Since the dawn of finance, people have sought to turn money into more money. This is no easy task – hence the rewards for professionals who do it consistently well. But this approach is beginning to feel insufficient alongside the existential challenges our societies and planet face.
Today, more savers want a better idea of what their money gets up to when it leaves the bank. What if savings could be used to both reap a return and improve the state of the world? This is a foreign notion to many of us who grew up when the only social responsibility of business was to maximize profits, as Milton Friedman, a Nobel Memorial Prize in Economics, once expressed it. He popularized the notion that the “only business of business is profits.”
What if savings could be used to both reap a return and improve the state of the world?
Yet, 50 years later, the investment world has developed quite contrary to his encouragement to chase profits at any cost. The growing demand for a more socially responsible, purpose-driven finance has been answered by the emergence of ‘impact investing,’ a new approach to putting capital to work.
Global Impact Investing Network (GIIN) is a non-profit dedicated to increasing the scale and effectiveness of impact investing. According to GIIN, impact investing refers to investments "made into companies, organizations, and funds with the intention to generate a measurable, beneficial social, or environmental impact alongside a financial return.”
The keyword is return, which distinguishes impact investing from charity. Impact investing is also different from sustainable finance, which ensures investments are not made into companies with a negative impact on society or the environment. In contrast, impact investing emphasizes the net positive impact apart from a financial return.
Doing Well by Doing Good
Impact objectives typically revolve around themes like affordable housing, clean energy, education, and healthcare services but are by no means limited to these categories. Imagine putting your money into a fund promoting solar panels in villages in east Africa. The impact parameters – number of villages served, number of jobs generated – need to be quantified and measurable in addition to the financial return. But if your money is invested in such a scheme, then you are a proud impact investor.
Yet, while it is getting easier to undertake virtuous investing, there are many challenges to overcome before the concept goes mainstream. Measuring impact in a meaningful and transparent way is the largest. Given the continuous risk of impact washing, setting performance indicators and reporting to all relevant stakeholders is crucial in managing the performance of impact investments.
Second, finding investment opportunities that provide adequate returns while creating a measurable positive impact is not easy. In this climate of war, soaring inflation and supply chain disruptions, many sectors struggle to provide market returns. Raising the bar by adding 'impact' measurements makes it even harder. And generating a healthy pipeline of impact investment opportunities is still even harder.
Yet, as the sustainability domain matures in terms of regulation, standardization of reporting and availability of reliable data, many aspects of these challenges will be overcome. So, is impact investing a more ‘social’ form of capitalism that can help save the planet and strengthen societies?
Impact investing can be a helpful addition to our toolbox as we go up against generational challenges like the climate emergency and income inequality.
The Bottom Line is More Than Just Feeling Good
Impact investing will certainly not upend the existing measures of government spending, charitable donations, and development finance. However, it can be a helpful addition to our toolbox as we go up against generational challenges like the climate emergency and income inequality.
Cynics may still diss impact investing as a fad, but that is to ignore the scale and progress of the approach. Ten years ago, anyone wanting to combine financial returns with virtue investing was restricted to social housing for poor people in rich countries, microcredit, and ethical mutual funds that spurned sinful shares such as tobacco and armaments.
Today, impact investments are becoming a fast-growing marketplace driven by investor demand. The International Finance Corporation reports that $2.3 trillion was already invested for impact in 2020. This is equivalent to about 2% of global AUM. While impact investing remains a small market niche, it is attracting growing interest and is being championed by a growing number of leading institutions in the capital markets.
Did you know...
Impact Investing was coined in 2007 by Rockefeller Foundation. At that time, it was defined as “mobilizing large pools of private capital from new sources to address the world’s most critical problems.” (investopedia.com)
According to International Finance Corporation (World Bank Group), a total of $2.3 trillion was invested for impact in 2020. (ifc.org)
A survey conducted by GIIN (Global Impact Investment Network) in 2020 found that 55% of impact investments produce market competing returns. (growthcapitalventures.co.uk)
New Face of Sustainable Finance
Sustainability themed investment practices have already become ‘mainstream’ in the financial markets, and with time there will be more focus on impact investing. This will be driven by the transfer of wealth to women and the young, whose investment goals differ from previous generations.
Many studies show that millennials consider and often prioritize social and environmental impact in all aspects of decision-making – from finances to jobs to consumer habits. Given that millennials are expected to inherit $30 trillion from their boomer parents and grandparents over the next few decades in the United States alone, their commitment to impact investing could be transformative.
This article reflects the personal views of the author.
