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Impact investing is on the rise, with numerous investors moving towards this strategy. But what is it, what are the goals and who is doing the investing? Finally, is this investment strategy for you?
What is Impact Investing?
Investing in something is simply the act of using money with the expectation of receiving some defined result, whether that be money, material goods, stocks or the always intriguing “other”. Philanthropy is the desire to help others to improve their way of being. This desire is generally expressed by donating to good causes. Think “humanitarianism” with money.
Impact investing bridges the gap between investing for profit and using large amounts of money for the welfare of others. It looks beyond the question, “What’s the profit for me?” to answer, “How can this help mankind?”
Of course, impact investing isn’t exactly altruistic. One can’t take out the expectation of financial return, as profit expectations are what make the difference between impact investing and philanthropy. The idea is to get the best of both worlds:
- Change the world (for the philanthropist)
- Make a profit (for the investor)
When impact investments are managed properly, impact investing can do both. It looks at three specific factors – environmental, social, and governance – with an added layer of financial analysis.
Myths of Impact Investing
This “social” investment strategy has often been thought of as yielding weak returns with a long realization for those returns. It’s been seen as the brain child of activist investors instead of a legitimate investment process: like crunchy, earthy granola without the milk.
A common myth is that impact investing is a fly-by-night, toss-money-into-the-air-and-hope-it-grows type of endeavor. The truth is far from the myth, however, in that it takes as much research and consideration as the more traditional forms of investing, if not more. In fact, for an investment to fall under the categories of “impact”, “sustainable” or “ESG”, they have to meet specific criteria.
Other myths include:
Myth #1: Impact investing isn’t worth it; it’s just a fad.
The name “impact investing” may only have been around since about 2007, but investing for the greater good has been around as far back as Biblical times. Both the Pentateuch (first five books of the Bible, written somewhere between 1500 and 1300 B.C.E) and the Qur’an (written between 609 and 630 C.E.) discuss the rules of ethical investing. Since then, any number of religious orders have looked at the relationship between wealth and helping to make the world a better place.
In the U.S, socially responsible investing (SRI) has been around since the 18th century, starting with the Quakers’ Friends Fiduciary corporation. In the last 120 years, it’s moved away from being a religious investment policy. It now incorporates government rulings in several countries, includes well-known colleges such as Harvard, and large foundations such as the Rockefeller Foundation.
Fact: Impact investing isn’t going anywhere any time soon.
Myth #2: Impact investing underperforms traditional investments.
This is still a widely held misconception, but it’s far from the truth. The reality is easily proved, however. One need only look at a review study published in 2015 by the Journal of Sustainable Finance and Investment.
The study brings together the data from 2200 individual studies and found that investing with ESG in mind is well-founded based on evidence:
“The results show that the business case for ESG investing is empirically very well founded. Roughly 90% of studies find a nonnegative ESG–CFP relation. More importantly, the large majority of studies reports positive findings. We highlight that the positive ESG impact on CFP appears stable over time. Promising results are obtained when differentiating for portfolio and nonportfolio studies, regions, and young asset classes for ESG investing such as emerging markets, corporate bonds, and green real estate.”
Gunnar Friede, Timo Busch & Alexander Bassen (2015) ESG and financial performance: aggregated evidence from more than 2000 empirical studies, Journal of Sustainable Finance & Investment, 5:4, 210-233, DOI: 10.1080/20430795.2015.1118917
Fact: Impact investing often performs equally well and, in many cases, outperforms traditional investments.
Myth #3: Impact investments are just about excluding “sin” stock.
The Quakers’ Friends Fiduciary corporation started their path to SRI by excluding so-called “sin” stocks. In other words, they chose not to invest in casinos, tobacco, firearms, and alcohol, among others. Some believe that impactful investing still means to simply not invest in products and companies that go against your moral grain. There’s a bit more to it than that.
Rather than looking at these sorts of stocks, impact investing looks instead at areas such as how a company treats its employees. Consider factors with both a sustainable and an ethical point of view, such as those laid out by the 6 Principles for Responsible Investing. (PRI) is a list of principles “developed by investors, for investors,” voluntarily agreed to by those with human interests in mind.
Fact: Impact investing has grown to include all areas of moral values, allowing investors to operate based on the continued health of the trio: environment, society, governance.
What Defines an Impact Investment?
As mentioned above, impact investing isn’t without its rules and guidelines. The Global Impact Investing Network, or GIIN, is a leading organization in impact investing. It defines the core characteristics of impact investing as:
Intend to invest responsibly
GIIN posits it is possible to invest in a company, organization, product or technology that can make a positive impact on the world without actually being considered an impact investor. The intent of the investment – to make the world a better place, solve social and environmental problems, strengthen renewable resource opportunities and so on – counts for a great deal. Without the intent to be impactful, it’s just investing.
Use evidence and impact data in investment design
Data is as important in impact investing as it is in traditional investments. However, more must be taken into consideration beyond the potential ROI in terms of monetary gain. Of extreme importance is what the investment is meant to achieve. How will it contribute to society or the environment? What are the overall benefits? To be considered an impact investment, investors will need this information.
Manage impact performance
Remember that impact investments must have intent. Investments have to be managed in a way that keeps future investments moving along that goal. One way to do this is to keep track of performance and share that information along the investment chain. How well is the investment doing in terms of reaching the goal of intent?
Contribute to industry growth
One overall intent is to grow the industry of impactful investing. Rather than keeping all the information to oneself, it’s expected that investors will work to create that growth. More impact investors equals a better, faster, positive impact on the world. This includes sharing what they’ve learned along the way in terms of which kind of investments actually contribute and which don’t.
