Impact Investing – Innovation in Sustainability and Funding for Social Enterprises
The idea of impact investing, or making an investment that does not solely yield profit but also contributes to solving social and environmental problems, has been around for decades. But when did this trend really take off? And why has it gained such traction in recent years? Learn all about the history of impact investing and what factors make this method of investing so attractive to investors today.
What Is Impact Investing?
The concept of impact investing was born decades ago, but it only recently gained prominence in the investment world. In 1987, Grameen Bank founder and Nobel Peace Prize laureate Muhammad Yunus wrote about how microfinance institutions could alleviate poverty by providing loans to small-scale entrepreneurs who had previously been excluded from the financial system.
The idea of applying business principles to social impact is not new, but it is gaining more and more momentum nowadays. Less than two decades after Yunus’ call for investors to invest in ways that improve the lives of their lowest-income clients, companies like Acumen Fund were raising venture capital funds dedicated exclusively to providing loans and grants to social enterprises that could generate a financial return by solving social problems.
But more recently, impact investing has shifted from applications of business principles towards a target-driven model based on what the beneficiaries most need. As a result, development organizations and private foundations have been establishing funds that aim to provide sustainable energy or access to essential services to communities in need, instead of exclusively prioritizing financial returns.
What Makes an Investment Impact?
There is no single metric to determine whether a particular investment has social or ecological value because the benefits vary by sector and goal. While some investors consider investments that generate both financial returns and social impacts as impact investments, others define them as simply “socially responsible” or “shared value” investments.
Impact investors focus on specific market failures and how they can be addressed, such as financing projects for underserved populations, improving public health, or mitigating environmental damage caused by pollution. In some cases, these investments generate financial returns of more than 15%, but impact investors are often willing to invest in projects that have a higher risk of failure.
In fact, most impact investors cannot afford to forgo financial returns altogether, which is why many focus on finding win-win solutions that include multiple benefits from one investment. In general, impact investments tend to produce a range of social and environmental benefits alongside financial gains. However, these investments can take a variety of different forms depending on the specific objectives and conditions of each project.
What Are the Main Types of Impact Investments?
Impact investors rely on a variety of investment strategies and instruments, including debt-based funding, such as loans, equity-sharing arrangements, grants to organizations that provide access to services or generate other social benefits, and impact-linked securities, such as green bonds or social impact funds that combine loans and equity positions to generate both financial returns and measurable social benefits.
Debt-based funding is the most traditional type of impact investing because it helps governments, nonprofits, and companies meet their expenses while repaying investors over time. This type of financing has typically been provided to institutions through loans, mezzanine financing, and micro-credit.
Equity investments are somewhat more complicated to track because they involve the purchase of partial ownership in a company or project. Unlike debt instruments—which provide set returns during specific timeframes based on agreed interest rates—equity investments tend to produce variable financial gains as the value of the underlying business fluctuates.
Grants are unsecured loans that do not require repayment, making them an attractive form of financing for nonprofits and other companies with limited access to capital. Like debt-based funding, grants provide financial support without requiring the institution to surrender any share of its ownership equity. They also enable investors to support the growth of social enterprises without being exposed to the risk that their investments will fail.
Impact-linked securities are debt or equity instruments that offer some combination of financial returns and social benefits. While green bonds fund environmentally sustainable projects, impact funds combine loans and equity positions with one or more social goals in mind; for example, offering low-cost loan products to underserved populations in emerging markets.
How Do Impact Investors Measure the Performance of Their Portfolios?
There is no single metric for measuring the social and environmental benefits of an impact investment as each project has its own specific goals, risks, and potential remedies. However, there are several guidelines that can help investors assess how effectively they are achieving their desired outcomes.
First and foremost, impact investors should assess the social impact of their investments throughout the term of each deal to see if they are meeting deadlines, producing tangible benefits, and expanding access to services or products. Social enterprises often report on these metrics at regular intervals so that investors can track how well they are achieving their objectives.
Additionally, many impact funds measure the financial performance of their investments by combining key criteria with specific social and environmental goals. For example, the Global Impact Bond Fund measures investment success based on a variety of factors—including earnings per $100 invested and economic value-added per $100 invested—to measure its overall effectiveness.
Impact investing is a growing niche of finance that combines traditional financial returns with measurable social benefits. Investors rely on several different types of instruments to achieve these dual objectives, including debt-based funding, equity investments, grants, and impact-linked securities.
By analyzing the social outcomes of their portfolios throughout the term of each deal—and measuring their success based on specific financial and social goals—impact investors can successfully generate both positive world impacts and sound returns.