11/30/2011 05:21 pm ET | Updated Jan 30, 2012

Don't Be Redundant

This is not an invitation to a picnic.

So warns the preface of Antony Bugg-Levine and Jed Emerson's book Impact Investing: Transforming How We Make Money While Making A Difference.

If you haven't heard of impact investing -- the practice of investing money for both financial return and social good -- it's worth tuning into the buzz. MBA students around the country are enrolling in courses on the topic with the hopes of finding a job in the industry after graduating. JP Morgan has predicted that the market for impact investments could grow to up to a trillion dollars in the next decade.

Impressively, for all this hype, Bugg-Levine and Emerson do not shy away from the hard questions. It's fun to think we can snap our fingers and find profitable companies that also transform the lives of the disadvantaged. But many challenges remain unresolved.

Possibly the most important question: why do we actually need impact investors? What can impact investors do that philanthropists, the government, and the commercial sector cannot?

The world of international development is the perfect cauldron in which to test these questions.

Decades ago, the developing world was full of dedicated idealists who started non-profits to help the poor. They built latrines and schools. They distributed bed nets. And they often found ready funding for their efforts. Today, as government dollars have dried up, there's been a decided shift towards market-based strategies as an additional way to finance social change projects. As a complement to making grants to non-profits, a key trend is to invest in for-profit companies that can give poor villagers access to needed services -- while still earning revenue to stay afloat.

But where is this really necessary?

When I chatted with Bugg-Levine, he pointed me to a recent New York Times article noting that even the most traditional Wall Street investors are rushing "to the ends of the earth" trying to find opportunities in the riskiest developing markets. Do we really need do-gooder investors running around in such places if the markets they're investing in would grow with or without them?

The short answer? Yes. But it's often a tricky calculus to determine exactly when and where their money can be put to best use.

In the book, Bugg-Levine and Emerson point to the example of International Finance Corporation (IFC). For decades, the IFC had had tended to concentrate its investments in the middle-income countries rather than the poorer ones -- despite its mandate to help the most disadvantaged. It's certainly easier to find investment opportunities in places where good infrastructure already exists, but these are not always the places where such funds are most needed. As one step towards resolving this quandary, the IFC recently recalibrated their distribution of investments. They shifted a small portion of their funds away from richer markets such as Eastern Europe and to higher-risk markets in places like Bangladesh, Sierra Leone, and the Central African Republic.

The authors also examine a related controversy that came up in the field of microfinance. No doubt you've heard the inspirational stories of women who use a loan to start a corner store -- and then use the profits to send their daughters to school. In the beginning, the microfinance industry was primarily capitalized by organizations that kept the social mission of microfinance front and center. The idea that poor people could repay loans was seen as laughable by most mainstream investors.

But in the 1990s, as the industry matured and the business case was proven, Wall Street took notice. Lots of large banks began knocking down the doors to start getting a piece of the action. In 2007, the non-profit organization MicroRate issued a controversial paper arguing that it was time for some of the early socially motivated investors to move out of the way; their presence was now not only superfluous, but actually preventing commercial capital from funding the industry.

Why would this matter? It's great for a few million people to have access to microloans -- but when there are billions of people living under two dollars a day, you need all the scale you can get in the microfinance industry. It's likely impossible to serve that many people without access to the sums of money that can only be found in the commercial sector.

Refreshingly, Bugg-Levine and Emerson steer clear of dogmatic responses to these debates. Instead, they offer us a simple call to action: don't be redundant.

Arguably the highest value add of impact investors is to catalyze new markets to serve the disadvantaged. Medical technology for the poor who don't live within driving distance to a hospital and often die from diseases that have easy cures. Financial services for people who don't make enough money to be deemed worthwhile by bigger banks, and are often forced to take payday loans at exorbitant rates.

Some impact investors will get involved in very early days, providing risk capital before commercial markets are convinced of the viability of a new product or idea. Some of these investments will fail, but some will succeed spectacularly; the learning from both will make an enormous contribution to the growth of the sector.

Others will choose to invest later, when proof points are more plentiful and more commercial capital is flowing. Here, impact investors can make a difference by ensuring that the markets continue to focus on underserved segments, or that these industries can keep growing to serve new geographies. But they also must be careful to ensure that any investments made on concessional terms don't prevent mainstream investors from placing their own money towards these same goals.

In short, impact investors need to get very clear on issues of staging and sequencing in their investment strategies. And there's a tremendous amount at stake in taking this task seriously.

There's not enough philanthropic or government money in the world to solve the problems we need solved. If impact investors do their job well, they can tap into new forms of capital we can use to help solve the world's burning issues. If they do their job poorly, they risk simply redistributing philanthropic funds from one bucket to another -- or worse, using them to support outcomes that the commercial sector would achieve with or without them.

Thankfully, there are industry leaders like Bugg-Levine and Emerson who will not let their colleagues be contented by simple catchphrases about "doing good while doing well" or "marrying profit and purpose." Impact investors can indeed change the world. But much of the difference between their success and their failure will be about asking the right questions.