What is Impact Investing?
Impact investing is aimed directly at creating a positive environmental or social impact by identifying and solving a particular environmental or social problem. Impact investing is an advanced stage of sustainable investing that began with the socially responsible investment movement that emerged in the 1970s and which was marked by the use of negative or exclusionary screening processes designed to avoid specific assets due to consideration of specific environmental, social and governance (“ESG”) criteria including moral values (e.g., tobacco or gambling), standards and norms (e.g., human rights), ethical convictions (e.g., animal testing), or legal requirements (e.g., controversial armaments such as cluster bombs or land mines, excluded in order to comply with international conventions). The next stage was based on “best-in-class” (positive) screening, which contrasts significantly with negative screening and calls for investment and lending decisions to be made based on demonstrated high ESG performance of sectors, companies or projects and adherence to minimum standards of business practice based on international norms relating to climate protection, human rights, working conditions and action plans against corruption.
As time went by, investors began to use positive screening in a more focused manner by concentrating their activities on specific high profile sustainability-related themes such as clean tech, infrastructure, affordable housing, energy-efficient real estate or sustainable forestry.[1] Social impact investing, sometimes referred to as social finance or solidary-based finance, became popular and included investments into projects with a social focus seeking to address a particular social or environmental challenge such as housing problems caused by increased poverty, unemployment, environmental issues such as organic farming or clean energy and development of third world economies.[2] Other drivers of maturation of the sustainable investment marketplace have included the development of new and emerging methodologies intended to systematically and explicitly include ESG risks and opportunities into traditional financial-based investment analysis and the growing role of “active ownership”, which focuses on engagement and dialogue with portfolio companies after an initial investment is made in order to influence ESG strategies and actions through exercise of ownership rights and being a visible activist for change.[3]
According to data from the Global Sustainable Investment Alliance (“GSIA”), global sustainable investment reached USD 35.3 trillion in five major markets at the start of 2020, a 15% increase in the past two years (2018-2020), and sustainable investment assets under management made up a total of 35.9% of total assets under management, up from 33.4% in 2018 and 28% in 2016.[4] The largest sustainable investment strategy globally was ESG integration, with a combined USD 25.2 trillion in assets under management (AUM) employing an ESG integration approach, and the next most commonly sustainable investment strategies included negative/exclusionary screening (USD 15.9 trillion) followed by corporate engagement/shareholder action (USD 10.5 trillion). Europe had the largest pool of sustainable investment assets globally as of 2018 and commentators have noted that sustainable investing has been broadly adopted in Europe and has reached the highest level of maturity compared to any other region. The US trails slightly behind Europe, with sustainable investment AUM held by institutional investors, money managers and community investment institutions in the US standing at USD 8.4 trillion in 2022, representing 12.6% of the USD 66.6 trillion in total US assets under professional management.[5] Data indicates that Asia is progressively catching up and that sustainable investing is gaining more traction in Asian countries outside of Japan, which was one of the earliest adopters of ESG-based investing. China has been particularly aggressive—it had the second biggest green bond market in the world as of the end of 2018—and Australia, Hong Kong and Singapore have launched initiatives to promote sustainable investing.[6]
The term “impact investing” was coined by the Rockefeller Foundation in 2007 and today the most commonly used definition is the one proposed by the Global Impact Investment Network (“GIIN”): “investing made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.[7] A similar formulation was adopted by the G8’s Social Impact Investment Taskforce: “the defining characteristic of impact investment is that the goal of generating financial returns is unequivocally pursued within the context of setting impact objectives and measuring their achievement”.[8]
BNP Paribas (“BNP”) has noted that impact investing, like microfinance and social impact bonds (i.e., bonds repaid upon maturation only if the social objectives of the project have been achieved), is focused on “social businesses”, which were described by BNP as being primarily social in nature but following viable economic models—in other words, a shared value concept that seeks both profit and social impact.[9] As for what “impact” might be in this context, the term has been defined as “any meaningful change in the economic, social, cultural, environmental and/or political condition due to specific actions and behavioral changes by individuals, communities and/or society as a whole.”[10]
In its 2020 Global Sustainable Investment Review, the Global Sustainable Investment Alliance (“GSIA”) identified “impact investing and community investing” as one of seven strategies of sustainable and responsible investment and went to provide the following definitions and descriptions[11]: “Impact investing is investing to achieve positive, social and environmental impacts, and requires measuring and reporting against these impacts, demonstrating the intentionality of investor and underlying asset/investee, and demonstrating the investor contribution. Community investing involves specifically directing capital to traditionally underserved individuals or communities, as well as financing that is provided to businesses with a clear social or environmental purpose. Some community investing is impact investing, but community investing is broader and considers other forms of investing and targeted lending activities.”
