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What is Impact Investing? Types and Performance of Impact Investing

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.

Impact Investing: Summary Table

💥 What is an impact portfolio?It is designed for positive social impact
📈 Is impact investing a good idea?Yes, it is
🥹 What is a disadvantage of impact investing?Less emphasis on financial returns
🏭 What industry is impact investing?Renewable energy, healthcare, education, etc

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.

Examples of impact investing & ETFs

There are many ways you can impact the world through investing. But how do you find companies that have an impact? It depends on how you want to define “impact investing.” If you really mean ESG investing, there are many options available. 

First, you can invest in stocks of companies that receive high environmental, social, and governance (ESG) ratings. Alternatively, you could invest in ESG mutual funds and ETFs.  Here are examples of impact investing ETFs:

  • Xtrackers S&P 500 ESG ETF
  • Low Carbon Innovation Fund
  • iShares MSCI USA ESG Select ETF
  • iShares MSCI UK IMI ESG Leaders UCITS ETF
  • Xtrackers MSCI UK ESG UCITS ETF 1D
  • iShares MSCI Europe SRI UCITS ETF
  • L&G Europe ex UK Equity UCITS ETF

If you are interested in environmental issues like environmental waste and carbon emissions, you can invest in companies that aim to reduce carbon emissions and recycle waste products. There are also foundations you can invest in, such as the Gates Foundation, Soros Economic Development Fund, and the Ford Foundation. The possibilities are endless.

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.

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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.

Impact Investing in the UK market

Globally, impact investing has experienced steady growth over the past decade, but there has been solid progress in measuring and managing impact. According to the Global Impact Investing Network, the total global market for impact investing was estimated at around $715 billion in 2019.

We’ve seen an increase in the number of equity deals involving impact investment firms within the UK private sector. 2021 was a big year for impact rounds. There were over 50 deals announced.

Since 2015, the value of these equity investments has grown year on year. According to Beauhurst, 2021 saw the most significant amount of money invested in impact investments, at a record £368 million. This represents a 109% increase on last year’s £176 million and a 504% increase on 2011’s £60.9 million. The number of impact investments will keep growing as more people mix ethics with investing.

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 in the world, help the community, and generate sufficient returns for them.

FAQ

Where do impact investors invest?

Impact investors can invest using different asset classes such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), venture capital, and private equity.

How do I start impact investing?

If you’re looking for ways to introduce impact investing into your portfolio, do your research and speak to a financial advisor. Your social and financial goals, areas of interest, industry choice and many others will help you evaluate firms, funds, ETFs and indexes that fit your bill.

What type of investors prefers an impact investing approach?

Foundations (such as the Bill and Melinda Gates Foundation), individuals, pension funds (private and workplace), and financial institutions invest using the impact investing approach.

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