The Big Deal of Impact Investing

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We’ve all heard such terms as “social entrepreneurship,” “conscious capitalism,” and “social investment.” Impact investing is part of the same philosophy, meaning that the process provides money for companies and projects meant to benefit the society and the environment — with financial gain.

It’s not cut from the same cloth as other types of investment, but rather serves as an alternative — with its own set of merits, hurdles and how-to guidelines — that is making great strides toward mainstream and has the ability to positively influence human progress. It is also changing the landscape of business practices and philanthropy as we know it.

What is impact investing?

“Impact investing is a spectrum. It means different things to different people,” notes Tony Abraham in his article for Baltimore. The articles praises Brian Trelstad’s (who is partner at Bridges Ventures, a fund manager company specializing in sustainable and impact investing) January 2016 guide in Harvard Business Review on the kinds of impact investing, but still calls it a “wonky breakdown.”

That’s because although impact investing is on the rise, in Trelstad’s own words, “not everyone agrees on what ‘impact investing’ actually means.”

Trelstad writes:

“Currently, impact can mean anything from venture investments in new health technologies to microfinance loans in Peru; from affordable housing in the US to renewable energy in India; from social impact bonds to private equity funds that create jobs. That’s just the beginning of the confusion — even if you accepted that such diverse investments should all be grouped into one category, how do you even measure and compare impact anyway?”

How do you measure impact?

According to Trelstad, investors often look at these three options, none of them ideal:

  • Searching for “examples of impact within their existing portfolios, bringing no incremental capital into the field”
  • Trying it out with a small, insignificant investment as an experiment, “which still holds back enormous amounts of capital”
  • Sitting it out “on the impact-investing sidelines” altogether

Instead, Trelstad suggest the investors should consider the following three questions:

  • What kind of impact do I want to have?
  • How deep/broad my intended impact should be?
  • What risks am I willing to accept?

Let’s look at each factor.

Identifying preferences for a type of impact

Identifying types of impact implies looking at these factors and figuring out your preferences, as the options are many, and you can mix and match:

  • Location. Do you want to invest in a developing economy? A particular community? Do you want your investment to benefit a particular group of people?
  • Business practices. Finding business practices that are important to you, such as fair trade and sustainable, eco-friendly labor practices, etc. Do you maybe want to invest in a company that gives away some of its products to developing countries?
  • Environment. Investing in companies that offer stated, measurable environmental benefits, like preservation of the habitat, restoration of the environment, or energy efficiency
  • Social benefits. Similarly, investing in companies that offer measurable and clear social benefits in such fields as education, medicine, etc.
  • Global positive change. This one is more ambiguous and deals with investing in companies that offer to revolutionize a certain field and make a considerable positive change on a large scale.

Timeframe and scope of impact

This, Trelstad notes, involves looking at the “depth, breadth, and the time horizon of impact.” He writes:

“Some investors might want to support strategies that generate critical long-term change… Others might seek smaller incremental changes that benefit a broader set of beneficiaries with more immediately noticeable change…”

The level of risk

Just as investors evaluate financial risk before they make a move, impact risk can also be evaluated based on both current evidence and expected metrics that would measure process before, during, and after.

The increased interest

Impact investing is a rapidly maturing practice that is not without its critics, but one that’s been gaining traction. In her recent article, Jean Case, a Forbes contributor who writes about social change, business and philanthropy, recalls two comments made to her directly on what impact investing represents.

One came from an unnamed “celebrated venture capitalist,” who, during a conference, told her something along these lines: “Impact investing is like a houseboat; it’s not a good house and it’s not a good boat.”

While guest-lecturing at Yale’s School of Management, Case, mentioned this comment, and one student offered his own:

“I think impact investing is like brunch, it’s better than breakfast and better than lunch!”

These two opinions represent both sides of the coin, but to Case it’s also reflective of how impact investing is permeating our consciousness and our pockets.

Case writes:

“Both in the U.S. and around the world we’ve seen segments of the market move from informed, to educated, to activated. We’ve seen new private capital unleashed with a focus on impact across sectors, geographies, industries, issue areas and asset classes.”

Case cites four areas indicative of the increasing acceptance of impact investing:

  • Increasingly extensive coverage in traditional and social media educates and creates public awareness
  • Policy changes that “demonstrate that the federal government recognizes the significant potential of impact investing and the role that 21st century policymaking plays in its success.” (For example, Treasury Department and IRS finalized Program-Related Investment regulations thataffect philanthropy.)
  • Research that demonstrates that “having an impact doesn’t mean sacrificing returns.” (One example is the “Great Expectations” report released by the Wharton School at the University of Pennsylvania in October 2015.)

The stats

As Amy Whyte reports in Chief Investment Officer, “Investors committed more than $15 billion to impact investments in 2015 — and plan to allocate even more this year, according to the Global Impact Investing Network (GIIN).”

Here are some findings of the report:

  • 79% of surveyed 158 impact investors managing $77 billion planned to maintain or increase their impact investments in 2016
  • About three quarters said their investments performed as expected in 2015; 19% said they exceeded expected performance; 11% said their investments underperformed
  • 70% invested in private equity; 56% in private debt
  • More than a third of investments were made in North America. Other locations included Africa, Latin America, and Europe
  • 95% targeted social impact goals (finance, health, education, income and employment growth; 52% focused on environment (mostly energy efficiency/ renewable energy)
  • 99% said they achieved or went above expectations for social and environmental impacts of their investments

Key demographics

ThinkAdvisor quotes Amber Nystrom, founder and CEO of Trinity Nexus and “impact investment pioneer,” who said: “Investors have $13.6 trillion in impact investments, representing 22% of professionally managed assets globally.” Nystrom also identified impact investment as “a huge market in terms of total dollars, in terms of fastest growth rate and also in terms of this being of interest to your highest potential clients, meaning women and millennials.”

Women and millennials are key demographics simply because they’re, according to Nystrom, “the largest emerging market on the planet.” They already control $20 trillion, and will inherit $60 trillion over the next three decades, she said, adding that millennials are also currently the wealthiest demographic, and that “by 2020, one in three adults will be a millennial.”

The challenges

Some think impact investing needs to overcome many hurdles before we could expect wide adoption. Pallavi Shah, consultant on sustainable/impact investing, writes in HuffPost:

“Some previously niche industries — such as clean tech, natural food — are moving toward the mainstream. While both investors and entrepreneurs are embracing this trend, they are having a hard time connecting.

Why? In my experience, it is a limited understanding by both parties on the opportunities of impact investing, the risks, and the realities and nuances of each other’s worlds.”

Some hurdles that need to be overcome include:

  • Lack of education on strategies
  • Lack of system to collect, evaluate, and report data
  • Lack of established practices on how to measure and report impact
  • Inability to identify and address key risks
  • Deals/products are too expensive, make it hard to secure funding
  • Confusion about definitions of different business models and investment terminology

Wishlist for 2016

Writing in Forbes, Case forecasts some trends and list what she would like to happen in impact investing:

  • Democratization. Simplifying access to capital for social entrepreneur and greater public integration of socially responsible investing
  • Data transparency. Coming up with clear processes to measure and report impact
  • Creating tools that would help investors understand their options

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