What is Impact Investing?
Masterworks Impact investing is a passion investment strategy to generate specific beneficial social or environmental effects in addition to financial returns. The point of impact investing is simply to use money and investment capital for positive social impact, and these investments can take many forms
Investors who utilize this strategy consider a company’s own commitment to corporate social responsibility when determining investment decisions.
Background of Impact Investing
The term impact investing was first coined in 2007, but the concept had been in practice for years prior.
Some investors consider this to be an extension of philanthropy because of the focus on bettering society. Tactics can include ESG investing, sustainable investing, investing in social enterprises, or investing in the private sector focused on sustainable development.
- Impact Investor: Invests with the intention to generate measurable social impact alongside a financial return.
- Impact Investee: A mission-driven organization (for-profit, nonprofit, or hybrid) with a market-based strategy.
Types of Impact Investments
Impact investments can come in almost any form of capital or investment vehicle. In 2019, the Global Impact Investing Network (GIIN) published the Core Characteristics of Impact Investing to provide clarity over what constitutes an impact investment. The following four tenets were established:
- Intentionality: An investor’s intention to have a positive social or environmental impact through investments is essential to impact investing
- Investment with Return Expectations: Impact investments are expected to generate a financial return on capital or, at minimum, a return of invested capital
- Range of Return Expectations and Asset Classes: Impact investments target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate, and can be made across asset classes including fixed income, venture capital, private equity and more
- Impact Measurement: A trait of impact investing is the commitment of the investor to measure and report the social and environmental performance and progress of underlying investments
Individual Stocks
While investing in individual stocks, investors can take an impact investing approach to filter companies to invest in and companies to avoid. To determine which companies align with an investor’s values, they can look to sustainability reports, equity and inclusion reports, or lists provided by third-party analysts.
Impact investors can invest in mutual funds, exchange-traded funds (ETFs) or bonds that choose companies that align with values that matter to them.
Investors may also avoid investing in companies whose practices they disagree with, often called “sin” stocks: this can include alcohol, tobacco, or weapons.
Impact Investing Funds
These funds allow investors to spread their capital across many different companies that have a social mission the investor supports. Funds can be focused on an emerging market or developed economies, can focus on a specific industry such as healthcare or renewable energy, or can be spread across multiple.
Environmental, Social, and Governance (ESG)
ESG refers to the practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors enhances traditional financial analysis by identifying potential risks and opportunities beyond technical valuations.
While ESG has an overlay of social consciousness, the main goal of ESG is not to promote positive impact but instead to utilize sustainability valuation for financial performance.
Socially Responsible Investing (SRI)
SRI goes a step further than ESG by actively eliminating or selecting investments according to specific ethical guidelines. Unlike ESG analysis, which shapes financial valuations, SRI uses ESG factors to apply negative or positive screens on an investment universe.
Why Does Impact Investing Matter?
Impact investing challenges historic views that social and environmental issues should only be addressed through philanthropic vehicles, and that market investment should focus exclusively on achieving financial returns.
How Does Impact Investing Help Further Impact Goals?
When applied to specific social causes, impact investing has the potential to bring more capital and innovative approaches to targeted issue areas. New capital and more stakeholders allow for further investment into these targeted issues, which snowballs into more impact opportunities to invest in. Once there is more capital ready to be invested in social welfare, more entrepreneurs and startups are able to engage in the stated mission, creating a ripple effect of social good.
On a basic level, impact investing helps further goals by providing the capital needed to implement socially or environmentally minded ventures. But on a global scale, the introduction of financial returns to socially responsible projects ripples through the rest of the economy and has the potential to make major changes to standard business practices.
How Does Impact Investing Help Further Financial Goals?
Impact investors have a wide range of financial return expectations. Some intentionally invest for below-market-rate returns, in line with their strategic objectives. Others pursue market-competitive and above-market returns, sometimes required by fiduciary responsibility.
Strong ESG practices have historically been associated with financial outperformance. The first well-known impact investing benchmark study was developed in 2015 by the GIIN and found that top-quartile returns of impact investments reached 9.7% or higher, in line with the average return of the top 10% of the S&P 500.
According to the GIIN 2020 Annual Impact Investor Survey, more than 88% of impact investors reported that their investment met or exceeded their financial expectations.
Examples Of Impact Investing
Mission-related investments can come from individual investors, private companies, institutional investors, private foundations, pension funds and fund managers.
For individuals, impact investing can take the form of investing in a brokerage’s impact portfolio or impact fund, such as an ESG fund, a climate fund, or a fund focused on a specific social issue such as affordable housing or investment into non-profit organizations. Some index funds implement impact investing strategies to provide easier diversification for investors.
The Gates Foundation is one of the world’s most well-known impact investment funds. While the Foundation is known mostly for its philanthropy, it also has a strategic investment fund with $2.5 billion under management, which is invested in ventures that align with the Foundation’s goals of improving health, education, and gender equality.
How Large is the Impact Investing Market?
2019 was the first year the GIIN developed a methodology to estimate the total size of the impact investing industry, and in 2020 they estimated the current market size at $715 billion USD, and expect it to grow to $1 trillion by 2025.
Bottom Line
Impact investing is part of a major shift in global finance that looks beyond purely financial returns in order to make asset allocation decisions. More businesses are taking part in socially responsible practices that seek to reduce some of the negative consequences of traditional business activities.
By investing in companies and industries that support causes the investor is passionate about, impact investing can aid in social or environmental benefits while also potentially making returns.
This material is provided for informational and educational purposes only. It is not intended to be investment advice and should not be relied on to form the basis of an investment decision.
