Unlocking the Potential of Impact Investing: Benefits for Investors and Society
Impact investing has the potential to benefit both investors and society at large significantly. By actively seeking out and supporting companies and projects that create positive social and environmental change, impact investors can drive meaningful transformation while generating financial returns. In this article, we will explore the essence of impact investing, its varied categories of intended impacts, and how it extends beyond conventional asset classes to include unconventional but impactful investment avenues.
Impact investing is a strategy in which investors allocate capital to projects, companies, or funds to generate measurable, positive social and environmental impacts alongside a financial return. The objective is to create beneficial outcomes across various domains, such as the environment, community, governance, and workplace while maintaining or achieving market-rate financial returns. This approach enables investors to contribute to meaningful societal and environmental transformations, reflecting a commitment to sustainable development and ethical investment practices.
Impact investing spans multiple categories, including:
- Environment: Investments in renewable energy, conservation, and sustainable agriculture.
- Community: Projects aimed at improving housing, education, and healthcare access.
- Governance: Initiatives that promote transparency, ethical business practices, and responsible management.
- Workers: Programs focused on fair labour practices, worker welfare, and inclusive employment.
- Customers: Products and services that enhance consumer well-being and address social needs.
This investment approach is characterised by a rigorous financial and impact performance assessment, ensuring that capital is directed towards initiatives that offer tangible benefits to society and the planet.
Its flexibility across various asset classes characterises impact investing. It extends beyond traditional investment vehicles like stocks or bonds to private equity, project finance, and microfinance loans. This diverse range of options allows investors to pursue innovative strategies to address societal challenges. The core characteristics of impact investing include intentionality in generating positive social and environmental benefits, using evidence and data for investment design, managing impact performance, and contributing to the industry's growth through shared learnings and practices.
Additionally, impact investing strategies can promote sustainable economic growth by luring money and entrepreneurial talent to businesses that bring about positive change. As evidenced by the Head of Sustainability Management for Asia at a global private bank, there is a growing client interest in Asia for impact investments focused on climate change, energy transition, industrial decarbonisation, sustainable food and agriculture, and sustainable transportation (PwC ESG Deals Creation and Impact Investing in Malaysia, July 2023).
The impact of companies in a portfolio can also vary based on their nature and stage. Early-stage impact investments need investors, offering a chance to significantly influence positive change and potentially earn profits, albeit with higher risks. On the other hand, late-stage impact investments have more entry barriers due to increased investor interest, yet investors are still needed. They offer a lower-risk avenue to explore impact investing, although with possibly lower rewards than early-stage investments. Ultimately, the choice between early and late-stage investments hinges on individual risk tolerance and investment goals, emphasising the importance of thorough research and alignment with personal values.
Early-stage impact investing presents a crucial opportunity for investors to make a substantial difference in the world while seeking profitability. By investing wisely in early-stage impact ventures, investors can be vital in supporting innovative and impactful ideas that need funding. Such ventures often operate in regions where capital is scarce, and they hold the potential to drive positive change on a large scale.
As the impact investing market grows, late-stage projects may face more barriers to entry due to an increasing number of investors entering the space. However, there is still a significant need for investors at this stage. Investing in later-stage projects allows investors to test the waters of impact investing with a somewhat lower risk than early-stage investments. Yet, it is essential to consider that while the risk may be lower, the potential reward might also be comparatively reduced.
To make informed investment decisions in the impact space, investors must reflect on their investment goals and risk tolerance. Early-stage impact investments offer a unique chance to support groundbreaking ideas with high potential for impact and returns. On the other hand, late-stage investments may provide a more stable entry point into the impact investing market, but the potential rewards may not be as significant.
Ultimately, investors should conduct thorough research, understand their values and preferences, and choose projects they genuinely believe in to align their investments with their impact goals.
Impact investing and ESG
Environmental, Social, and Governance (ESG) factors are included in investment decisions when they significantly affect an investment's performance. Despite their similarities, it is essential to understand that ESG and impact investing are different. ESG investing looks at how well a company looks after the environment, treats people well, has sound systems to make decisions, and is doing financially.
On the other hand, impact investing is more about helping businesses or organisations do specific projects that will positively affect society. For example, ESG investing might consider whether a company is doing things to reduce pollution. In contrast, impact investing might support a company building a new clean water well in a community that doesn't have access to clean water. So, while ESG investing is more about evaluating companies on a mix of their good practices and financial performance, impact investing focuses more on funding projects or companies that aim to change society positively.
