As part of a competition I am involved in with a group of Harvard Kennedy School classmates, I’ve been enjoying exploring ways in which organizations can creatively implement investment strategies that offer both financial returns and social returns. This idea, impact investment, is an increasingly popular concept because it is a sustainable model for achieving social returns (in contrast to philanthropic or charitable models). Impact investing is also often called triple bottom line or blended value. As described by Paul Sullivan of the New York Times, impact investing is an “emerging hybrid of philanthropy and private equity.”
Although mixing social good with high returns seems like a sexy investment concept, impact investing is still in its infancy. It is estimated that current impact investments amount to approximately $50 billion and is projected to grow ten-fold by 2014, but still only barely reaching 1% of all managed assets. The existing impact investing players, such as Acumen Fund, Root Capital, and Grassroots Business Fund, have proven models of success with high and sustainable returns. Non-profits such as Endeavor and Ashoka have also played a valuable role in supporting individuals who want to develop and implement their own impact investment ideas.
Many of the innovative models revolve around doing debt financing of export commodities, or tying the loan to some sort of productive asset (like a sewing machine, drip irrigation system, etc) such that future earnings can be used as a substitute for traditional commercial collateral. But one idea I’ve been thinking about recently is quite different — why not invest in human capital directly, reaping returns from potential future earnings as a substitute for collateral or traditional loan re-payment? Here’s the basic idea:
The need: The marginal cost of annual school fees, for example the 500-rupee cost ($10) in Jalandhar, Punjab, of entering 8th grade in public (government) schools, is often the limiting factor for a high-achieving student from continuing their education. The child’s family does not have commercial education loan options available that don’t require burdensome repayment in an environment of uncertain returns to education. There is a significant under-investment in education in many parts of the developing world, for a whole host of reasons — the cost of enrollment, the opportunity cost of lost earnings, the low quality of schools, and the uncertain economic returns to education.
The concept: Imagine if you could tell a first-grader in that all of their education costs will be covered for as long as they wish to study — through grade 10, through college, through law school, PhD — whatever thay choose — in exchange for a fixed percentage of their post-graduation earnings. Essentially, transfer the risk of returns to education investment to a third party. A company would establish and manage a social investment fund that invests in the secondary education of a diverse pool of students. The fund would commit to financing all education costs, in exchange for a fixed percentage of the student’s future earnings. The students face little risk of overly burdensome debt payments, students receive a flexible source of financing needed to complete their education. Rather than a loan, education costs are financed up front in exchange for a form of “human capital” collateral. Payments are zero when income is zero, and payments are low when income is low.
Any existing players? Lumni is the sole player in this space right now that. Lumni focuses only on financing college-level education, and the typical contract involves a 4% repayment of future earnings for 120 months following graduation. Currently Lumni operates both for-profit and non-profit funds in Chile, Colombia, Mexico, and the U.S., with over $15 million in commitments from 100 investors, financing almost 2,000 students to date. Since Lumni profits more when students earn more, they also have active career coaching, job search help, and other professional development functions available to their students. Their model is depicted in the diagram below:
Can this model truly work at the secondary or even primary school level? Lumni is paving the way in college education financing, but what about applying their same model to primary or secondary education in the developing world?Definitely a host of obstacles arise. Would it be possible to truly predict the future earnings of a first grader in rural Mali? How would you factor in mortality rates, or school drop-out likelihood? Would the model of repayment through future earnings too closely resemble an indentured servitude arrangement and receive negative public feedback? Would students have perverse incentives to avoid repayment, or take lower-paying jobs during the repayment period? I’m interested in any and all feedback.