Why Impact Investing Matters: A Primer

Impact investing connects financial markets with the real economy. It’s relevant for investors, fundraisers, or any organization that seeks capital.

Ten years ago, the concept of impact investing was almost unknown. Now, impact investing is in the spotlight, with widespread news coverage and estimates of a $250 billion market.

If you are an investor, a fundraiser, or work with any organization that seeks capital, impact investing is relevant to you.

This primer defines impact investing, examines measurement issues and types of investment, and reflects on the implications of impact investing for financial returns and market purpose.

Impact Investing 101

Impact investing seeks to support organizations that will create social and environmental benefits, in addition to generating financial returns. Impact investors want their money to make a difference for employees, clients, and other groups in society — while creating financial value.

Impact investors fund organizations that positively affect society. They might invest in companies that install solar panels, develop affordable housing, or provide health screening, for example.

So far, most impact investors have been institutional investors (e.g. foundations, pension funds, and investment management companies). But the landscape is changing, with individual investors increasingly interested and able to access dedicated mutual funds or community bonds.

Some impact investors are impact-first; they are willing to accept a lower financial return (compared to a conventional financial product) for a greater impact. For finance-first impact investors, the return on investment is higher priority.

Measuring impact is art and science

Investors and managers alike increasingly want to assess businesses’ impact on society. But measuring a firm’s wider societal impacts is not easy. Accounting standards for measuring impact do not exist, and the measures in use are still evolving. Impacts sought are diverse, so measures are as well. For example:

• Forest bonds would likely include measures of carbon sequestration and biodiversity protection

• A social bond targeting homelessness would evaluate the number of homeless people receiving shelter

• A real estate development might look at measures of neighborhood health, energy use, and access to employment.

Greater clarity on measurement is slowly emerging. Academic researchers are studying impact assessment, and organizations such as the Global Impact Investing Network, GIIRs and Principles for Responsible Investmentseek to develop standards for the industry.

For now, impact assessment remains a craft that requires a bit of faith, some skill and a lot of innovation.

Vehicles for impact investment include bonds – and more

Impact investing is often associated with green or social impact bonds, which raise money from investors for specific types of projects. Bonds are driven by institutional investors, and can be issued by governments, corporations or public-private partnerships. Here are some examples:

• In 2016, the International Finance Corporation worked with mining company BHB Billiton, and the nonprofit Conservation International to issue a $152 million bond to protect forests and expand carbon-credit markets in developing countries.

• In 2017, Canada’s Heart and Stroke Foundation launched the first national health-focused social impact bond, in partnership with the Public Health Agency of Canada and the Mars Centre for Impact Investing.

• After the Paris climate accord, France issued a EUR7 billion green bond, while Apple proposed a USD $1 billion green bond to fund renewable energy generation.

Impact bonds are popular and typically oversubscribed – for instance, the total demand for the French bond exceeded EUR 23 billion.

But impact investing goes beyond bonds. It also includes:

• Investing in companies that demonstrate a positive impact on communities. Vox Capital, a venture capital firm, has launched multiple investment vehicles to support businesses that develop scalable solutions for problems facing low-income Brazilians.

• “Place-based financing,” where local investors provide money to fund local activities. In London, Canada, Verge Capital launched a fund supported by local investors. The Breakthrough Fund makes loans to social enterprises and affordable housing developers in Southwest Ontario.

Innovation is everywhere – securitization offers endless possibilities. Impact investing has become a sort of Research & Development for finance.

Impact investing is not inherently riskier

Impact investing is not more or less financially risky than other investment strategies.

Some argue that as soon as one limits an investment decision, e.g. by adding a social or environmental requirement, the financial product will perform worse. This belief comes from “portfolio theory,” which argues that diversification decreases risk.

But in reality, this argument is often proved wrong. Diversifying risks among a pool of companies that are all bad investments is unlikely to make more money. With any investment approach, investors must do due diligence and carefully study the deal.

Impact investing is new, so it lacks a historical record. But that gap forces investors really to think about how capital is raised and spent, to connect with the organizations they invest in, and to ask — as any investor should — where does my investment’s value come from?

Impact investing can restore the purpose of financial markets

By focusing on the origins of value, impact investing is tackling one of the main issues of our contemporary financial system: the growing disconnect between financial markets and the “real economy.”

Many gains in today’s markets come from investors repeatedly exploiting tiny pricing differences between two markets. These pricing differences tend to be artificially created by a few financial actors eager to appropriate value that did not even exist before they decided to believe in it; high frequency trading represents this approach.

As a result, today’s financial markets are not doing their basic job: connecting those who have capital to those who need capital, in order to help the economy and society thrive. Impact investing speaks to BlackRock CEO Larry Fink’s recent challenge to CEOs. In a letter entitled “A Sense of Purpose,” he wrote that “society increasingly is turning to the private sector and asking that companies respond to broader societal challenges… To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society.”

Many investors are not greedy. They actually want to do what they are paid for: put their financial power at the service of organizations that participate in building sustainable and long-term growth.

The best way to fish for a long time is to make the fishes flourish. Impact investing creates a healthy ecosystem for those fishes — the organizations and stakeholders that compose our society. Without them, the “fishermen” in financial markets will ultimately fail.