Impact Investing: What is it and why should you care?

When you begin exploring the world of responsible investment, you will come across terms that you need to understand. That’s okay. It’s part of the journey. One of the most important terms you will see and hear is impact investing. In this space, I will offer you a deeper understanding of the term, its meaning and the context in which it gets used.

Impact investing vs. socially responsible investing

Because I’m passionate about everything related to responsible investing, I care deeply about these terms and their meaning. They provide context for everything else.

Three of the most useful terms in the world of responsible investing are:

· Socially Responsible Investing

· Environmental, social and governance investing

· Impact Investing

Each of these terms has a different meaning in the field of responsible investing. And when you understand each term more deeply, you will better understand the field overall.

In her book Your Money Your Impact, Lynn Whetham tells us that:

“Socially responsible investing is a way for investors to make a profit and respect their principles. The goal is to make returns without compromising your conscience.”

In contrast:

Impact investing goes further still, making positive (non-financial) outcomes the most crucial focus. In this kind of investing, businesses and companies are chosen for their positive impact on society or the environment.

Let me take a moment to point out that I had the great privilege of working on the book with Lynn as an advisor and editor. Thanks for the privilege, Lynn.

For most investors, impact investing is a second-tier strategy. In other words, you start your investment strategy by developing a portfolio that covers your principal/first-tier needs. You examine your second-tier needs only after you have satisfied your primary requirements.

For most people, first-tier needs include setting up an emergency (rainy day) fund and saving for your retirement or your children’s education.

Because impact investing is focused on a more comprehensive array of outcomes, you should only pursue it with money you can more easily afford to lose. Not that you intend to lose it, but…

What is the difference between ESG and impact investing?

Another term that receiving attention in the news these days is ESG. ESG stands for Environmental, Social, and Governance. It is a way of quantifying potential social or environmental benefits a corporation or investment vehicle offers. It helps give context to a sustainable investing portfolio beyond just financial returns. The wonderful part is that those returns generally meet or exceed those of traditional mutual funds.

The term first entered common parlance about twenty years ago. According to the Corporate Governance Institute, “A 2004 report from the United Nations – titled Who Cares Wins – carried what is widely considered the first mainstream mention of ESG in the modern context.”

In a broad sense, ESG is an attempt to add numbers to the emotions that underlie socially responsible investing. Those numbers offer measurements of an investment’s impact, a pass-or-fail assessment of those investment choices and even rank them.

These assessments have generated controversy in the US. Some state legislatures are trying to keep their staff pension funds from investing with any fund managers who consider or even discuss ESG criteria in their investment reviews. The institutional investors at these pension funds have countered and complained that these investment restrictions have the potential to cost their members/investors billions in the years to come.

Impact investing takes things one step further. It is the active process of putting money and resources into individual investment properties to make positive social change. As you will see, this can relate to both program-related investments and mission-related investments.

So, I think of the main difference between ESG and impact investing as a difference between understanding and action.

Why does impact investing matter?

Because impact investing takes a broader view of investments and financial expectations, it can be used to pursue a more comprehensive array of outcomes. Impact investors can afford to take a longer picture and a greater overall risk when they work to develop their impact investing portfolios.

Because the outcomes they seek are based on different criteria, they can and will look for investment opportunities outside normal channels. Investments that present the opportunity to have a more profound social, environmental or political impact.

Under a regular socially responsible investment strategy, you may pass over some opportunities, however socially beneficial they may be. But because it views things differently, impact investing will allow motivated investors to pursue those opportunities anyway.

Does impact investing work?

With an estimated market presence of $2.5 trillion, it is hard to think of impact investing as a failure. And throughout the sites I have reviewed and cited here, there are innumerable examples of projects that would have never happened without impact investors willing to step in, see the bigger picture, and help make a difference.

Impact investing is an optimistic adventure for anyone who can and does get involved, and it offers individuals the chance to witness real change. And by those standards, impact investing works. As time goes on, the financial returns these impact investments make are able to be reinvested, multiplying their impact – like any investment is intended to do.

Is impact investing a good idea for you?

The most important thing to consider when considering impact investing is that it starts from a different perspective. By definition, you are looking beyond financial performance and financial returns within an investment option – you are also evaluating social and environmental impact.

Most of us can only begin to consider impact investing after we have put the rest of our financial plan together. If you are at that point in your financial journey, impact investing can be very rewarding – on many levels.

However, it can take some work to find a financial advisor who genuinely understands how to help socially responsible investors and impact investors. Many financial advisors will be out of their depth as you begin this journey. And that may become a significant challenge.

What is the current state of the impact investing market, and how big is it?

The COVID-19 pandemic has had a significant impact on the impact investing market. On one hand, the pandemic has highlighted the importance of investing in social and environmental solutions. It has increased interest in impact investing among investors seeking to support pandemic response and recovery efforts. On the other hand, the economic disruption caused by the pandemic has also led to a slowdown in the growth of the impact investing market, with some investors shifting their focus towards more traditional investments. Overall, the full impact of COVID-19 on the impact investing market remains to be seen, but it has certainly brought challenges and opportunities for impact investors.

Like everything else, COVID-19 refocused our understanding of international health policy and economic opportunity. It pointed out ongoing inequities in things like vaccine distribution and testing. Its influence on the current impact investing market is still being felt.

In November of 2021, Omicron, one of the most virulent COVID mutations, was discovered in Southern Africa and spread worldwide. As the old pop song (and theme park ride) goes, “It’s a small world after all….” and we’re all in this together.

To me, this just goes to prove that we must work together to build a better world that benefits and protects all of us.

