A growing number of social impact investment firms are onto their second or third funds, a reliable sign that the earliest funds had returns good enough to make their limited partners want to come back for more. SJF Ventures of Durham, North Carolina, has three; DBL Investors of San Francisco has two and is said to be raising a third; Catamount Ventures, also of San Francisco, has four, and Renewal Funds of Vancouver has two.

“When I see growing subsequent funds, it suggests they’re investing money successfully. It suggests the market likes what it’s seeing,” says Brian Trelstad, a partner with Bridges Ventures, a social impact investment manager based in New York City and London with eight funds.

But, in the secretive world of private equity, a category into which most social impact funds fall, fund returns are generally not disclosed. As a result, the common assumption that an investor must sacrifice financial returns for the sake of achieving social progress goes uncontested.

Social impact investing — making investments to achieve social and environmental goals while at the same time earning financial returns — has been enjoying a groundswell of interest in the last several years. While arguably having started in the late 1960s when the Ford Foundation began making mortgage loans to African-Americans who were being redlined by banks, it has only begun to gain currency in the last 15 years. The term “social impact investing” itself was not widely coined until 2007.

In the last 10 to 15 years, the number of social impact funds has grown from a handful to several hundred. Since 2012 alone, the number of funds globally has increased from at least 206 to 316. Assets have grown from at least $13 billion to $23 billion, according to the Global Impact Investing Network (GIIN), an industry trade group.

This growth has occurred despite the widespread assumption that in making investments intended to achieve social objectives, investors are accepting more modest financial returns than they would if they were to choose investments solely on the basis of their return potential.

The idea that there is a tradeoff makes intuitive sense, according to researchers at Wharton who are doing research to answer this and related questions about social impact investing. “If you’re not only looking for financial gains, it implies that you’re almost necessarily sacrificing financial gain,” notes David Musto, a professor of finance, who is leading the research.

On the other hand, it is possible that the two objectives are entirely unrelated — that one factor does not affect the other. In the language of investing, it is possible that they are uncorrelated, says Katherine Klein, vice dean of Wharton’s Social Impact Initiative.

Or, there could indeed be a tradeoff, but if so, within the broad category of impact investing, there is likely to be a spectrum of opportunities, potentially enabling investors to choose where they want to be on the risk-return continuum, according to Christopher Geczy, adjunct professor of finance at Wharton and co-leader of the Wharton social impact research.

“When I see growing subsequent funds … [it] suggests the market likes what it’s seeing.”–Brian Trelstad

Finding answers to the tradeoff question could be very helpful to investors interested in achieving social impacts. It could also entice more investors to try what is sometimes referred to as “double bottom line” investing, which refers to the financial bottom line combined with social benefits.

“We hear over and over, ‘I need more data. Am I going to lose my shirt? Where are the opportunities in education, energy and elsewhere?’ Data would help with the skeptics,” says Kate Ahern, vice president of social innovation for The Case Foundation, which, in addition to making social impact investments, is working to promote the growth of such investing through education, policy change and network building.

Few Answers

But comprehensive answers to these questions are not yet available, according to the Wharton researchers. Considerable research has been done on the tradeoffs in what is known as socially responsible investing (SRI), a related form of investment. Although the various research efforts have reached different conclusions, several collations of that research have concluded that SRI investments achieve returns generally comparable to those of the overall market.

However, very little work has been done to assess whether, and if so to what extent, there is a tradeoff in social impact investing. The question demands its own research because despite some similarities, SRI and social impact investing are quite different, experts say. SRI investing has traditionally meant excluding from a portfolio of largely public companies those that are deemed to have undesirable characteristics from a socially responsible point of view — e.g., companies that pollute, mistreat employees or are not transparent in their governance. Some experts also exclude companies in industries such as armament manufacturing or tobacco, on the grounds that these are socially harmful despite being profitable. In contrast, social impact investments are made in companies whose mission is explicitly to create some positive social impact, such as improving access to clean drinking water, reducing malaria or improving the quality of education. Most of these companies are early stage, private companies while most SRI companies are public.

There have been several recent studies of performance in limited numbers of social impact funds. In 2013, the KL Felicitas Foundation published the results of an analysis of investments in a range of asset classes in its social impact portfolio, concluding that social impact investments could match or exceed market returns. Duke University’s Center for the Advancement of Social Entrepreneurship, in conjunction with Pacific Community Ventures and ImpactAssets, two non-profit proponents of impact investing, also last year announced the results of an examination of 12 funds that had met or exceeded their financial and social impact return objectives. And, JPMorgan in collaboration with the GIIN, has conducted annual surveys of impact investors for the past four years, collecting data on the investors’ level of satisfaction with financial and social returns (without gathering data on actual financial returns), their assessments of limitations in the marketplace, and where they were finding opportunities. In 2013, it surveyed 99 impact investors with $46 billion in investments.

