What is impact investing?
Impact investing refers to an investment strategy that seeks to generate financial gains, along with creating social and environmental benefits. Impact investments are usually targeted to solve specific issues within different asset classes. Impact investors typically evaluate potential investee companies by their adherence to Social Corporate Responsibility (SCR) and Environmental, Social and Governance (ESG) factors.
SCR is a business model designed to help companies be socially accountable. In this context, this means that companies aim to implement practices and policies that create net positive benefits for society and the environment instead of negatively affecting them. Companies implementing SCR still aim to maximize profits,
ESG on the other hand is a more all-encompassing set of criteria designed to evaluate potential investments. The E in ESG refers to all things concerning the natural environment, from air pollution and deforestation to climate change. The S refers to social factors, meaning how a company deals with its employees, customers, suppliers and communities impacted by their business. Finally, the G refers to governance factors, that concern a company’s leadership, employee compensation, audits, human resources issues, and shareholder rights. The main current issue with ESG is that criteria that would define an investment as ESG is largely ambiguous, meaning it can be hard to determine whether an investment can be considered ESG. Nonetheless, ESG is being implemented into more and more investment strategies, ranging from institutional investors like pension funds, hedge funds, banks to private equity among other investors.
Most impact investors seek market neutral or market passing returns. However, some may sacrifice returns for a greater positive impact. Impact investing through the implementation of CSR and ESG aims to reduce negative externalities while increasing positive ones.
Is impact investing Profitable?
The profitability of impact investing has been contemplated since its inception. In the past, mainly non-governmental organisations (NGOs) invested with the hopes of achieving a positive impact. Now however, the situation looks different. Investors are starting to face the risk of not considering ESG factors, meaning it can be considered as a risk management strategy. This is because natural disasters caused by climate change can negatively impact investments and investors and consumers are becoming more and more conscious about the importance of it. Current empirical research by Royal Bank of Canada shows impact investing does not negatively impact investments and some studies even show ESG investing to deliver market-beating returns. This largely depends on the type of ESG investment made. Figure 1 below shows how the MSCI KLD 400 Social Index, one of the largest impact investing funds in the world, has outperformed the S&P 500.
Figure 1: MSCI KLD 400 Social Index Vs S&P 500 (Source: Invested Interests)
What is the future of impact investing?
The Global Impact Investment Network (GIIN) estimates the impact investing market to be worth $715 Billion in assets in 2020. An important factor in the growth of impact investing is to consider generational wealth transfer. Worldwide activist movements like the Extinction Rebellion and Fridays for Future have shown that younger generations show significant interest in the preservation of natural resources and in the prevention of climate change. Once this generation is equipped with more capital, they are likely to invest at least a portion of it towards impact investing.
It is likely that as more and more investors turn towards socially responsible investing, the market size will grow ever more. The UN is putting increasing pressures on governments who signed the Paris Treaty, an agreement to minimise the impact of climate change by 2030, and this will likely cause more regulation to force companies to more openly declare their environmental impact. Regulation is currently the main lagging factor in the expansion of the ESG market, as companies may declare themselves ESG friendly, but in reality, are far from it. This practice may also be called greenwashing. As regulation increases, companies greenwashing themselves may face fines and public scrutiny.
In the future, impact and ESG investing will be seen as mandatory. Most large companies today already have a section on their website dedicated to informing consumers and stakeholders of what they are doing to lower their carbon footprint and develop their ESG integration.
References
GIIN. “What You Need to Know about Impact Investing.” The GIIN, 2022, https://thegiin.org/impact-investing/need-to-know/#what-is-the-current-state-of-the-impact-investing-market.
- Lamy, Yasemin Saltuk, et al. “The next 10 Years of Impact Investment (SSIR).” Stanford Social Innovation Review: Informing and Inspiring Leaders of Social Change, https://ssir.org/articles/entry/the_next_10_years_of_impact_investment.
- 27 January 2022 at 7:45 am Abhilash Mudaliar, et al. “Predictions for 2022: Impact Investing.” Pro Bono Australia, 31 Jan. 2022, https://probonoaustralia.com.au/news/2022/01/predictions-for-2022-impact-investing/.
- Kaufman, Karl. “The Future of Global Impact Investing.” Forbes, Forbes Magazine, 6 Dec. 2021, https://www.forbes.com/sites/karlkaufman/2021/12/03/the-future-of-global-impact-investing/?sh=b47e0b6405b5.
- Team, The Investopedia. “Environmental, Social, & Governance (ESG) Criteria Definition.” Investopedia, Investopedia, 8 Mar. 2022, https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp.
- Chen, James. “Impact Investing Definition.” Investopedia, Investopedia, 31 Mar. 2022, https://www.investopedia.com/terms/i/impact-investing.asp.
