Investors seeking to align their financial goals with their social and environmental values have turned to impact investing. Impact investing goes beyond traditional financial considerations and seeks to create positive change in the world while also generating returns.
Impact investing is an investment approach that aims to generate both financial returns and positive societal or environmental impact. Unlike traditional investing, where the primary goal is maximizing financial gains, impact investing intentionally directs capital toward businesses, organizations, or projects that promote sustainable solutions, address social issues, or reduce environmental harm. It involves considering a broad range of factors beyond financial performance, including social and environmental metrics, to evaluate investment opportunities.
The make-up of impact investors, according to the Global Impact Investing Network, is a mixture but prominently this movement is led by fund managers.
There are several compelling reasons why fund managers choose to engage in impact investing:
- Aligning values with investments: Impact investors seek to support causes and initiatives they believe in, allowing them to contribute to positive change while growing their wealth.
- Mitigating risks: By investing in companies that prioritize sustainability and ethical practices, investors can reduce exposure to reputational, legal, and operational risks.
- Driving innovation: Impact investing can foster innovation by channeling capital toward businesses that develop and implement sustainable technologies and solutions.
- Attracting like-minded LPs: Impact investments can attract investors who share similar values, leading to the formation of communities and networks focused on creating positive change.
How is impact investing different from ESG?
While impact investing and ESG (Environmental, Social, and Governance) investing share similarities in terms of considering non-financial factors, they have distinct characteristics:
ESG investing involves integrating environmental, social, and governance criteria into investment decisions. It often focuses on assessing and ranking companies based on their ESG performance and may involve excluding certain industries or companies with poor ESG records. ESG investing is typically passive and aims to align investments with broader sustainability goals.
Impact investing, on the other hand, goes beyond ESG criteria by actively seeking investments that create measurable, positive impacts. Impact investors prioritize the achievement of specific social or environmental outcomes and may be willing to accept lower financial returns in pursuit of these goals. It is a proactive approach that aims to drive change through capital allocation.
Types of Impact Investing
The impact investing market has experienced significant growth in recent years. According to the Global Impact Investing Network (GIIN), as of 2021, the total market size was estimated to be over $715 billion.
This growth reflects increasing demand from investors, including individuals, foundations, institutional investors, and governments, who recognize the potential of impact investments to address pressing global challenges. Each firm’s strategy will be different but here are a few of the common types of impact investing.
Renewable Energy Projects: Impact investors often fund renewable energy projects such as solar, wind, and hydroelectric power generation. These projects contribute to reducing greenhouse gas emissions and combating climate change. For instance, an impact investor might invest in a solar energy company that provides clean and affordable energy to underserved communities.
Microfinance Institutions: Impact investors frequently support microfinance institutions that provide small loans and financial services to low-income individuals and entrepreneurs in developing countries. These investments help alleviate poverty, empower women, and stimulate economic growth. Organizations like Kiva and Accion are well-known examples in this space.
Affordable Housing: Impact investors may invest in real estate projects that focus on creating affordable housing for low and middle-income individuals. By doing so, they address housing shortages, promote community development, and improve the overall quality of life for residents.
Sustainable Agriculture: Investments in sustainable agriculture initiatives can support environmentally friendly farming practices, reduce food waste, and improve food security. Impact investors might back companies that promote organic farming, reduce the use of pesticides, or enhance supply chain sustainability.
Education and EdTech: Impact investors can fund educational institutions and technology-driven education initiatives. These investments aim to improve access to quality education, close the educational achievement gap, and foster lifelong learning. EdTech companies like Khan Academy and Coursera have received impact investments.
Clean Water and Sanitation: Impact investors may support projects that provide access to clean drinking water and sanitation facilities in underserved regions. These investments have a significant impact on public health and can help prevent waterborne diseases.
Healthcare and Biotech: Impact investments in healthcare and biotechnology can lead to the development of innovative medical treatments, vaccines, and diagnostic tools. These investments contribute to improving healthcare outcomes and addressing global health challenges.
Social Enterprises: Impact investors often back social enterprises that combine profit-making activities with a strong commitment to addressing social or environmental issues. For example, a company producing reusable and eco-friendly products that also employ marginalized communities.
Community Development Funds: Impact investors can invest in community development financial institutions (CDFIs) or impact-focused funds that channel capital to underserved communities, promoting economic development and job creation.
Conservation and Biodiversity: Impact investments in conservation projects help protect and restore natural habitats, conserve endangered species, and promote biodiversity. These investments are critical for preserving ecosystems and addressing ecological challenges.
Clean Technology Startups: Many impact investors support startups working on clean and sustainable technologies, such as electric vehicles, energy-efficient appliances, and waste reduction solutions.
What about returns?
One of the ongoing debates surrounding impact investing is whether it can deliver competitive financial returns. Critics of impact investing argue that prioritizing social and environmental impact may come at the expense of financial performance.
A large portion of impact funds money flows from pension funds. GPs have a responsibility to their LPs to create value. Returns are not an optional perk of their impact investing.
Investors agree that returns are an essential part of impact investing, but there are conflicting reports about what those returns look like.
While numerous studies and real-world examples demonstrate that impact investments can achieve competitive or even superior returns. It's important to note that the financial performance of impact investments can vary widely depending on the specific strategies and timeframes.
According to GIIN, 74% of impact investors surveyed are not expecting any trade-offs in financial performance.
But critics, like Aswath Damodarian, have done extensive research into specific industries only to find that not only are high returns unlikely, but the “impact” on social issues like climate change has been underwhelming.
The Future of Impact Investing
Impact investing represents a way for individuals and institutions to leverage their capital for positive social and environmental change.
As the impact investing market continues to grow, the opportunity for investors to make a meaningful difference should be constantly assessed to see if their investments are 1) meeting the minimum threshold for their clients and 2) actually making a tangible difference in the world.
Grata’s optimizes the data-gathering processes and drives thematic sourcing for PE firms and banks. Organizations can use the platform to search for target companies based on company size, industry or specific keywords, such as “customer success software,” “organic baby products” or “warehouse automation.” Then they can build targeted lists of companies to support their impact investing mandates.