Impact investing has also been explained to include a range of investment opportunities that exist between traditional investing, which focuses on maximizing profits, and philanthropy, which has generally been undertaken to achieve environmental or social good with regard for financial returns. Singh explained that unlike traditional investing, which focuses only on financial data, sustainable investing (including impact investing) also considers and manages ESG metrics in order to generate long-term value and reduce risk.[12] Impact investing has been aligned with the concept of venture philanthropy, which has been described as the application or redirection of principles of traditional venture capital financing to achieve philanthropic endeavors.[13] According to Singh, venture philanthropy and impact investing comprise a broader category called “concessionary investing” that includes projects that produce social impact which only generating below-market expected financial returns. He notes that while this result may be satisfactory for certain types of impact investors, such as relatively inexperienced high-net-worth individuals, foundations or development agencies, banks and pension funds that need to deliver strong financial returns must engage in “non-concessionary investing”, an approach that has been criticized as steering asset managers too far away from ensuring real environmental and social impact and diverting capital away from social enterprises working on innovative market-based solutions in difficult contexts.
Impact investing has occurred in both emerging and developed markets and as discussed above the goals of impact investors in committing their capital and ancillary resources have ranged from market-driven risk adjusted returns to concessional and capital preservation. Impact investing has occurred in a broad range of sectors including sustainable agriculture, renewable energy, conservation and microfinance, and governments and private enterprises have turned to impact investing tools to address challenges that have arisen relating to the delivery of basic services such as housing, healthcare and education to underserved individuals or communities. According to the GIIN’s Annual Impact Investor Survey 2020, the five areas of highest compound annual growth with respect to allocation of capital by impact investors responding to the survey were water, sanitation, and hygiene; financial services (excluding microfinance); healthcare; food and agriculture; and energy.[14]
GIIN has expanded on its definition by identifying and explaining the following core elements of the practice of impact investment[15]:
· Intentionality: An investor’s intention to have a positive social or environmental impact through investments is essential to impact investing.
· Expectation of Financial Returns: Impact investments are not grants that do not need to be repaid. In fact, investors expect that their investments will generate a financial return on capital or, at minimum, a return of capital (an important distinguishing factor from philanthropic contributions to impact projects, which are often made with the expectation of partial or full capital loss).
· Range of Return Expectations and Asset Classes: Impact investments target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate (two-thirds of the capital for impact investment seeks risk-adjusted market rates), and can be made across asset classes, including but not limited to cash equivalents, fixed income, venture capital, and private equity.
· Impact Measurement: A hallmark of impact investing is the commitment of the investor to measure and report the social and environmental performance and progress of underlying investments, ensuring transparency and accountability while informing the practice of impact investing and building the field.
The GIIN supplemented its list of the elements of impact investing with the development of the following core characteristics of impact investing[16]:
“…
· Intentionality: Impact investing is marked by an intentional desire to contribute to measurable social or environmental benefit. Impact investors aim to solve problems and address opportunities. This is at the heart of what differentiates impact investing from other investment approaches which may incorporate impact considerations.
· Use Evidence and Impact Data in Investment Design: Investments cannot be designed on hunches, and impact investing needs to use evidence and data where available to drive intelligent investment design that will be useful in contributing to social and environmental benefits.
· Manage Impact Performance: Impact investing comes with a specific intention and necessitates those investments be managed towards that intention. This includes having feedback loops in place and communicating performance information to support others in the investment chain to manage towards impact.
