Part I: The Imperative and Rationale for an Impact Investment Fund Specifically Targeted to Distressed Communities

In the aftermath of the April 2015 unrest in Baltimore, several policy approaches, including legislation in Congress, have been proposed to address poverty and unemployment in distressed communities such as West Baltimore.

However, given the current political gridlock in Congress, which will likely persist for at least several more years, it is unlikely that Congress will fund substantial public investments that can transform distressed communities, as the Brookings Institution’s Bruce Katz has noted and President Obama has acknowledged.

In the absence of significant increases in public investment, growth in impact investing is expected to make available substantial capital that could finance ventures that uplift urban communities. However, as recent reports by the National Advisory Board on Impact Investing (NAB) and the Accelerating Impact Investing Initiative (AI3) have noted, facilitative public policies and government involvement – such as through public-private partnerships – are needed to foster the growth of impact investing and ensure that it has the desired impact. This is particularly critical for investment in largely segregated communities such as West Baltimore with concentrated poverty and high unemployment rates.

Thus, even if impact investing grows…it is unrealistic to expect that impact investing capital will flow to distressed communities in large enough amounts to have substantial impact in creating jobs and reducing poverty.

Unfortunately, there is no indication that even the modest public policies that can foster more robust private-sector-driven investing in these communities – such as those advocated by Living Cities, NAB, AI3, economists Jared Bernstein & Kevin Hassett, the Urban Institute, the Brookings Institution, and the Hamilton Project – will be approved by Congress within the next few years, regardless of the outcome of the 2016 presidential election.

Thus, even if impact investing grows to the anticipated high levels, it is not a given, and it is unrealistic to expect that impact investing capital will flow to distressed communities in large enough amounts to have substantial impact in creating jobs and reducing poverty.

Reportedly, there is currently plenty of “mainstream” private capital available that would be invested in businesses in underserved communities but for the high risk usually associated with them. For example, while there have been massive inflows of capital into Detroit in the last few years (from J.P. MorganChase, other financial institutions, and investors), the capital reportedly has largely financed the revitalization of the downtown and some adjacent areas. Although some of these investments were made in the hope that the jobs that they create, for example, would benefit low-income people, these efforts have little direct impact on the poorer neighborhoods themselves. See, for example:

Clearly, waiting for facilitative public investments and policies that can foster impact investing in distressed communities is largely futile. Thus, only impact investors who are willing to assume high risk even with relatively low expected returns will be willing to direct their capital to investments in such communities.

It is for this reason that I am exploring the possibilities of and developing an impact investment fund that would finance for-profit businesses as well as nonprofits that clearly demonstrate the potential to have the desired high impact on communities – through entrepreneurship and innovative initiatives that can substantially reduce unemployment and poverty and provide needed services in critical areas such as education, job training, early childhood development, affordable housing, and healthcare – but are hampered by limited access to capital. The fund would particularly focus on providing the types of capital that minority entrepreneurs and businesses in distressed communities need the most (due to low levels of wealth and liquidity constraints), especially equity or startup capital, i.e., beyond lending by banks, Community Development Financial Institutions (CDFIs), and initiatives such as Kiva and Ours to Own.

In many other cases, risk is perceived to be higher than it actually is largely because of erroneous negative stereotypes.

Some geographical areas and businesses are indeed too risky for most private investors; however, in many other cases, risk is perceived to be higher than it actually is largely because of erroneous negative stereotypes. Thus, there are numerous business opportunities whose actual risks are much lower than the perceived ones, and such businesses could even provide market rate (or even higher) risk-adjusted returns.

Even presuming that market-rate opportunities are limited, other business opportunities that may only be able to provide below-market rate returns would still be acceptable to certain categories of impact investors, as long as they believe the businesses will have substantive social impact.

In terms of where the capital for this fund would come from, the most obvious prospective impact investors in this regard are philanthropic-minded people, black as well as non-black, who, motivated by altruistic, racial uplift, self-interest, or national progress reasons, already engage in charitable giving to help uplift these communities. Obviously, such investors have to be convinced that reallocating part of their giving to an impact investment fund will have greater impact in uplifting the communities than “traditional” charitable giving, while also providing them financial returns (even if the returns are below market-rate). Philanthropic giving by well-off as well as low-income African Americans (including millennials) is already considerable in the aggregate. There is also a significant segment of the black community that will be motivated enough to allocate larger portions of their investment portfolios (i.e., beyond “normal” charitable giving) to impact investing, if they are provided with credible and convincing evidence that their capital can deliver tangible social impact.

I hypothesize that, much like venture capitalists, who accept the high risks and high failure rates of their investments, such impact investors would accept the relatively high risks of their investments. However, instead of the high financial returns commensurate with high risks required by the typical venture capital fund, these impact investors would accept low, below-market returns as long as the social returns, in the form of upliftment of distressed communities, are substantive.

The risk that such investors would face would be no worse than the risk that they accept in terms of their charitable giving, namely that their donations will not be put to good use or have the desired impact. In fact, investment through a reputable, well-run, and business/entrepreneurship-oriented fund with industry-standard transparency and accountability practices is arguably more likely to have much greater impact than giving to charitable organizations, since their effectiveness is often difficult to evaluate. Obviously, proving this hypothesis out would require harnessing best practices in terms of measuring the impacts of impact investments.

Ideally, within a few years, the fund that I am envisioning would be large enough to invest in businesses located in several cities to provide substantial risk reduction for investors. Look out for Part II of this blog that will present details on the framework, feasibility and implementation of such a fund.

Read the full series: Part I, Part II and Part III.