Impact investing is the process of making investments in companies that prioritise a positive social or environmental impact as well as generating financial returns for investors. Interest in impact investing has grown as people are, in general, becoming more aware of their social and environmental responsibilities.
In essence, impact investing provides access to capital for companies working towards good causes, while allowing investors to support companies creating a positive social and environmental impact. It also helps businesses to approach social and environmental challenges, including healthcare, education, renewable energy, microfinance, and sustainable agriculture.
Types of impact investments
Impact investments can be done by individuals, NGOs, pension funds, insurance companies, financial institutions, religious institutions, and fund managers – they all aim to address social and environmental issues while generating financial returns.
They can be of various types, depending on the purpose of investors and investment vehicles. Investors can invest in a number of different ways, including debt, fixed income, private equity or venture capital. They can invest in both developing and developed economies, in industries ranging from healthcare and education to energy and agriculture.
These types of socially responsible investing also vary in terms of the impact of the returns investors can expect. The financial returns on impact investments range from below-market returns through investments in grant support, equity, senior loans, and subordinated loans to market-rate returns by investing in cash, fixed-income, public equity, or private equity.
How do impact funds differ from SRI funds and ESG funds?
While ESG investing, socially-responsible investing, and impact investing are often used interchangeably, they are quite different from one another in terms of how portfolios are structured, financial returns are generated, and social impact is made.
ESG investing ensures that the environmental, social, and governance practices associated with the investment are integrated into its technical analysis. It caters to social impact, but the primary purpose of ESG investing is to generate financial returns. Overall, ESG is a framework that evaluates companies rather than assessing investments.
On the other hand, socially-responsible investing goes one step further by choosing or discarding investments based on ethical guidelines. In fact, SRI implements ESG factors to determine whether to add an investment to the portfolio or not, depending on how positive or negative an impact it creates.
So, unlike SRI and ESG investing, the explicit purpose of impact investments is to create a positive impact. It doesn’t focus as much on boycotting or eliminating negative investments as it does on promoting investments that will positively impact the world in one way or another. It aims to support organisations to reach goals that will help society and the environment.
How does impact investing work?
Impact investments work as an extension of philanthropy. They aim to reduce the negative effects of business activities on society and the environment, all while generating financial returns for investors. Thus, it works in a similar way to traditional investing but with the added advantage of a positive social impact.
The most common way that impact investment works is through microfinance loans. Individual and institutional investors loan their money to businesses in growing markets for their growth and expansion. The funds are then used by the businesses to either create environment-friendly products and services or a positive impact socially.
In terms of financial working and performance, impact investing can generate below-market, market-competitive, or market-beating returns. According to the Annual Impact Investor Survey conducted by the Global Impact Investing Network (GIIN), over 67% of impact investors look for market-rate returns, while only 33% seek below-market-rate returns.
It is also heartening to know that the performance of impact investing portfolios usually meets or exceeds the expectations of investors for both social impact and financial returns. According to the same survey by the GIIN, 68% of impact investors were able to meet their financial expectations from impact investments, while 78% met their impact expectations.
Why choose impact investing?
Impact investors use their capital in ways that not only benefit them but also bring about positive change in the world around them. In theory, these investors generate returns, while the world gets fresh solutions to long-standing problems. So, for investors that want to target social and environmental impact as well as returns on their investments, impact investing is the right choice.
Impact investments go against a few deeply rooted misconceptions. They disprove the idea that philanthropic acts cannot generate financial returns, and that only a specific section of society can address social and environmental issues. Impact investing ensures that all individuals can become a part of the change in the world at large, along with gaining financially.
The bottom line is that impact investing is becoming increasingly important in today’s world as environmental and social concerns grow. Investors are also becoming more inclined towards investments that make a difference to the world, help the community, and generate sufficient returns for them.