Elizabeth Lewis, managing director and deputy head of ESG at Blackstone, the world's largest alternative investment firm and an investor in Sphera, highlighted the positive impact of ESG integration during Sphera's virtual ESG Summit in June 2022. According to her, companies that integrate material ESG issues into their investment process experience better operational performance and witness increased revenue. Moreover, such integration has been found to reduce risk and create value for investors and companies. Specific ESG elements may be chosen based on how material they are to the portfolio's financial performance and how pertinent they are to the asset owners.
ESG is frequently used in public market strategies. It may involve excluding assets that don't adhere to specific ESG standards. Because ESG standards require businesses to monitor and disclose their performance on various fronts, including concerns about workplace accidents, total emissions, and waste generated by anti-corruption practices, more stakeholder advocacy can be done.
ESG is frequently used in public market strategies. It may involve excluding assets that don't adhere to specific ESG standards. Because ESG standards require businesses to monitor and disclose their performance on various fronts, including concerns about workplace accidents, total emissions, and waste generated by anti-corruption practices, more stakeholder advocacy can be done.
Defining the Core Principles of Impact Investing and ESG
Even some of the most knowledgeable and accomplished investors and instructors worldwide might use the terms impact investing and ESG interchangeably and have difficulty telling the difference.
The following elements define the practice of impact investing:
- Intentionality: The investor must intend to create a positive social and environmental impact through their investments.
- Investment with Return Expectations: Impact investments are expected to generate financial returns, ranging from below-market to market-rate.
- Range of Return Expectations and Asset Classes: These investments can be made across various asset classes, including cash equivalents, fixed income, venture capital, and private equity.
- Impact Measurement: Investors commit to measuring and reporting their investments' social and environmental performance, ensuring transparency and accountability. This involves setting objectives, using standardised metrics, monitoring performance, and reporting outcomes to stakeholders.
The past must inform the future because the future cannot be included in the past. It is conceivable, though not best practice, to incorporate ESG-focused results into future investments because impact investing is fundamentally prospective. The same cannot be said for ESG funds because they concentrate on already-completed activity.
An ESG framework, for instance, may usually forbid investing in businesses that generate considerable greenhouse gas emissions. On the other hand, an impact fund may only invest in companies that are actively reducing them.
Numerous definitions of impact continue to exist despite efforts by impact market participants to clarify the motives and objectives of impact investment. Are non-impact organisations with diverse leadership, for instance be considered as worthy of carrying the label of ‘impact-grade’ investment? Supporting diverse founders appears to be one of the objectives of impact investing, but where should the line be drawn, and, more significantly, how should one assess the investors' impact goals about the businesses they support?
Operating principles for impact management
Investors may want to distribute the money among impact and ESG investment methods in varying percentages because both have a place in the market. Both can potentially improve the world and offer higher financial performance, but they operate differently despite some overlaps.
For instance, many impact investors screen for and manage ESG risk as part of their investment procedures, as required by the Operating Principles for Impact Management. , which over 100 investors worldwide have endorsed. ESG investment has a significant beneficial impact when corporate leaders alter their behaviour in response to these pressures or when they have a sound bounce on capital markets to reduce the cost of capital for businesses that positively affect the world. Overall, understanding the varying levels of risk and opportunities inherent in each investment will empower investors to make informed decisions aligned with their individual preferences and financial goals.
[1] Invest for Impact | Operating Principles for Impact Management (impactprinciples.org)
Add in the references from GIIN, as showcased in the comments above.
ADEC Innovations. (n.d.-b). What is Impact Investing? - ADEC ESG. ADEC ESG.
Anilkumar, B. (2024, July 10). What Is the Difference Between ESG and Impact Investing? Inrate.
Bell, M. (2021, March 9). Why is ESG performance growing in importance for investors? EY.
Bhagat, S. (2022, March 31). An Inconvenient Truth About ESG Investing. Harvard Business Review.
Core Characteristics of Impact Investing. (n.d.). The GIIN.
What you need to know about impact investing. (n.d.-a). The GIIN.
Yu, T. (2023, August 18). ESG vs. Impact Investing: Understanding the Difference. Novata.
Zhou, M. (2022, November 29). ESG, SRI, and Impact Investing: What's the Difference? Investopedia.
Related Quizzes
