In today's world, the typical investor is no longer satisfied with simply choosing investments that offer maximum financial returns. In fact, several are adapting their investment strategies to account for personal interests and values. Is it really feasible to attempt to "do well by doing good"? Can investors truly hope to achieve an appropriate amount of financial return while making a clearly defined positive social impact? The growing area of Impact Investing aims to do just that.
What is Impact Investing?
Impact Investing is investing with the intention of achieving financial returns and positive economic, social or environmental impact that is measurable. Impact Investing is not philanthropy because investors expect positive financial returns, although they may be willing to sacrifice maximum returns in favour of achieving quantifiable social results. Simply put, Impact Investing is about using traditional debt and equity instruments to pursue investments with actual return potential, while supporting companies that have the power to change their communities and the world for the better.
It is important not to confuse Impact Investing with Socially Responsible Investing (SRI); the latter is more closely associated with seeking out socially conscious "green" or ethical investment strategies by avoiding morally questionable businesses. Furthermore, it's important to note that the acronym SRI is not always used uniformly. Some investment professionals use it to refer to Sustainable, Responsible, and Impact Investing - an umbrella term that encompasses all return/impact trade-off strategies - so it's crucial for investors to make note of the context in which these concepts are discussed. (We will refer to SRI in the traditional sense through the rest of this post.)
The Capital Continuum
According to Bridges Ventures' definition of the market in Sustainable and Impact Investing, SRI and Impact Investing can be considered part of a continuum where the position of investment strategies is dependent on the relative importance of financial return and social impact to an investor.
If you imagine the continuum with traditional investment management (where return optimization is prioritized) on one end, and philanthropy on the other, both SRI and Impact Investing would fall somewhere in the middle. Within SRI and Impact Investing, there are varying degrees to which an investor is willing to forego financial return for greater impact potential and vice versa.
There are two basic ways to invest for Impact. The first is called Thematic Investing, which according to the CFA Institute's Environmental Social and Governance (ESG) Issues in Investing guide, focuses on a limited number of ESG issues with the goal of creating opportunities for market-rate or market-beating returns e.g. investments in clean tech, green real estate, healthcare. The second method - Impact-First Investing - concentrates on ESG issues that require capital funding in order to succeed, and as a result may not provide very high financial returns e.g. trading charities.
Although the concept of investing to create social impact has been around for a long time, Impact Investing as a formal discipline is still in its infancy. Since investors are likely to have different priorities when it comes to impact vs. returns, it can be challenging to identify a standardized set of principles and approaches to these investments. As a result, there are also very few reliable standards around impact measurement available to investors.
According to a 2015 survey conducted by J.P. Morgan and the GIIN (Global Impact Investing Network), the greatest challenge faced by investors is the lack of appropriate capital available across the risk/return spectrum. Just as challenging is the relative inaccessibility to high quality investment opportunities, especially those that have a track record of allowing investors to easily and effectively assess risk/return and the financial /impact trade-offs highlighted above. According to the study, the immaturity of the market often means that investors have to rely on word of mouth and informal networks to find investment vehicles or deal flow, which often serves as an entry barrier for newer investors.
Investing for Impact can also require a long investment horizon. Impact Investments are often illiquid, and it can be difficult to determine the probability, timing, and level of financial gains at the time of investment.
The Road Ahead
Although relatively new, Impact Investing is quickly gaining favor with investors. According to the survey by J.P Morgan and the GIIN, the size of the global Impact Investing market is approximately $60bn AUM, but is predicted to grow to somewhere between $400 bn- $500 bn AUM by 2020. Many of the issues that investors currently face around the lack of capital and deal flow, and the illiquidity of assets will likely dissipate as more capital is earmarked for investments that can show ESG impact alongside appropriate financial gain.