New Year, new possibilities with impact investing

  • Written by 
  • 14/12/2016

As investors, we are always mindful of the financial returns of our investments. But how many of us consider the social and environmental impact of those investments? And how that impact can affect our financial aims?

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Residents of the United States, please read this important information before proceeding

Please read this important information before proceeding.

5 Key Takeaways

  • Impact investing is intentionally investing to generate financial returns and societal impact to protect and grow assets and to make a positive contribution to our world
  • In-house research covering 2,000 individuals showed that 56% of investors were interested in impact investing
  • Partly driven by the UN Sustainable Development Goals, there are increasing flows of capital into initiatives seeking to address societal challenges such as climate change, ageing populations, structural unemployment, and chronic diseases
  • Impact investing does not mean having to give up financial returns
  • Impact investing offers investors new possibilities for their capital and can add value to investment portfolios

Historically, most investors haven’t been aware or interested in how their investment capital has been used – just that it produced the expected return. However, considering the impact of an investment can be material to its value.

For example, investors tend to become very cognisant after a scandal causes a material drop in their investment’s value – as we’ve seen in the recent past for energy, textile, or auto companies. Consider, for example, the effect on your portfolio’s value if part of it had been allocated to the coal industry. According to Bloomberg, due to the issue of stranded assets (assets that have suffered from unanticipated or premature write-downs, devaluations or conversion to liabilities), “more than half the assets in the global coal industry are now held by companies that are either in bankruptcy proceedings or don’t earn enough money to pay their interest bills1.” Clearly, the industry’s impact in terms of climate change has had an influence on companies’ valuations.

Investing with dual aims – financial returns and societal impact – is the purpose of impact investing.

On a more positive note, investors are increasingly allocating capital to initiatives seeking to address societal challenges such as climate change, ageing populations, structural unemployment, and chronic diseases. The UN Sustainable Development Goals, which committed 193 countries to social, environmental and economic targets for global development, is estimated to require another $2.5 trillion, in developing countries alone, to deliver on their commitments2. Here, investors have an opportunity to grow their assets while generating impact by supporting solutions to the world’s most pressing problems.

These are some of the new approaches which, by factoring impact considerations into investing, can benefit an investor’s portfolio.

Latent demand

Although arguably the concept of impact investing has been around for a long time, the term was only coined at a meeting convened by the Rockefeller Foundation ten years ago. Since then, it has been gaining increased visibility and interest amongst governments, companies, philanthropic organisations, financial institutions, investors, academia and the media.

Having observed the concept during its early years, we decided to delve deeper into the topic in 2015 with those we see as the key participants – investors. Our Behavioural Finance team conducted research with around 2,000 individuals about their attitudes and activity in impact investing. Among many intriguing insights, we found that 56% of investors were interested in impact investing but only 9% had actually made any impact investments.

If a majority of investors are interested, it is unclear why so few are involved. We spoke further with those who were active, and those who were not, as well as the leading experts in the field.

What we’ve realised is fairly simple. As a nascent and rapidly evolving field, it can be difficult to understand and access the market. Moreover, impact investing is frequently confused with other related alternative approaches such as ethical investing, socially responsible investing (SRI), sustainable investing, social investment, etc.

So, while many investors want to get involved, a lack of time, familiarity and support has been creating a ‘latent demand’ to participate.

Providing clarity

Given our role as proactive partners to our clients, it became a natural extension for us to support clients to consider how to bring impact into their portfolios. With sponsorship from our Social Innovation Facility3, we’ve been able to commit to this journey over the next several years and support the industry as it matures and reaches the mainstream.

As we have already begun to build our presence and capabilities this year, it seems a good time to share some of the insights and ideas that we’ve developed; while also dispelling a few of the myths and misunderstandings which frequently arise when investors first learn about impact investing.

Myths & misconceptions #1: Impact investing requires giving up financial returns

The first, and most frequent, misunderstanding is that you have to sacrifice returns to have an impact.

Consider institutional investors active in impact investing who, as part of the Global Impact Investing Network (GIIN), annually complete a member survey4. For those investors targeting market rate returns, they reported 9% of their investments were underperforming, whereas 66% were in line with expectations, and 25% were outperforming.

