By Olympia De Castro
Depending on your perspective, the world of investing can sometimes have a negative stigma. It’s a world that turns on risk assessment, valuations, and returns. It’s not exactly a warm and fuzzy segment of society.
But there is another way.
Impact investing is the act of investing in companies, organizations, and funds with the intention of generating social or environmental impact alongside a financial return, according to the Global Impact Investing Network (GIIN).
Many financial experts agree that philanthropy and government funding don’t go far enough in solving society’s problems and that private equity will be necessary to tackle the big hurdles that we face. The United Nations estimates that $3.9 trillion will be needed per year between now and 2030 for its Sustainable Development Goals. With current models and trends, there is a $2.5 billion shortfall to meet these goals. That’s where impact investing comes in.
“The concept of impact investing is relatively straightforward. Investment dollars can be used to generate positive social and environmental changes while still providing a market financial return.” – Olympia De Castro
Background and History
While the term “impact investing” is relatively new, its roots stretch further back.
Regulation and philanthropy have long been used to minimize negative social consequences that often arise from business activities, while individual investors have employed socially responsible investing techniques to express their values.
Beginning in the early 2000s, a greater emphasis was placed on corporate social responsibility. It was in this environment that the Rockefeller Foundation coined the term “impact investing.”
How does it work?
Investors who follow impact investing look for companies or alternative investments that seek intentional positive impact as part of their core business model or strategy. This is different from the typical company’s commitment to corporate social responsibility (CSR), which tends to combine, often under investor relations, the organization’s efforts around philanthropy, employee engagement, renewable energy and governance efforts.
Once investors identify their values, they can put in place a strategy that identifies investment opportunities that advance these goals. The type of impact that arises from these investments will vary depending on each individual investor’s goals and the underlying company and investment opportunities they choose. Impact themes can vary from addressing social and economic inequality, climate change, water to gender gaps. These impact goals should be integrally aligned with the company’s core business model or the investment manager’s investment strategy. This is different than CSR efforts where companies choose to give back to the community by investing in sustainable energy practices or sponsor local charities.
The majority of impact investing is handled by institutional investors because opportunities tend to be niche and only available for accredited investors (investors that meet a minimum income or net worth threshold according to SEC regulation), but there are increased efforts to democratize access for retail investors so that everyone may have the opportunity to participate in this growing investment approach. Financial service companies, investor networks and web-based investment platforms are just some examples of organizations looking to stretch their socially conscious investment muscles over new opportunities where individuals may participate.
Rates and Returns
A wide example of impact investment is “Pay for Success” bonds, now widely known as social impact or green bonds. By establishing measurable social or environmental targets, companies are able to issue these bonds in the debt capital markets and reach impact investors. Provided the impact targets are met, companies benefit from lower cost of capital. Investors widely recognize that well-defined and well-measured sustainability and environmental targets improve the company’s resilience to shocks and long-term performance.
Moreover, as this investment space expands, investors are seeing impact investments outperform their benchmarks. According to a 2018 study from GIIN, more than 90 percent of impact investors said their investments met or surpassed their projections.
Impact investing appears to be here to stay. It appeals to younger generations which are currently experiencing a $12tn wealth transfer in the next decade as money passes from baby boomers to their spouses and then heirs. These women and young investors are increasingly more attuned to considering social and environmental impact in their investment decisions. Couple that with the social and financial benefits stemming from impact investment and it’s a movement that looks likely to continue to grow.