By Richard Turley – International Banker
Impact investing is the new kid on the block in the world of socially responsible investment, and its objectives are more ambitious than its predecessors’. Impact investors are focused not only on financial return; their investments must create a measurable beneficial impact on society or the environment.
This is a very different mindset than that of traditional investment models, which focus on some form of internal rate of return (IRR). Investors and managed funds have historically paid lip service to making investments for reasons other than profit, and some have screened out companies or industries that they feel do not align with their or their unitholders’ values and objectives. But to specifically state an investment must have some measurable objective other than a financial one is a step into the unknown in terms of traditional investment models. These are not just investments into philanthropic ventures, where it would be nice to get a return but not entirely necessary. Impact investors want to have their “cake and eat it, too”.
A popular example of how impact investing works is the reduction of prisoner re-offending rates. If you can make an investment that reduces the re-offending rate, for example in post-incarceration job training, then this minimises the cost to the government of reincarceration, which by some estimates costs around $30,000 per annum. Governments are prepared to pay for this kind of reduction in costs by providing an attractive yield to investors.
But the scale of potential impacting investment is limitless. Almost any social or environmental ill would benefit from timely and well-placed investment, and if these ills are costing governments and societies money, then they will be prepared to look at “cheaper” solutions.
The Global Impact Investing Network (GIIN), a non-profit organization dedicated to increasing the scale and effectiveness of impact investing, states on its website that “impact investing has the potential to unlock significant sums of private investment capital to complement public resources and philanthropy addressing pressing global challenges”. If impact investors can direct significant funds to some of the world’s most pressing problems, while still making money, this could really be a “win, win”.
GIIN recently estimated that the market for impact capital, currently sized at $60 billion, could grow over the next decade to $2 trillion, or 1 percent of invested assets globally. Impact investing is growing across all geographies and a range of sectors, and this magnitude of growth could certainly start to send tremors through the traditional investment market.
Impact investing is being driven by both high-net-worth (HNW) investors and larger organisations looking to match their organisation values with their investment portfolios. Fidelity investments recently surveyed their HNW clients and found that as many as 40 percent of their respondents had anywhere up to 20 percent of their investments in impact investments.
Generational change is also fuelling the growth in impact investing. The older generation is understanding impact investing and slowly expanding the market, but as wealth transfers to the younger generations, who are pushing to do more with their money than make a yield, this industry will go from strength to strength.
Long-term data on the returns made from impact investing is still patchy, yet a 2015 study by Morgan Stanley’s Institute for Sustainable Investing found that “investing in sustainability has usually met, and often exceeded, the performance of comparable traditional investments”. This is backed up by a variety of other reports and projections in recent years.
So if the financial performance of impact investing is becoming competitive, how is the social-beneficial impact measured? This is a far more difficult concept on which to gain accurate data, and is one of the reasons the GIIN was founded. The GIIN aims to standardize a set of measurement norms by which the beneficial impacts of different types of impact investments can be compared. This will improve transparency and consistency across a broad and varied range of objectives and organizations.
To allow this to happen the GIIN has created Impact Reporting and Investing Standards (IRIS), a catalog of generally accepted performance metrics. The goals of these standards as set out by GIIN are to be “a one-stop shop for reporting metrics, aggregate and compare information across the sector, increase the credibility of impact investing and to reduce the burden of reporting for impact investors”. The IRIS has some influential backers; initial development was performed jointly by the Rockefeller Foundation, Acumen Fund and B Lab, with support from Hitachi, Deloitte and PricewaterhouseCoopers.
Impact investing is also beneficial to the projects that are being invested in. Investors want to see a competitive return from their investments and are prepared to put in time and money to ensure that the objectives that projects have identified are achieved. The accountability this creates is arguably far greater than the allotment of funding from an aid program. This is important because it brings financial discipline and expertise to social change and environmental programs; it brings an oversight of their activities in line with any normal monitoring program from mainstream investments.
Impact investors will continue to face challenges, with “lack of appropriate capital across the risk/return spectrum” and “the shortage of high-quality investment opportunities with a track record” being called out by J.P. Morgan’s Eyes on the Horizon: The Impact Investor Survey.
Yet while the impact-investing industry is still relatively embryonic, change is happening fast and is being fueled by powerful forces. Redirecting the huge flows of global financing into projects with positive societal and environmental impacts can only be a good thing, and if the reputation and performance of investors continues to improve, this could be a real game-changer.