What Is Impact Investing?
Impact investing is making investments to help create beneficial social or environmental effects while also generating financial gains. This investment strategy can involve different types of asset classes, such as stocks, bonds, mutual funds, or microloans. The point of impact investing is to use money and investment capital for positive social results.
Key Takeaways
- Impact investing is an investment strategy that seeks to generate financial returns while also creating a positive social or environmental impact.
- Investors who follow impact investing consider a company's commitment to corporate social responsibility or the duty to positively serve society as a whole.
- Socially responsible (SRI) and environmental, social, and governance (ESG) investing are two approaches to impact investing.
- More than 88% of impact investors reported that their investments met or exceeded their expectations.
- A 2021 study showed that the median impact fund realized a 6.4% return, compared to 7.4% from non-impact funds.
Understanding Impact Investing
The term impact investing was first coined in 2007, but the practice was developed years earlier. A basic goal of impact investing is to help reduce the negative effects of business activity on the social or physical environment. That's why impact investing may sometimes be considered an extension of philanthropy.
Investors who use impact investing as a strategy consider a company's commitment to corporate social responsibility (CSR) or the sense of duty to positively serve society as a whole before they become involved with that company. The type of impact this creates varies based on the industry and the specific company within that industry. Some common examples include giving back to the community by helping the less fortunate or investing in sustainable energy practices to help save our planet.
Impact investing actively seeks to create positive social and environmental outcomes through investing, for example, in nonprofits that benefit the community or in clean-technology enterprises that benefit the environment.
The bulk of impact investing is done by institutional investors, including hedge funds, private foundations, banks, pension funds, and other fund managers.
However, a range of socially conscious financial service companies, web-based investment platforms,and investor networks now offer individuals an opportunity to participate, too. One major venue is microfinance loans, which provide small-business owners in emerging nations with startup or expansion capital. Women are often the beneficiaries of such loans.
Types of Impact Investments
Impact investments come in many different forms of capital and investment vehicles. Like any other type of investment class, impact investments provide investors with a range of possibilities when it comes to returns. But the most important thing is that these investments offer both a financial return and are in line with the investor's conscience.
67%
According to a 2020 survey by the Global Impact Investing Network (GIIN), the majority of investors who choose impact investing look for market-rate returns.
The opportunity for impact investments varies and investors may choose to put their money into emerging markets (EM) or developed economies. Impact investments span several industries including:
- Healthcare
- Education
- Energy, especially clean and renewable energy
- Agriculture
Environmental, Social, and Governance (ESG)
Environmental, social, and governance (ESG) refers to the practices of the company being invested in. ESG investors look for companies that have ethical governance, prioritize the well-being of workers in their supply chain, or work towards positive environmental outcomes and sustainable business practices.
The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyondtechnical valuations. While there is an overlay of social consciousness, the main objective of ESG valuation remains financial performance.
Socially Responsible Investing (SRI)
Socially responsibleinvesting (SRI) goes a step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. For example, SRI investors may avoid investing in companies that are involved in producing or selling alcohol, tobacco, or firearms.
The underlying motive could be religion, personal values, or political beliefs. Unlike ESG analysis which shapes valuations, SRI uses ESG factors to apply negative or positive screens on the investment universe. SRI is often considered a type of impact investing. However, SRI may focus more on avoidance of harm, while impact investing also suggests a positive impact via its investments.
When focused on environmental causes, SRI may be known as green investing.
Many asset management companies, banks, and other investment houses now offer funds specifically tailored to socially responsible investors.
Special Considerations
Socially and environmentally responsible practices tend to attract impact investors, meaning companies can benefit financially from committing to socially responsible practices. Impact investing appeals largely to younger generations, such as millennials and Gen Z, who want to give back to society, so this trend is likely to expand as these investors gain more influence in the market.
Investors also tend to profit. A 2020 survey by the Global Impact Investing Network found that more than 88% of impact investors reported that their investments were meeting or surpassing their financial expectations.
By engaging in impact investing, individuals or entities essentially state that they support the message and the mission of the company in which they're investing. A long-term goal of impact investing is that, as more people realize the social and financial benefits of impact investing, more companies will engage in socially responsible business practices.
While money isn't everything, in a 2020 survey of impact investors, more than 88% of respondents said that their investments were meeting or exceeding financial expectations.
Examples of Impact Investing
The Gates Foundation
One of the most well-known impact investment funds is the Bill & Melinda Gates Foundation, launched by the celebrated Windows pioneer with a total endowment of over $67 million. While most of the Gates Foundation is engaged in philanthropy, it also has a strategic investment fund.
The fund has over $2.5 billion under management, which is invested in ventures that align with the Foundation's goals of improving health, education, and gender equality. As explained on the fund's website, the strategic investment fund supports "organizations or projects that benefit the world's poorest and are often overlooked by traditional investors."
Soros Economic Development Fund
The Soros Economic Development Fund is part of the Open Society Foundations, launched by billionaire philanthropist George Soros. As of December 2022, the fund had $130 million actively invested in impact ventures. As the name implies, the Foundation seeks to support "open societies" by promoting democracy, legal reforms, higher education, and journalism, as well as other fields.
The Ford Foundation
The Ford Foundation was launched in 1936 by Edsel and Henry Ford, with an initial endowment of $25,000. Today, the Ford Foundation has one of the world's largest private endowments, with more than $16 billion under management. Most of that money is given as grants to support causes aligned with the values of the foundation; however, in 2017 the Ford Foundation announced plans to invest $1 billion in business ventures aligned with their mission.
What Is Impact-Focused Investing?
Impact-focused investing, or simply impact investing, is an investment strategy that seeks to achieve social or environmental goals, as well as generate profit. Unlike philanthropic endeavors, impact investors typically expect a return on their investment, although this may be a secondary consideration.
Does Impact Investing Work?
Most impact investors seek returns that are comparable to market rates, and some impact funds can even outperform the market. Generally speaking, the returns from impact investing tend to be slightly lower than the market average. In a 2021 study by the University of California, the median impact fund had a median internal rate of return of 6.4%, compared to 7.4% from non-impact-seeking funds.
What Is the Difference Between ESG and Impact Investing?
Environmental, social, and governance practices refer to business decisions that could affect the returns of that company. For example, a company that knowingly employs child labor or engages in discrimination could be at a competitive disadvantage, particularly when marketing to socially conscious consumers.
Impact investing, on the other hand, is the practice of seeking investments that specifically optimize a goal other than profits. This might include investments in clean energy, education, or microfinance.
What Is an Impact-Investing Firm?
An impact-investing firm is an investment fund that specifically seeks to support beneficial social or environmental outcomes, in addition to generating financial returns. Some impact funds invest in causes that they believe will generate strong returns; others consider profits to be a secondary consideration.
What Is an Impact-Investing Strategy?
An impact-investing strategy is an investment strategy that targets companies or industries that produce social or environmental benefits. For example, some impact investors seek to support renewable energy, electric cars, microfinance, sustainable agriculture, or other causes that they believe to be worthwhile.
The Bottom Line
Impact investing is part of a growing trend of socially responsible practices that seek to reduce some of the negative consequences of traditional business activities. By supporting companies and industries in worthwhile causes, impact investing can produce social or environmental benefits while also earning a profit.