· Contribute to the Growth of the Industry: Investors with credible impact investing practices use shared industry terms, conventions, and indicators for describing their impact strategies, goals, and performance. They also share learnings where possible to enable others to learn from their experience as to what actually contributes to social and environmental benefit.”[17]
The Impact Investing Institute noted that impact investment is often conflated with other terms such as “responsible investment” and “sustainable investment” and pointed out that the strategies associated with each of these terms differ significantly in terms of both their financial and impact goals and intentions.[18] Specifically, “[w]hen investors are typically looking to ‘avoid harm’ or ‘generate benefits to stakeholders’, they are generally employing responsible or sustainable investing strategies”; however, impact investors invest with “an intention to create measurable social or environmental benefit alongside a financial return”.[19] Traditional, responsible, sustainable, and impact investors are all willing to accept competitive risk-adjusted financial returns, and responsible, sustainable, and impact investors have a common desire to avoid harm, mitigate ESG risks, and benefit stakeholders.[20] The GIIN has noted a steady change in expectations of impact investors regarding balancing impact and financial performance, with attitudes that originally assumed that there was an inherent tradeoff between these two outcomes evolving to the point where respondents to the GIIN’s more recent annual impact investor surveys report they expect “risk-adjusted, market-rate returns but are satisfied with concessionary financial performance, if this is in line with what they target”.[21]
The most important factor distinguishing impact investors from responsible and sustainable investors is intention. Impact investors accept lower risk-adjusted returns in exchange for creating solutions and intentionally target companies and projects that will deploy their capital to generate positive changes for otherwise underserved people or the planet. Many investments attributed to responsible and sustainable investors do generate positive social or environmental benefits even if that is not the primary intent, but intention must be supported by a commitment to measuring and reporting impact. While impact investors share common goals with philanthropy, impact investors expect a financial return while philanthropic organizations are willing to accept partial capital preservation and even full loss of contributed capital in certain instances.[22]
Godeke and Briaud pointed out that enterprises launched to pursue an environmental or social purpose and goals can, and often do, benefit from the support of both impact investors and other investors that do not fall within the definition because they are only interested in a financial return or impact.[23] They also noted that some impact investors use another variable that has been referred to as “contribution”, or “additionality”, and which is a kind of “but for” question that asks whether a particular investment will cause “an increase in the quantity or quality of the enterprise’s social outcomes beyond what would have otherwise occurred”.[24] For example, the Impact Investing Institute adopted the GIIN definition for purposes of its March 2022 report on the size and characteristics of the UK impact investing sector, but added the attribute of “additionality”, which the Impact Management Project has defined as “the extent to which desirable outcomes would not have occurred without intervention”.[25]
The GIIN has noted that since impact investing is a relatively new term, used to describe investments made across many asset classes, sectors and regions, it has been challenging to develop a rigorous methodology for estimating the total size of the market and, in fact, estimates continue to vary widely. According to the GSIA, global AUM employing an impact/community investing strategy stood at USD 352 billion in 2020, a 42% increase in the past four years (2016-2020).[26] On the other hand, the GIIN estimated the size of the worldwide impact investing market as of 2022 to be USD 1.164 trillion, the first time that the organization’s widely cited estimate had exceed USD 1 trillion.[27] Reference should also be made to other efforts to estimate the size of impact investing markets in various regions and countries.[28] Understanding of the goals and preferences of impact investors can be derived from the GIIN’s Annual Impact Investor Survey 2020 in which 60% of the respondents indicated that they targeted both social and environmental impact in their investments, and 73% of the respondents used the SDGs for at least one measurement and management purposes (75% of the respondents targeted decent work and economic growth (SDG 8) and, on average, respondents targeted eight different SDG-aligned impact themes).[29]
Impact investing has been characterized as an attempt to incorporate an evidence-based mechanism for measuring accountability into giving, a move driven by the evolution of philanthropy from charitable giving from foundations and philanthropists to development financial corporations, multilateral banks and impact focused asset managers.[30] Impact investment is the smallest by assets among the various categories of sustainable financing, but it has attracted a lot of attention in recent years and is perceived to be the most ambitious of all of the strategies. A project is only suitable for impact investment if it is feasible to quantify and measure its precise environmental and/or social impact (e.g., the reduction in the volume of carbon dioxide emitted during the company’s operations or the number of girls within a certain age group that gain access to education in a particular village).[31]