Measuring Financial and Social Returns

Still, no comprehensive data on financial and social impact returns is publicly available.

“We hear over and over, ‘I need more data. Am I going to lose my shirt?'”–Kate Ahern

Cambridge Associates, an investment management and consulting firm, also in conjunction with GIIN, is currently conducting extensive research to develop a benchmark for social impact investments that it will make public, according to Jessica Matthews, the head of Cambridge Associates’ Mission-Related Investing Practice. The firm aims to collect financial performance data on hundreds of funds and their underlying investments. However, there will be no effort to assess the financial returns with respect to social impact investments in developing the benchmark, except to establish that the companies included meet the firm’s definition of a social impact investment, Matthews notes. As it has done in the past, its research on the social impact of investments will be used to advise clients, but will not be made public.

The Wharton study, in its second and final year, aims to survey all existing social impact funds, both U.S. and non-U.S. based, and use the data to help clarify the tradeoffs. Of 350 funds identified, 330 have agreed to respond to an extensive questionnaire seeking information about social and financial returns at both the company and individual investment level, the nature of agreements between general and limited partners, how companies measure achievements in social impact, how they ensure that their social missions are carried on after they are sold, and numerous other factors.

Like Cambridge Associates, the Wharton research will measure financial returns in terms of internal rates of return. Measuring social impacts is not so clear-cut. “Of all the difficulties [in assessing tradeoffs], understanding, monitoring and standardizing social impact are extremely challenging,” said Geczy.

Defining starting points, determining what has changed and pinpointing exactly what has caused that change requires extensive studies that demand time and resources well beyond what investment managers can undertake, according to Jacob Gray, senior director of the Wharton Social Impact Initiative. As a simple example of the complexity of making such measurements, imagine a company that provides bicycles to bottom-of-the-pyramid girls in Rwanda with the mission of improving their school attendance rates. Coincidentally, the government begins providing subsidies to families to help them pay school costs for their children. If school attendance rates improve during the overlapping investment and subsidy period, how would one determine to what degree the improvement was the result of the bicycles and to what degree it was attributable to the subsidies?

Where possible, Wharton researchers will use an existing rating system, the Global Impact Investing Rating System (GIIRS), which while not universally accepted, does quantify social gains. The rating system yields a single measure (in points, from 0-200) that is derived from the earning of points based on practices in four areas — governance, workers, community and environment.

Wharton survey participants who use the GIIRS rating system will be asked to report the difference in the GIIRS ratings of their investments at the beginning and end of the investment period. If they do not use the GIIRS ratings, they are being asked to describe if, and if so how, they measure the social impact of their investments.

“If you’re not only looking for financial gains, it implies that you’re almost necessarily sacrificing financial gain.”–David Musto

While investors are likely to be interested in whether there is a tradeoff between financial returns and social impact, whether or not there is a tradeoff is “probably not the most earth-shattering question” that the research will address, according to Gray. Beyond the binary tradeoff question, there is a great deal to be learned about how best to minimize risk and maximize financial returns while investing for social impact or, put another way, “Where are the best opportunities within social impact investing?” The Wharton research attempts to find answers to this question by looking at a range of factors.

For example, the researchers are asking to what degree women are involved in the management and governance of portfolio companies and to what degree the services or products of companies cater to the needs of women or girls. They will then look to see if the data suggests that participation by women either enhances or depresses returns.

Other questions investigate whether — and, if so, how — portfolio companies attempt to ensure that their missions are continued after they are sold and how their approaches affect returns. Is it better to invest in companies that rely on their culture to make their mission enduring, or to invest in those that include covenants mandating a continued mission in their private placement memoranda or limited partnership agreements?

Along the same lines, does the manner in which a company assesses its social impact affect its value? For example, does having a third-party evaluator make periodic assessments hurt or improve a company’s value?

Whether or not the researchers can devise a quantitative scheme for measuring tradeoffs will not be determined until the data is in and has been analyzed. “We’re at the observing stage,” says Geczy. “We’re trying to understand the units of input.”

And, what if there is no tradeoff? That’s OK, too, because that could lead to investors thinking about social impact investing as an attractive new asset class, notes Geczy. “Such companies may actually expand opportunities and take risk in more diverse organizations,” he says. “They may, for example, provide access to frontier markets. It’s very exciting. It turns the question [of whether there’s a tradeoff] on its ear.”