their search for impact? What if, instead of gently nudging the market towards sustainability and with targeted investments, investors could invest directly in impact itself? That is the tantalizing promise of a new class of impact investments called “Pay for Success.”
A New Way to Invest in Impact: Pay for Success
Pay for Success (PFS), also known as Social Impact Bonds, allows investors to invest in organizations that directly “manufacture” impact. These organizations can be nonprofits, social enterprises, or for-profits but their distinguishing characteristic is that they produce a defined impact and are able to sell it into the PFS marketplace (usually to government but potentially to any organization that is willing to buy it). Like any other company that produces and sells a product, these organizations are able to borrow money based on how much of their product—impact, in this case—they are likely to sell and at what price. That is the investable opportunity created by PFS.
Consider the Salt Lake County PFS project, for example. In an effort to increase school readiness among low-income kindergarteners, Salt Lake County and the United Way of Salt Lake offered to pay $2,470 plus 5 percent annual interest, per student, for every year of remedial special education avoided through sixth grade as a result of high-quality preschool. On the basis of this future payment commitment (and a three-year study demonstrating an 85 percent track record of success), the Granite School District high-quality preschool program was able to raise $1.1 million in impact investment from Goldman Sachs Bank and the philanthropist J.B. Pritzker to provide 600 low-income three- and four-year olds high-quality preschool. The investment will earn a return based on how effectively the Granite School District preschool program can increase school readiness among a subset of those students that were highly likely to need special education as a result of a skills deficit beginning before kindergarten.
But no investment is without risk, of course. If the Granite School District high-quality preschool program fails to increase school readiness as promised, Salt Lake County and the United Way of Salt Lake will not be obligated to “pay for success” and, as a result, there will be no revenue with which to repay Goldman Sachs and J.B. Pritzker. Impact, in this case, is the entirety of the investment and not just an ancillary benefit to be measured alongside financial returns.
In another PFS example, the state of Massachusetts is attempting to reduce recidivism among at-risk young men aging out of the juvenile justice system. To do this, the state procured the nonprofit Roca to provide a range of behavioral and employment services to young men recently released from prison and on probation. The state, with the help of an $11.7 million grant from the U.S. Department of Labor, agreed to pay investors in Roca up to $27 million if Roca succeeds in measurably reducing recidivism and unemployment among a target population of at-risk young men.
Roca, whose tagline is “Less Jail, More Future,” has successfully served more than 20,000 high-risk 17-24 year olds since 1988. This year, 92 percent of Roca’s program participants have avoided arrest and 80 percent have retained employment for at least 90 days. Most important to Roca’s investors, however, was a study by the Harvard Kennedy School Social Impact Bond Technical Assistance Lab (Harvard SIB Lab), which demonstrated a 33 percent reduction in recidivism rates among Roca program participants compared to the state average. That rigorous evaluation, combined with Roca’s historical impact data, was sufficient to convince Goldman Sachs, Kresge Foundation, and Living Cities to invest a total of $12 million in Roca, allowing it to serve 929 at-risk young men over a seven year period.
But the Massachusetts and Salt Lake County PFS projects are unusual in a crucial way: the relative availability of robust project-specific impact data. Today, there are very few evidence-based interventions on par with Roca and the Granite School District preschool program or rigorous program evaluations like that administered by the Harvard SIB Lab. This may soon change, however, as impact investors’ interest in PFS grows. Over time, metrics systems like IRIS may be more readily adapted for PFS use and certification tools like GIIRS and B Corporation may evolve to extend investor “stamps of approval” to organizations like the Granite School District and Roca.
There are admittedly many potential data related challenges with PFS. For one, narrow definitions of impact can create potentially perverse incentives. If an investor can achieve impact by denying access to critical services—special education for eligible children, for example—in order to increase their return on investment, it could do great harm to already vulnerable populations. For another, tying financial returns directly to impact raises the stakes for efforts to calculate and validate it. If PFS investments are going to enter the mainstream, the impact data collection and analysis process will need to be unimpeachable, which is difficult even for trained evaluators.
But these challenges also illustrate the great opportunity created by PFS investing: accurately measuring impact is at its core. If impact is not created, the investment is lost. This elevates impact to a central role in the impact investment, not simply a side benefit, as can be the case when impact and financial returns are calculated separately. PFS projects also require a very high level of statistical rigor: experimental evaluation designs, such as Randomized Control Trials, are used often to prove impact, for example. And promisingly, as more PFS deals are done the impact-investing field will have access to increasingly high-quality data and analytics on social interventions.
