Impact investing is money injected into companies, organisations and funds with the intention to generate a measurable, beneficial social or environmental impact – alongside a financial return. In short, the capital made by investors is to address social and environmental issues and have an ‘impact’.
The aim is to generate specific and measurable effects as well as the traditional aim of investing – making financial returns. Impact investing can take the form of different asset classes and can result in thousands of different but specific outcomes.
Impact investing 101
Impact investment strategy generates financial returns whilst creating socially and environmentally constructive outcomes. The strategy seeks to do so by investing in nonprofits that benefit a target community, or enhance the development in clean technology enterprises, for example.
Who are impact investors?
The constructive investment strategy attracts individuals as well as institutional investors like a hedge fund, private foundations, banks and other fund managers.
Types of impact investments
Impact investments are made in many different forms of capital and investment vehicles. As will all types of investment class, they come with a range of possible returns – the most important of which, is that these investment returns are in line with the investor’s conscience.
A study carried out by the Global Impact Investing Network (GIIN) found that the majority of investors who chose impact investing look for market-rate returns. In other words, they aim to accept the standard level of interest in that industry.
Investors also often choose to put their money into emerging markets or developing economies – where the social and environmental impact will be significant relative to the initial cash injection. Popular industries include:
- Clean and renewable energy
Impactful investing is centered around the belief that a company can be positioned to grow to tackle the world’s problems. It promotes pioneers to find better ways to do business and create momentum to encourage people to opt in to a more sustainable future.
Meaningful impact investing is the combination of traditional investment strategies with environmental and social governance insights (ESG).
Impact Investing in the 21st Century
The wealth management industry is in the midst of an unprecedented transition. Over the next few decades, we will see the baby boomers age and consequently transfer their wealth to the next generation. $41 trillion of wealth in America alone, for example, is set to be passed to the next generation (McKinsey) – and investors and companies alike will have to adopt more socially-minded practices.
The young inheritors are, of course, Millennials – those born between 1978 and 2000. It just so happens that this group of young, newly financed individuals share a common attitude when it comes to social responsibility, private capital and the intersection between the two; and it differs starkly from those of their parents.
Unsurprisingly, this trend has captured the attention of financial institutions who are realising that they need to change their own approach to impact investing if they want to retain any amount of this huge transfer of wealth.
Who’s driving impact investing?
Research shows that millennials have the strongest desire to integrate giving back to the environment and driving social change across their personal and professional lives. They strongly believe that the responsibility for making a social and environmental impact is not limited to one sector, rather it’s shared among a large and wide group of players – including businesses.
In fact, over 87% of Millennials argue that the success of a business should be measured in terms beyond its financial performance (Deloitte). Those businesses who are actively implementing sound ESG initiatives are more likely to attract investment from millennials.
At the same time of the rise of the Millennials, impact investing has become far more accessible to the average consumer. There has been exponential growth in options for exchange-traded funds focused on companies that have social and environmental practices.
The apparent shift in attitudes and growing accessibility of impact investing has materialised into greater knowledge and the adoption of impact investing by average consumers, affluent investors and your typical millennial.
What else is driving impact investment?
The drivers behind impact investing are all incredibly causal and relative to each other. As a result of better knowledge and a shift in priorities of millennials, in particular, financial institutions are asking more of companies and are seeking more sustainable investment solutions.
In addition to this pressure from financial institutions, regulators and governments around the world are expanding their focus on incorporating sustainability into investments information and decision making. Meanwhile, there has been growing recognition that ESG research and analysis can potentially identify investment opportunities, risks and generate excess returns.
Measuring Impact investing
Investors, researchers and governments alike are increasingly looking to assess businesses’ impact on society. There is no direct way of measuring such impact since there is no accounting method or quantifiable formula to do so. The measures that are in use are still evolving and becoming more sophisticated. Since the impacts sought are diverse, so too are the measuring strategies.
Forest bonds, for example, are likely to involve measurement of carbon sequestration and biodiversity protection. Elsewhere, social bonds targeting homelessness in society would account for the number of homeless people receiving shelter. And real estate development might use different techniques to quantify neighbourhood health in terms of energy use and access to employment and education.
Impact investing: Risk and reward
Contrary to popular investment theory, impact investment is not inherently riskier than other investment strategies. For example, some argue that by limiting an investment decision by adding a social or environmental requirement – the financial product will perform worse. Those familiar with ‘portfolio theory’ will understand that diversification decreases risk.
However, in reality, this argument is incorrect since diversifying risks among a pool of assets that are all bad investments is unlikely to make money. As with all investment approaches, the key to sound investment is due diligence.
Ultimately, the focus on impact investing is on the rise across all sectors of the economy and amongst all types of investors. There is still scope for companies to adopt better ESG initiatives, to rebrand themselves as impactful businesses to attract more investment. In the meantime, better practices for measuring the impact of socially and environmentally responsible investment will lead the way to more strategic impact investing.
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