Investments, irrespective of their nature, tend to impact all — individual investors, community and the economy as well. Apart from generating positive returns for the investors, investments can create jobs and expand the provision of goods and services.
Investments also have the potential to impact the community and the environment in either a negative or a positive way. Impact investing goes beyond avoiding harm and managing Environmental, Social and Governance (ESG) risks.
Coined in 2007, the term seeks to manage investments to generate a positive impact and also helps reduce the negative effects of business activity on the social environment.
Impact investing can be defined as “investments made into companies, organizations, vehicles and funds with the intent of contributing to measurable positive social, economic and environmental benefits in addition to financial gain.”
Impact investing can be made in both emerging and developed markets and actively seeks to make a positive impact by directing capital to address some of the world’s most critical challenges in projects ranging from affordable housing to sustainable agriculture, healthcare, renewable energy, microfinance, education and conservation among others– sectors that are often ignored by traditional business models.
Characteristics of impact investing
- Intentionality: An investor’s intention to positively serve society by giving to those less fortunate or investing in clean technology is integral to impact investing.
- Investment with return expectations:Impact investments are expected to generate a positive return on the investment made or at least, a return of capital.
- Impact measurement: A very important characteristic of impact investing is the commitment of the investor to measure and report the positive social, economic and environmental impacts the underlying investments are making.
Why Impact investment?
Developing nations need trillions of dollars a year to tackle issues of food security, climate change risks and basic infrastructure, including housing, healthcare, and education. But foreign investment into these countries dropped by 16% in 2014 to $1.23tn (£ 962.106 billion), further widening the $2.5tn gap (£ 1.9548 trillion) needed annually to address the most demanding challenges of third-world countries.
“The global challenges are so complex, and the size of the funding that’s needed is so large that traditional funding sources like philanthropy are probably not going to be sufficient to meet them,” said Anna Kearney, associate director for corporate social responsibility at the Bank of New York Mellon (BNY Mellon).
Experts believe that impact investing might be one of the best ways to meet the shortfall to address the planet’s most pressing developmental issues.
Who is making impact investments?
Apart from financial returns, an impact investor aims to achieve socially and environmentally responsible goals. Impact investment, as such, attracts a wide variety of investors, both individual and institutional.
- Fund Managers
- Pension funds and insurance companies
- Private foundations
- Religious institutions
- Development finance institutions
- Individual investors
- Diversified financial institutions/banks
- Family offices, etc.
However, Mo Rassolli, senior consultant of TrendScout, believes that institutional investors, family offices, younger generations, such as millennials, who want to give back to society, and religious institutions face plenty of challenges when it comes to impact investing.
It’s a disjointed and nascent market, says Rassolli. Accessibility is a major factor as investors aren’t sure about companies that can put their money into a good cause which efficiently meets their risks and requirements. Transparency is another major issue, as investors cannot understand their investment’s social and financial benefits. However, he hopes that the advent of more investing advisory firms is likely to address these issues and help investors expand their operations
The tremendous growth of Impact Investing
Impact Investing has registered highly impressive growth in recent times. A significant portion of this money is going towards helping developing countries.
A survey by financial services firm JP Morgan and the non-profit Global Impact Investing Network (GIIN) shows that nearly half of the $60bn (£46.932 billion) in impact investments managed by respondents was invested in emerging markets.
Challenges faced by Impact Investment
Heightened activism in this field is a welcome development, but it is still not enough to fill the gap. As part of their Corporate Social Responsibility (CSR) initiatives, companies have been investing in social and environmental causes for years. However, impact investment has taken off only recently and still faces many challenges.
Mainstream investors often shy away from this form of investing, being more than happy to leave the field to audacious venture capitalists and nongovernmental organisations (NGOs) who act as “first institutional investors.”
Organisations are aware that socially-conscious investment raises their stature among their customers and employees but still fear treading this terrain, held back by their belief that these investments lack the potential to generate healthy returns and carry higher overall risk, being illiquid and difficult to exit.
Impact investing is expected to grow to more than $300 billion (£234.66 billion) by 2020, but this pales in comparison to the $2.9 trillion (£2.268 trillion) that is likely to be managed by private-equity (PE) firms around the same time.
As a relatively-fragmented and nascent field, social finance has yet to have the track record to generate investor confidence. Third-party measurement tools – like the Global Impact Investing Rating System (GIIRS) which measures a particular fund’s social and environmental impact- can greatly help attract investment.
The myth of lower returns—true or false?
A report by global management consulting firm McKinsey about impact investments in India has demonstrated how socially-conscious investment can meet the financial expectations of investors.
The firm looked at 50 investors who have poured $5.2 billion (£4.068 billion) into projects since 2010 and found that they produced a median internal rate of return (IRR) of about 10 per cent. Another 2018 study by the Global Impact Investing Network (GIIN) found that over 90% of impact investors reported that their investments were meeting or surpassing their projections, clearly indicating that investors could factor in profit instead of just social gains or goals while committing to socially responsible practices.
Impact investing—only for developing countries?
It is a myth that impacts investing can only be for the developing market. One prime example is a relatively new concept of social impact bonds – private money that pays for social projects usually funded by the public sector or philanthropists. The bonds typically involve partnerships between private investors, governments and non-profit organisations.
The UK was one of the first countries to champion the idea, and the results have been impressive. Three programs centred on teenagers and education have achieved their specific objectives — investors have booked profit, and the literary skills and attendance in schools have shown a marked improvement.
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