Moving Assets Into the Future: An Introduction To Impact Investing
What is Impact Investing?
Until most recently, philanthropic endeavours and capital investments have been regarded as two mutually exclusive pursuits. The first strives for social and environmental improvements, while the latter seeks financial return. Impact investing intends to unite these two ventures and thereby maximise well being globally. The most agreed upon definition is: “investments made into companies, organisations, and funds with the intention to generate social and environmental impact alongside a financial return.”
Impact Investing vs. Sustainable & Responsible Investing
More than often, general and broad terms such as ‘sustainable’ and ‘responsible’ are tossed around by companies and industry leaders, usually in pursuit of positive PR coverage. Ultimately, this results in blurry definitional lines and difficulty in categorisation. The distinction becomes increasingly more complicated when considering that investments that fall under the aforementioned terms make up an estimated quarter of the global financial assets. The debate has led to a global effort by independent organisations to establish clear and distinct principles to push more financial capital towards this category. The International Finance Corporation has already defined 9 core principles that belong to Impact Investing:
- i) Define strategic impact objectives for the portfolio or fund to achieve positive and measurable environmental and social goals, in alignment with the SDGs or other broadly accepted goals.
- ii) Manage strategic impact and financial returns at the portfolio level, recognising that impact may vary across individual investments.
- iii) Establish the investor’s contribution to the achievement of impact through a credible, transparent, evidence-based narrative.
- iv) Assess and try to quantify the expected impact of each investment in advance, assess the likelihood of achieving the intended impact, and identify risk factors.
- v) Assess, address, monitor, and manage the potential negative effects of each investment.
- vi) Use the results of the framework (described in Principle iv) to monitor the progress of each investment in achieving impact against expectations and respond appropriately.
- vii) Consider the effects that the timing, structure, and process of exits will have on the sustainability of the impact.
- viii) Review, document, and improve decisions and processes based on the achievement or shortfall of impact and lessons learned.
- Publicly disclose alignment with the Principles annually and publicly disclose regular independent verification of the extent of alignment.
Fundamentals of Impact Investing
Aside from the nine previously mentioned principles, there is a common set of approaches that impact investors take as a business model to determine which stocks and investments are sustainable. Investors invest with the intention of having a positive social impact, while having certain return expectations. It is common to have a range of return expectations depending on asset classes, resulting out of the pursuit of two simultaneous goals. Certain investments will be focused on the impact side, generating below-market (or concessionary) returns, whilst other investments focus on market-rate or above market-rate returns.
Parties that engage in impact investments will mainly constitute of fund managers, development finance institutions, individual investors, NGOs, and religious institutions. Each party is able to reap particular benefits by shifting part of their portfolio into impact investing. Financial institutions can attract clients with a more socially responsible selection of services, while philanthropically centred institutions are able to structure economically viable investments.
Industry Trends & Potential
The growth of impact investing has been significant. The Global Impact Investing Network most recently estimated that in 2018 alone, assets managed have grown from $114 billion to $228 billion. Less conservative estimates value the impact investments market at $9 trillion in the US alone. These figures indicate a lot regarding the potential for achieving social and economic goals. Money held by US philanthropic foundations is valued at approximately $390 billion, and government spending is $3.9 trillion, yet total global investments reach $300 trillion. Shifting 1% of global investments into impact investing could cover the remaining $2.5 trillion annual funding requirements to attain the United Nations Sustainable Development Goals, meanwhile generating return for investors.
Benefits & Challenges of Impact Investing
As with all new trends, there will exist dispute between its proponents and critics, wherein both parties can offer significant insight.
- Return on investment: in contrast to donations, which yield no monetary return.
- Assets can be enlightened with social and economic endeavours: in many countries, companies are required by law to disperse a proportion of assets to charitable goals.
- Lack of conflict: investors in the impact market will not struggle morally to receive returns on what could otherwise be an ethically compromised investment.
- Investments carry significant risk: impact investments can carry significantly more risk than an amoral portfolio, especially in the short to medium term.
- Lack of expertise and market fragmentation: financial experts lack expertise in philanthropic investments, whilst philanthropic experts lack financial expertise. New experts take time to establish themselves.
- Difficulty of measurement: There are very few agreed upon means of measuring the overall social and environmental impact of investments.