Is There a Difference Between Impact Investing, ESG and SRI?
Absolutely. Although they’re often used interchangeably, there are some notable differences between the three.
Instead of a singular investment strategy, remember that ESG is a set of investment assessment factors. For an impact investment to truly be considered an impact investment, it has to look at all the factors:
Environmental Impact Investing
Environmental factors include concerns such as climate change, pollution and waste. It looks at how we might preserve our natural resources and looks at opportunities to do so. Investing in the environment is investing in clean tech, sustainable forestry, green construction, biodiversity conservation and more. It’s one of the top reasons investors get into impact investing in the first place: to battle environmental issues.
Social Impact Investing
Where there is production, there are people. Where there is growth, there are people. Investing socially takes that into account, targeting such things as product liability and stakeholder opposition. It looks at human rights, issues such as forced labor, and social opportunities like community engagement. It works to make sure people have food, water, clothing, health care, gender equality – those things considered to be the basic rights of every human being.
Governance is less than an investing focus and more of an investing metric. It looks at corporate governance and behavior. Do they operate with integrity? Do they believe in accountability and equality? Corporations that are concerned with governance tend to be transparent about political spending, have executive pay-caps, and share their earnings somehow in their community.
What is the difference between impact investing and socially responsible investing?
Both impact and socially responsible investing look at ESG factors to choose investments. However, SRI is focused specifically on the “social impact” part of ESG and is mostly used in public markets. Socially responsible investments are easy for any investor to access. Impact investing, on the other hand, looks at all the ESG factors, and is prominent in private markets. Because of this, it’s limited to a smaller number of investors.
SRI investors screen investments, excluding certain types that are considered to have a negative social impact. These include alcohol, gambling and tobacco companies due to the addictive nature of their product. Instead, SRI investors favor social justice companies or those interested in producing clean technology and a sustainable environment.
There is some inherent risk involved with any investment, and SRI is no different. Since these investments are based on the social value at the time – what society looks at as negative or positive – the investment could fall out of favor before returns are realized. Because of this SRI has moved to look more specifically at ESG factors, since investing on social values alone often causes financial loss.
Impact investing looks at whether the investment will have a positive impact in some way. It works to help organizations, corporations and the like to move toward actions that benefit the environment, society, or some form of both. Because it’s based on “doing good while doing well” rather than specific negative screening, it’s not dependent on social mores at the time, and is more likely to bring a return.
Who’s Participating in Impact Investing?
Rather than an investment outlier, impact investing is rapidly becoming a mainstream investment choice. This change is due, in part, to a societal push towards sustainable practices in companies, the idea of reducing human misery around the world, and the need to preserve our world. Commerce has ever been driven by supply and demand, and the demand for impactful change is strong. In turn, more and more companies are making a commitment for impact investing.
- Bain Capital Double Impact fund routinely invests in “sustainability, health and wellness, and education and workforce development,” to the tune of roughly $800 million in 2020.
- KKR (Kohlberg Kravis Roberts) has invested $7.2 billion in 10 years under the KKR Global Impact Fund and began 2020 with $1.3 billion in impact investing funds.
- The Rockefeller Brothers Fund has invested over $204 million in impact investments since October 2014, with a set target of 20% of it portfolio going toward impactful investing.
- The Ford Motor Company Fund regularly invests millions in community programs, for a total of more than $2 billion since its inception in 1949. In 2019, the Fund continued this promise by investing $62 million.
Along with these four and many others, one can find a variety of investors, including:
- Fund managers
- Private foundations
- Religious organizations
- Family offices
Why You Should Consider Impact Investing
As shown above, impact investing is no longer just a niche investment market, but a legitimate, mainstream investment opportunity. But why would you get involved?
Impact investing has wide-reaching value, far beyond the idea of saving the planet from the pitfalls of plastic and climate change. It can be done by anyone – small and large investors, individuals or foundations –, all working towards the same goals:
- The eradication of poverty
- Providing quality healthcare and education worldwide
- Achieving gender equality
- Ensuring sustainable agriculture
A large nod to market growth
Altruistic motives aren’t the only reasons for consideration, however.
The GIIN publishes an Annual Impact Investor Survey every year. In 2016, 157 respondents committed $15.2 billion to 7,551 impact investments. In 2020, there were 294 respondents. Those leading impact investors collectively committed $404 billion to 9,807 investments, with a planned growth of reaching over 12,000 investments by 2021.
Despite the current pandemic, none of the respondents saw impact investing as a declining market. In fact, 69% still see it growing steadily, with 21% feeling that it’s about to take off. And, although 87% said they invested because being impactful was central to their mission, 70% found impact investing to be financially attractive. The survey states:
Interestingly, 70% of investors find the financial attractiveness of impact investing relative to other investment strategies at least somewhat important. Together with the fact that 88% of respondents report meeting or exceeding their financial expectations and over two–thirds of respondents (67%) seek risk-adjusted, market-rate returns for their assets, this finding may imply a shift from the increasingly outdated perception of an inherent tradeoff between impact and financial performance. The initial survey conducted a decade ago noted investor’s expectation of a tradeoff. It also found wide variance in return expectations; by contrast, respondents to this year’s survey appear to have consolidated more strongly around risk-adjusted, market-rate returns but are satisfied with concessionary financial performance, if this is in line with what they target. (pg. 7, GIIN 2020 Annual Impact Investor Survey, emphasis ours)
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