Impact investing challenges the long-held views that environmental and social issues should be addressed only by philanthropic donations and government aid, and that market investment should focus exclusively on achieving financial returns. Impact investing is as a means for bringing together the tools and disciplines of investment, philanthropy and policy to generate more environmental and social benefits than would be created if these individual tools were not combined. Each of the nonprofit, public and private sectors have their own unique structural characteristics, processes and accountabilities that must be considered, and which make collaboration problematic in many instances. For example, nonprofits depend on their donors for support; however, those donors may not have the same incentives as the persons and groups that are the intended beneficiaries of the organization’s activities (i.e., the stakeholders). Public agencies and officials must act in accordance with agendas and budgets established by elected officials who are responding to the sentiments of voters, which often makes working with the private sector difficult. Private companies have traditionally been built and operated to achieve profit maximization for the benefit of their shareholders and have often escaped responsibility for the negative externalities of their activities.
Impact investing, properly structured, draws on the specific strengths from each of the three sectors and combines them effectively to create environmental and social benefits utilizing the distinct institutional elements of each sector. One example is an impact investment project to address a need initially identified in the public sector: affordable housing. In order to effectively achieve the social benefits from the project, the public sector contributed policy tools such as tax incentives, the nonprofit sector provided the experienced gained from developing similar projects (including its skills and competencies in engaging with the beneficiaries of the project in the local community) and the commercial investors from the private sector established the goals and performance metrics to ensure that the project was completed on a timely basis and designed to fulfill both social and investment objectives.[32]
The diverse and viable opportunities for both impact and financial return in the emerging and evolving impact investment marketplace have been a catalyst for motivating investors to participate. In the early days of impact investing only small, niche firms participated; however, the last few years has seen a dramatic rise in interest among larger players such as BlackRock, Goldman Sachs, Bain Capital and TPG, all of which have launched funds or offered other opportunities to investors focused on ESG.[33] A wide range of individual and institutional investors that have entered the impact investment marketplace including fund managers, development finance institutions, diversified financial institutions/banks, private foundations, pension funds and insurance companies, private funds, hybrid funds, ethical banks, microfinance institutions, social stock exchanges, crowdfunding, government institutions, family offices, individual investors, NGOs and religious institutions.[34] Continued growing enthusiasm can be expected given that feedback from investors indicated that portfolio performance has generally met or exceed their expectations for both social and environmental impact and financial return; however, access to capital from impact investors may be limited for companies that lack scalable high-quality investment projects.
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Notes
[1] A. Krauss, P. Kruger and J. Meyer, Sustainable Finance in Switzerland: Where Do We Stand? (Zurich: Sustainable Finance Institute, September 2016), 18-19; Environmental, Social and Governance Issues in Investing: A Guide for Investment Professionals (CFA Institute, 2015); and Changing Dynamics of Sustainable Finance: The regulatory push in the direction of sustainable growth, Sia Partners (February 25, 2020).
[2] Sustainable Finance: What’s It All About?, BNP Paribas (January 23, 2018). For further information on social impact investing, see the website of Finansol, a French organization that certifies certain social finance products and monitors trends in social finance.
[3] A. Krauss, P. Kruger and J. Meyer, Sustainable Finance in Switzerland: Where Do We Stand? (Zurich: Sustainable Finance Institute, September 2016), 18-19. A large percentage of the respondents to a 2023 GIIN survey of impact investors confirmed that they engaged with their investees to discuss opportunities to improve their impact performance (85%) and financial performance (77%) and the GIIN reported that common mechanisms for engagement included membership on the investee’s board of directors, shareholder advocacy, proxy voting and the provision of non-financial support and/or technical assistance. See D. Hand et al., 2023 GIINsight: Impact Measurement and Management Practice (New York: The Global Impact Investing Network, 2023), 14. See also A. Gutterman, Sustainable Finance (Oakland CA: Sustainable Entrepreneurship Project, 2024).