There are, however, investments that explicitly target lower returns than other comparable investments. Although this is not an attribute of all impact investments, in these cases, it is the investor’s choice whether or not they choose to invest.

As a starting point, we consider impact investing as:

“Investing to intentionally generate financial returns and societal impact - to protect and grow your assets, and to make a positive contribution to our world.”

One of the key terms in this view is the ‘intention’. Impact investments need to have an eye on both the financial return and societal impact. This is not philanthropy – investors are seeking financial returns for the capital at risk. Neither is this just an investment which happens to have an impact – the intention from the outset must be to seek a positive social or environmental impact.

Linked with the intention to make an impact, these investments also seek to measure the outcomes they achieve. Given the early stage of the industry, providing good quality data is one of the most challenging elements of investing for impact. However, given the efforts in this area and increased investor demands, we expect significant improvements in the coming years.

We would also highlight how impact investing can add financial value to investment portfolios, i.e. “protect and grow your assets”. This could be through incorporating additional considerations into the investment process to select more viable long-term investments, or finding new investment opportunities where organisations are generating innovative commercial solutions to social and environmental challenges.

Myths & misconceptions #2: Impact investing is a separate asset class or allocation

Impact investments are fundamentally investments but are not themselves a distinct asset class. As options for impact investments exist across most asset classes, an investor would not need to allocate a separate portion of their portfolio to impact investments. Rather, they would look at how many of their investments include impact considerations in their investment approach.

To provide an example, an investor would not have a portfolio made up of 40% equity, 40% fixed income, and 20% impact investments. Why not? Imagine if the investor wanted the 20% of impact investments to be in ‘green bonds’, which are fixed income investments where the proceeds are applied specifically to environmental projects. Because green bonds are fundamentally fixed income investments, the 20% impact investment is really an additional 20% allocation to the existing debt allocation in the portfolio.

While today it may not always be possible for every investment in an investor’s portfolio to be an impact investment, we expect this will be feasible over time. Already, some leading impact investors in a network called ‘Toniic’ have deployed $1.1 billion into what they call 100% ‘Impact Portfolios’, where they have found investments they consider impactful across all asset classes in their portfolios5.

Choosing to make an impact

As we approach the start of a new year, now may be an ideal time to consider whether impact investing is relevant for you by considering whether you have a preference for:

  • Preventing your capital from funding companies/investments that potentially harm people and/or the planet
  • Allocating your capital to companies operating effectively and generating positive societal outcomes
  • Using your capital to target pressing social and environmental issues, particularly causes that are personally important to you

Overall, impact investing offers investors new possibilities for their capital. As a recent and evolving field of investing, we expect some challenges to be addressed now while others lie ahead. We will continue to provide more insights to clarify and help investors to navigate this field. In the end, we believe the true potential of impact investing is to enable every investor’s portfolio to perform, and have the power to benefit wider society and the environment.

Myths & misconceptions #3: Impact investing is private equity investing in early stage businesses

The most visible and recognisable form of impact investing has been providing financing to early stage businesses addressing social and environmental challenges, often in developing countries. These are critical and ambitious organisations that often lead the innovation around finding solutions with commercial business models.

However, they are not the only impact investment option or way to invest for impact. For example, we believe that it is possible to incorporate impact in investment decision-making when selecting publicly-listed companies which issue stocks and bonds. These organisations generate an impact, which is often significant, in how they operate and in the goods/services they provide.

We recognise that investing in these more established organisations may not have the same additional effect as funding a start-up, and it may not be as easy to directly measure the impact of these investments. However, for many investors, these investments are accessible or appropriate for their circumstances, and can be made in line with the intention to invest for impact.

Additionally, investing in listed companies with this intention in mind can, in itself, be catalytic insofar as it generates behavioural change amongst businesses, driving them to think about the overall outcomes of their operations beyond the bottom line, the impact they have in the environment and communities, and the role they may want to have in society. This presents an opportunity for positive change and comparable financial returns.