What is impact investment?
Impact Investor is a relatively new term. Traditionally, investors would be people or institutions looking for a financial return, with certain risk preferences. Activities for the benefit of society would be in the form of donations or charity. Most investors would consider it the role of charity and government to overcome social challenges, and the role of business only to invest and make money.
The term “impact investment” was coined in 2007 when a group of investors met at the Rockefeller Foundation’s Bellagio Center to discuss a new form of financial investment that could achieve a social or environmental impact (Forbes). Impact investment is defined as “investing that aims to generate specific beneficial social or environmental effects in addition to financial gain.” (Investopedia).
Whereas socially responsible investing, or more general, corporate social responsibility is aimed at investing or conducting business in a way to avoid harm, the focus of impact investing is actually at the social and environmental benefit, though with a financial return expectation. In other words, impact investors primarily judge their investment by the social benefit, rather than the financial return.
The advantage of impact investments over charity is that the need to make a profit, and in addition to a financial return, ensures measurable positive social and environmental impacts from an investment (UNDP).
Impact Investment Asset Classes & Returns
In general, sustainable investment is shown to deliver similar returns to conventional investment (‘ESG and financial performance: aggregated evidence from more than 2000 empirical studies’, Journal of Sustainable Finance and Investment, Gunnar Friede, Timo Busch, Alexander Bassen, 2015).
Impact Investors are expecting a financial return but the key objective is the social impact, not to maximise profit. Different investment instruments deliver a different balance between impact and return; from grant support, or equity with sub-market return expectations all the way to pure market private equity (see figure below).
There are different types of Impact Investors. Also, the balance between impact and return differs per investor. Impact investors can be categorised as:
- Foundations: Some of the best-known impact investors are wealthy persons dedicating significant shares of their capital towards impact investing, such as Bill & Melinda Gates Foundation or Michael & Susan Dell Foundation. There are also other foundations such as university endowments. These foundations invest with a financial objective, but only to reinvest the proceeds, hence the key focus is on the impact.
- Seed investors/Venture Capital: like ‘normal’ seed investors or Venture Capitalists, these impact investors invest in early-stage companies that solve a social/environmental issue whilst aiming for financial return. For these impact investors the balance can be either more on the impact or on the financial return
- Public institutions: pension funds, developing finance institutions are also more active as impact investors. Some shift away from traditional charity to a more commercial approach.
A wide range of investors are now active in Impact Investing (GIIN)
- Fund Managers
- Development finance institutions
- Diversified financial institutions/banks
- Private foundations
- Pension funds and insurance companies
- Family Offices
- Individual investors
- Religious institutions
What do Impact Investors Invest in?
Impact Investors could invest in any opportunity offering a social or environmental benefit whilst aiming for financial returns. Typical areas are (WEF)
- Agriculture: such as increase productivity or yield as a result of technology or training
- Education: participation rates of girls, quality of education, innovative education solutions
- Energy: access to electricity for rural areas, clean energy
- Environment: CO2-avoidance, clean technology, waste or recycling solutions
- Financial services: cheaper or accessible financial services, financial access for those without bank accounts
- Health: access to healthcare, vaccinations, affordable health care, qualityu
- Housing: affordable and quality housing solutions
- Water: availability of clean drinking water, or ocean preservation
Sustainable Development Goals (SDG)
The united nations has set 17 key sustainable development goals (SDG), goals to achieve a better and sustainable future for all. They address the global challenges we face, including those related to poverty, inequality, climate, environmental degradation, prosperity, and peace and justice. (website)
Many Impact Investors would relate to the SDGs. They would look for impact investments fitting one or multiple of the SDG themes. For example an impact investor might focus on investments improving health care in developing countries (SDG3). Also, impact investors might require their investments to report on the impact of the SDG and assess them accordingly. For example, an impact investor focusing on SDG7: affordable and clean energy, might require all current and future investments to measure the carbon emissions avoided by their activities.
Other types of Social Investments
Impact Investment is just one type of social investments. There are various other forms of investments with a social/environmental angle (MaxImpactBlog)
- Sustainable and Responsible Investing: investing whilst avoiding harm, usually by preset Environmental Social and Corporate Governance (ESG) criteria. Such investments would ensure all investments meet, for example, minimum human rights standards
- Ethical Investing: Ethical investing means selecting or excluding investments based on beliefs or values. This could mean the exclusion of certain investment categories such as weapon manufacturers or fossil fuel companies, or selecting certain investments such as halal investments
- Triple bottom line investing: This relates to investments following the reporting practice of People, Planet, Profit; this requires reporting not only profit but also the society and environmental impact.
- Blended value investing: a philosophy of investing putting the concept of value at the heart of decisions
- Social enterprise investing: providing capital to support businesses with positive social or environmental impacts, such as deprived communities, renewable energies
- Crowdfunding: though some crowdfunding is clearly commercial, some social causes revert to crowdfunding in which, usually through an online platform, retail investors dedicate money to a certain cause or company.