Allied Market Research goes on to estimate that “The global impact investing market was valued at $2.5 trillion in 2021 and is projected to reach $6 trillion by 2031, growing at a CAGR of 9.5% from 2022 to 2031.”

Impact investment strategy

As we have seen, impact investments do more than maximize the investor’s financial well-being. They aim to improve everyone’s well-being.

Because of that, impact investing looks for opportunities to improve our world and bring opportunities to everyone in it. And because many of the problems in today’s world are so significant and widespread, our response must be just as substantial.

How does impact investing help further impact goals?

Impact investing helps promote impact goals by offering seed money and resources to help initiate and support those goals. That way, it is no different from a regular investment; only the goals and objectives differ.

How can philanthropy help advance impact investing?

So much of what we have examined about impact investing fits my definition of philanthropy and no doubt it fits into yours as well. Some of the best-known examples of international impact investors could as easily be defined as philanthropists.

Two of the best-known impact investors/philanthropist entities are the Bill and Melinda Gates Foundation and the Soros Economic Development Fund. These private foundations deserve special attention.

The Gates Foundation

The Bill and Melinda Gates Foundation, also known as the Gates Foundation, is probably the world’s best-known impact investor, utilizing impact investing to pursue positive social change. The history of philanthropic efforts by the Gates dates back almost thirty years to 1994, with the launch of the William H. Gates Foundation. The Bill and Melinda Gates Foundation opened its doors in 2000.

Their most prominent efforts have been in international health, especially in promoting vaccination efforts that have helped eradicate polio, minimize the threat of HIV/AIDS, and address COVID around the world.

But that is not their only effort. Health, education, sanitation, and food supplies have all benefited from their assistance. And in 2021, the last year they have records for, the foundation made 2052 investments worth $6.7 billion.

Soros Economic Development Fund

The Soros Economic Development Fund is another prominent player involved in impact investing, generally through offering equity investments that generate social value in emerging markets. According to their website:

The Soros Economic Development Fund is the impact investment arm of the Open Society Foundations. We make private-sector investments to advance the Foundations’ enduring equity, expression, and justice commitments.

They list their vision statement as follows:

SEDF envisions a world in which financial capital is responsive to societal needs; works in partnership with stakeholders; tolerates greater financial risk to increase social impact; and shares its returns more equitably with labour. We deploy investments—as catalytic capital—to enable markets to serve rather than subjugate societies and to create economies that prioritize the well-being of people and the planet.

That is an excellent definition of impact investment.

Its efforts appear more focused on changing the economic infrastructure that holds some participants back, regardless of ethnicity, gender or financial background. The social and environmental performance these investment opportunities offer easily outstrip the barriers so many of their local communities seem to put in their way.

Those are investments for change that will not appear on the usual income statement.

Impact investments made by companies and foundations

These two are not the only entities trying to make a positive difference by using impact investments to provide private equity that makes a difference in the business world.

The Council on Foundations points out that many foundations “have made impact investments that intend to generate financial and social returns to complement grants, partnerships, advocacy, and other tools in the philanthropic toolbox.”

And the Global Impact Investing Network calls upon their corporate compatriots to “(j)oin corporate impact leaders… in the Corporate Impact Investing Initiative.”

Impact investing funds

What if you consider yourself a much smaller player in the market? You can’t start your own foundation or fund vaccination drives in far-off countries. You “know” that the investment capital you can offer cannot make a difference on its own.

But you can still participate in impact investing. Investopedia has an article titled The Top 5 Impact Investing Firms. Maybe here’s where you can find your impact investing fund.

These fund managers offer impact investors a straightforward way of making a difference with their investment portfolio. And a lot of the impact investments these firms offer for your involvement are pursuing sustainable development goals much closer to home.

Microloans can bring impact investing closer to home

Global efforts to eradicate polio or provide micro-funding for African family farms are vitally important. But investing in improving our local economies can also be essential. One of the best-known versions of this is known as microloans.

Microloans are precisely what they sound like. North American impact investors have the opportunity to get involved at both the local and the international levels through microfinance institutions. Community Reinvestment Fund, USA, is one of the funds listed in the Investopedia articles on players in the impact investing industry. They have been out there using impact investment strategies to help their communities grow since 1988. Even developed markets have gaps that need to be filled.

Community Development Financial Institutions (CDFI) are generally non-profit organizations that offer loans and support to small businesses in underserviced communities that traditional banks are not interested in. According to a report from the Community Development Financial Institutions Fund in 2017, over half (51%) of all Certified CDFI were loan funds. The second largest category was Credit Unions (28%) – making up 4 out of 5 of the registered entities.

Once again, any impact investing strategy must go beyond a simple review of the investment’s financial return. Business plans with broader goals and objectives will get these organizations’ attention and allow essential entities to get started making a difference.

Microloans can bring impact investing closer to home

Global efforts to eradicate polio or provide micro-funding for African family farms are vitally important. But investing in improving our local economies can also be essential. Both of them offer the opportunity to use venture capital to offer a social or environmental impact – or both.

One of the best-known versions of this is known as microloans.

Microloans are precisely what they sound like. And North American investors can get involved at both the local and the international levels through microfinance institutions. Community Reinvestment Fund, USA, is one of the funds listed in the Investopedia articles on impact investing. They have been out there helping their communities grow ethically since 1988. Even developed markets have gaps that need to be filled.

Once again, an impact investing strategy goes beyond a simple review of financial performance. Business plans with broader goals and objectives will get these organizations’ attention and allow essential entities to start and make a difference.