What is Impact Investing?

Even though the definition of impact investing cannot be confined in a single declarative sentence, various stakeholders are coalescing in describing the term as investments which are made with the aim of generating positive, measurable social and environmental impact while pursuing financial returns. Impact investing can therefore be seen as an innovate method of using the capital of the world’s financial markets to address the world’s seemingly incurable problems.

A prime example of impact investing is when investors place their capital in renewable energy companies since they believe that such investments will have a positive impact on the environment alongside a financial return. Another illustration of impact investing concept is when investors set up for-profit companies which provide small loans to individuals in developing countries who struggle to obtain them from retail banks, hence addressing a long-established social challenge. These investments can also address challenges in sectors such as sustainable agriculture, microfinance, healthcare and education but the fields in which social/environmental difference can be made are practically endless.

Impact Investing Blended Value

The framework underpinning impact investing is captured by the proposition of blended value. Enterprises, both for-profit and non-profit, can create value which includes social, environmental and economic components. This fundamental principle is frequently being misplaced in an international market which tends to identify value as being only economic, which is established by for-profit enterprises, or only environmental/social which is established by governments or non-profit organizations. When such misplacement takes place, both enterprises and their investors miss the opportunity to take advantage of their full value potential.

Fortunately, over the last decade, this misplacement seems to be addressed as enterprises are increasingly and intentionally adopting blended value strategies with the aim of maximizing their value to society and the conservation of the natural world while maximizing their financial returns. This is based on enterprises’ enhanced recognition that social impact, environmental impact and financial returns create more value combined than independently.

The Balance between Impact and Financial Returns

Many investors still support that impact investing inevitably results in trading-off financial returns to accomplish a social or environmental mission. In other words, the higher the impact the lower the return on their investment. However, empirical data and market trends support otherwise, rendering this long-held view a busted myth.  

Specifically, research shows that assessing investments based on a holistic set of impact factors, which go beyond the traditional model of “risk and return”, enhances the selection of investments and significantly contribute to decreasing volatility in portfolios therefore boosting their risk-profile.

Apart from this, data defend the position that, in the long-term, impact investing is capable of delivering financial returns at market rate and beyond. For example, pre-pandemic in mid-2019, Morgan Stanley Institute for Sustainable Investing issued its Sustainable Reality Report which analyzed more than ten thousand exchange traded and open-ended mutual funds. Based on this analysis, it was found that there is no financial tradeoff with regards to the returns of sustainable funds and traditional funds. Importantly, it found that sustainable funds exhibited 20% lower market risk compared to traditional funds.

Similarly, Morningstar in its European Sustainable Funds Landscape 2020, found that sustainable funds have delivered higher returns on average compared to their traditional peers during the past 10 years and during Covid-19 market selloff.

The Future of Impact Investing

The value proposition which is provided by impact investing seem to enjoy ample acceptance. Both enterprises and investors are realizing that to prosper over time, they must not adopt a tunnel vision towards financial performance, but rather assess their positive social and environmental impact. In short, through impact investing enterprises and investors are enabled to do well by doing good.

In asserting this positive momentum, Morningstar in its very recent Global Sustainable Fund Flows Report found that continued interest in environmental and social issues drove global sustainable fund assets to shy of USD 2 trillion at the end of the first quarter of 2021. Additionally, during the first quarter of 2021, the global sustainable market attracted more than USD 185 billion and Europe accounted for 79% of these flows.

It is becoming evident that the orientation toward impact investing is significant for various types of investors in an attempt to achieve alignment with the interests of our broader society without sacrificing financial returns. However, it can be argued that for this market to grow further, it is important to completely comprehend why and how impact factors must be integrated in the investment selection and process in order to harvest the full potential of impact investing value in an attempt to address the world’s challenges.