What is Impact Investing?

To date, most investor attention has been focused on Exclusionary Screening and Environmental, Social and Governance (ESG) investing. Exclusionary Screening solutions typically omit investments in companies that are deemed to cause harm – a company that profits from tobacco, for instance. ESG-focused funds can take explicit consideration of and best practices in environmental, social and governance issues in the underlying investments. However, some investors are evolving their approach from a “do no harm,” values-driven strategy, towards making their financial investments active forces for solving the world’s leading sustainability challenges. The latter is referring to impact investing. According to the Global Impact Investing Network, impact investing assets globally are estimated to be around $1.16 trillion.¹

However, it is important to distinguish between seeking impact through investing versus seeking impact via philanthropy. Impact investing focuses on investing in solutions that generate both a financial return and positive impact in their area of focus.

Within impact investing, there is a spectrum of solutions that seek market rate or sub-market rate (also referred to as catalytic, first-loss or concessionary investments).

Finally, within impact investing, there is also a concept of “place-based” or “community investing,” where investors seek to drive impact in a specific geography or community in addition to financial returns.

The balance between return and impact, like the level of targeted return or the sector a fund manager might concentrate on, is a choice for the investment management team when constructing the product, and the end investor when choosing it.

What is "Good"?

One of the first questions for an investor adding impact to their portfolio is how to decide what “good” means to them, and therefore what impact they wish to support with their capital. The most commonly used framework for defining impact, both by investors and investment managers, is the United Nations’ 17 Sustainable Development Goals (SDGs). 

The UN SDGs are a helpful framework to approach impact investing because they cover both general and specific aspects. From a general perspective, the list has been agreed on and adopted by 193 countries as a “plan for achieving a better future for all,” making it arguably the best proxy for a common view on where change is most needed and consequently where efforts or capital should be targeted locally or internationally.

That said, we recognize the UN’s SDGs are not exhaustive. Institutions and individuals will have other focal points for the impact that they wish to create – perhaps a faith-based mission or one concentrated in the arts. The important takeaway is that being clear about the goals you wish to achieve is to the foundation of an effective impact strategy.

How Do We Know if an Investment Has Made an Impact?

Once the impact goal is established, it’s necessary to consider whether an investment helps to achieve that goal. There are two questions that are useful when thinking about this: Has impact capital directly caused a desired change? Would this change have occurred without the addition of impact capital? In the lexicon of impact investing, these two questions are referred to respectively as causality and additionality.

Here’s an example: An impact fund’s goal is to make investments that support women and tackle gender inequality, while generating a return to investors of between 4% and 5% per annum. A core component of its strategy is to acquire houses and apartments which it then leases to a registered charity. The charity provides temporary accommodation to women and their children forced to leave their homes due to domestic violence, before finding them more permanent housing.

The impact fund purchases three homes at the beginning of the year and leases them to the charity. On average, each home will have three different families living in it over the course of a 12-month period – so an additional nine families should have been found permanent housing because of the capital that the fund invested.

At the end of the year, the fund manager sees the charity has rehomed an additional nine families over and above the prior year. The fund’s analysts eliminate other external factors that might have caused this increase (such as the charity leasing other properties or the local government making a large amount of new permanent housing available) and draws a causal link between its invested capital and the successful achievement of the goal.

The analysts then use the idea of additionality to dig further and test how many of the increased re-housings were due to the properties that the charity was leasing from the fund. They find that three of the additional re-housings were because the charity had increased the efficiency with which it used its existing properties. The additionality of the fund’s investment is now less than it might have appeared, because one third of the change created in the year occurred without their investment.

This example is simplified, of course. Yet it illustrates how causality and additionality are helpful ways to determine two things that should be fundamental to an impact investor: First, how effectively the investment being contemplated is able to generate Impact – and second, the need to focus on measuring how much impact is being generated for the capital invested. 

What Kinds of Impact Investment Funds are There?

There are Impact Funds which invest in public equities, public bonds or in private equity and debt. Ownership of an equity, a bond, a private equity stake or a private loan each bring different relationships and levels of influence with the corporate issuer and a different method of impact.