The ever-increasing importance of impact investing as a tool for combatting poverty and underdevelopment is greeted with both excitement and skepticism. Broadly speaking, impact investing is the use of capital investments to achieve sound financial returns as wells as positive social and/ or environmental impact(s). Advocates of impact investing see the opportunity to unlock massive amounts of capital to invest in solving all types of social and environmental challenges globally. In the international development context, impact investing promises to add significant resources to traditional donor aid and philanthropic grant making funds that are allocated to the reduction of poverty and inequalities. Skeptics, on the other hand, have many worries, among them the concern that impact investments might be vehicles for unchecked “extractive” and “predatory” practices that could have the unintended consequence of doing further harm to already vulnerable communities.
Notwithstanding skeptics’ concerns about impact investing, the opportunity to leverage significantly more resources to invest in solutions that produce positive social and environmental benefits is a welcome addition to the development sector. However, to achieve the full power of impact investing, it is critical to address those factors that may lead an impact investor to deem certain products, or even whole sectors, as too risky for investment.
Understanding and managing risk is a top priority for traditional as well as impact investors. While impact investors are committed to using their assets to drive positive social and environmental impacts, they also expect fund managers to achieve sound financial returns. Therefore, assessing risk relative to potential financial returns, remain a key part of investors’ decision-making equation. Given the relative newness of impact investing, especially in the international development context, there are many factors that may lead potential investors to determine that certain investments are too risky to make, including:
- Unfamiliarity with country contexts
- Unfamiliarity with investment products
- Complexity of defining and measuring social and environmental outcomes and impact, and
- The influence of unconscious bias.
The potential influence of unconscious bias on risk perception is of particular concern, as it may be the issue about which the least is spoken, but is potentially highly consequential. The evidence from the burgeoning literature on unconscious bias suggest that no one is exempt from bias, regardless of intentions. Investors’ assessment of the risk of certain investments in the global south, particularly in Africa, bumps up against a lifetime of exposure to a narrative of incompetence of leaders, corruption, backward or traditional mindsets, and overall deficit of every kind, as shown in popular media and texts. Exposure to such narratives can shape perception, driven by unconscious biases, that certain investments are too risky to make. In reality, “perceived” risk can be over emphasized relative to “real” risk.
What can be done to narrow the gap between “perceived” and “real” risk? Recognition and acknowledgement of the existence and individuals’ susceptibility to unconscious bias is a good place to start, yet a more practical step is to leverage existing data and evidence to “ground-truth” ideas and test assumptions about risk. For practitioners and promoters of evidence-based decision-making, relying on existing empirical evidence to test assumptions is common practice. For investors who may be new to development generally, or to specific sectors, making use of existing data sets and lessons learned from evaluations and studies is critical. Leveraging existing datasets (e.g., the Living Standards Measurement Surveys (LSMS), and the Demographic and Health Survey (DHS)) to produce simple analytics can be useful in shaping understanding of context and the social outcomes that have been demonstrated as achievable. Many existing datasets have been established across time and geographical contexts, can help establish the robustness of key expected social outcomes.
In addition, the use of other rapid assessments methodologies such as focus groups, key informant interviews, and systematic reviews can also provide evidence that can blunt the potential influence of unconscious bias on risk perception. The use of existing evidence is critical in the due diligence phase of investment development, and moreover can be essential in tracking and monitoring the performance of investments. While using secondary data may not provide the most precise and rigorous answers to questions about risks, potential returns, and impacts, they can serve as a strong check against biased opinions and seat-of-the-pants assessments.
In conclusion, impact investors can use existing data and evidence to help mitigate the potential of unconscious bias to skew the perception of risk, and that may lead to premature conclusion that certain investments are not worth making. By leveraging existing data to generate simple analytics, investors can ground-truth their assumptions, understand what outcomes are possible, estimate potential financial returns, as well as position themselves to rigorously monitor the performance of their investments. This small, but important step, of leveraging existing data and information, can help to unleash the power of impact investing in the development sector.