PFS is by no means a panacea, nor should it represent the entirety of the impact investing market. Nevertheless, it allows for a direct approach to impact investing that will eventually serve as a useful complement to existing investor efforts to harness market forces for good. It will also create more demand for data and help foster a robust data infrastructure (as we now have in the traditional capital markets) that will contribute greatly to our knowledge of what counts.
The views expressed in this essay belong to the author and do not necessarily represent the views of the Federal Reserve Bank of San Francisco or the Federal Reserve System.
http://www.thegiin.org/cgi-bin/iowa/resources/about/index.html. Solar Energies Industries Association. “Solar Means Business 2014: Top US Commercial Solar Users,” available at http://www.seia.org/sites/default/files/resources/17ay15uqAzSMB2014_1.pdf.
 C. Fishman. The Wal-Mart Effect: How an Out-of-Town Superstore Became a Superpower. (Penguin Press: 2006).
 Clara Barby and Mads Pedersen. “Allocating for Impact: Subject Paper of the Asset Allocation Working Group.” Social Impact Investment Taskforce: September 2014, available at http://www.socialimpactinvestment.org/reports/Asset%20Allocation%20WG%20paper%20FINAL.pdf.
 Impact Reporting and Investment Standards (IRIS).
 These metrics span: 1) financial performance; 2) operational performance; 3) product performance; 4) sector performance; 5) and social and environmental objective performance. More information on IRIS metrics is available at http://iris.thegiin.org/guides/getting-started-guide.
 U.S. Small Business Administration. “SBIC Program’s Impact Investment Fund Policy Update.” September 25, 2014, available at http://www.sba.gov/sites/default/files/articles/SBA%20Impact%20Investment%20Fund%20Policy%20-%20September%202014_1.pdf.
 The Foundation Center. Tools and Resources for Assessing Social Impact: The B Impact Rating System. Available at http://trasi.foundationcenter.org/record.php?SN=29.
 Global Impact Investing Network. KL Felicitas Foundation: Case Study. IRIS Case Study Series. April 18, 2011, available at http://www.thegiin.org/binary-data/RESOURCE/download_file/000/000/226-1.pdf.
 Interview with Jennifer McKaig, Social Impact Lead at Etsy. B Impact Assessment Case Study: Etsy. Available at http://bimpactassessment.net/case-studies/jennifer-mckaig.
 B Impact Assessment. Etsy Improvement Report. Available at http://bimpactassessment.net/etsy-improvement-report.
 There are currently five PFS projects underway in the United States: in New York City, Salt Lake County, New York State, Massachusetts, and Chicago. Each of these projects is designed to produce a predetermined impact ranging from reduced prison recidivism to improved kindergarten readiness for low-income students. Each raised upfront investment from impact investors to pay for a program designed to create the pre-negotiated impact. Depending on how effective a given program proves to be, its investors will receive, in most cases, mid-single digit returns with an opportunity for higher returns for higher levels of impact. More information on the current state of the PFS market is available at http://www.payforsuccess.org.
 This payment rate drops to $1,040 per student, per year, once the investors have recouped their principal investment. More information on the Salt Lake County PFS project is available at http://www.goldmansachs.com/what-we-do/investing-and-lending/urban-investments/case-studies/impact-bond-slc-multimedia/fact-sheet-pdf.pdf; and John Williams. “Letting Investors Take a Shot at Curing Social Ills.” Wall Street Journal. Opinion Section. September 24, 2014.
 Low-income students in Salt Lake County without access to high-quality preschool require special education 33 percent of the time. When exposed to Granite School District’s high-quality preschool that rate dropped to five percent. “In our opinion: Social impact bonds offer a way to get measurable results for social service investments.” Deseret News Editorial. May 19, 2014, available at http://www.deseretnews.com/article/865603339/Social-impact-bonds-offer-a-way-to-get-measurable-results-for-social-service-investments.html?pg=all.
 Young at-risk men in Massachusetts typically reoffend 55 percent of the time within three years.
 The Massachusetts Juvenile Justice Pay for Success Initiative Fact Sheet, available at http://www.thirdsectorcap.org/wp-content/uploads/2014/01/MA-JJ-PFS-Frequently-Asked-Questions.pdf.
 Massachusetts Fact Sheet.
 Several foundations also contributed grants to support the Massachusetts PFS project and both Roca and the project intermediary, Third Sector Capital Partners, agreed to defer a portion of their fees conditional on impact.
 Daniel Stid. “Pay for Success is Not a Panacea.” Community Development Investment Review. Volume 9, Issue 1 (2013), available at http://www.frbsf.org/community-development/files/pay-for-success-not-panacea.pdf.