[5] 2022 Report on US Sustainable Investing Trends, Executive Summary (US SIF Foundation), 1-2. ESG incorporation strategies used by investors include ESG integration, positive/best-in-class screening, negative screening, impact investing, and sustainability-themed investing. For further discussion, see A. Gutterman, Sustainable Financing (Oakland CA: Sustainable Entrepreneurship Project, 2024).
[6] Changing Dynamics of Sustainable Finance: The regulatory push in the direction of sustainable growth, Sia Partners (February 25, 2020).nbsp;
[7] Impact Investing (GIIN). A sample of additional definitions of impact investing is available in Definitions for Responsible Investment Approaches (CFA Institute, November 2023), 21.
[8] Impact Investment: The Invisible Heart of Markets (Social Impact Investment Taskforce, 2014), 18. The Taskforce was convened in 2013 to bring together governmental and sectoral experts from the G7 countries, the European Commission and Australia to discuss and report on recommendations for “catalyzing a global market in impact investment”.
[9] Sustainable Finance: What’s It All About?, BNP Paribas (January 23, 2018). BNP noted that with the consent of investors profits generated from impact investment projects may be reinvested to combat exclusion, protect the environment or promote development and solidarity.
[10] S. Godeke and P. Briaud, Impact Investing Handbook: An Implementation Guide for Practitioners (Rockefeller Philanthropy Advisors, 2020), 8. See also D. Burand, “Resolving Impact Investment Disputes: When Doing Good Goes Bad”, Washington University Journal of Law & Policy, 48 (2015), 55, 57 (Note 6) (“Some observers trace impact investing’s roots in the United States to 1950, when the United States started selling political risk insurance to US companies investing abroad.”)
[13] Venture Philanthropy.
[17] Most respondents to the GIIN’s Annual Impact Investor Survey 2020 indicated that they planned to contribute by sharing best practices for reporting and impact measurement and management resources, supporting the development of businesses focused on impact, and creating an environment conductive to impact investing. See Annual Impact Investor Survey 2020 (GIIN), 10.
[18] Estimating and Describing the UK Impact Investing Market (Impact Investing Institute, March 2022), 11.
[19] Id.
[20] Annual Impact Investor Survey 2020 (GIIN), 6 (noting that 87% of survey respondents considered both “impact being central to their mission” and “their commitment as responsible investors” as “very important” motivations).
[21] Id.
[22] Id. (70% of investors found the financial attractiveness of impact investing relative to other investment strategies at least “somewhat important” and 88% of respondents reported meeting or exceeding their financial expectations, which were identified as being risk-adjusted, market-rate returns by 67% of the respondents).
[23] S. Godeke and P. Briaud, Impact Investing Handbook: An Implementation Guide for Practitioners (Rockefeller Philanthropy Advisors, 2020), 28-30 (includes a table that describes how the International Finance Corporation assessed the degree to which specific asset classes have the impact investing attributes of intent, contribution (explained below) and measurement).
[24] Id. (quotation taken from P. Brest and K. Born, “Unpacking the Impact in Impact Investing”, Stanford Social Innovation Review: Informing and Inspiring Leaders of Social Change (2013)). Godeke and Briaud conceded that the inclusion of “contribution” as one the hard boundaries of what constitutes an impact investment is still being debated.
[25] Estimating and Describing the UK Impact Investing Market (Impact Investing Institute, March 2022), 10.
[27] GIINsight: Sizing the Impact Investing Market 2022 (GIIN). GIIN estimated that fund managers and development finance institutions represented 61% and 27%, respectively, of the assets under management, and reported that other organization types in the sector included foundations, diversified financial institutions, and family offices. 55% of impact assets under management were managed by organizations headquartered in Western, North, and Southern Europe, and 37% of impact assets under management were managed by organizations headquartered in the US and Canada.
[28] Id. at 6 (citing reports and estimates relating to the size of impact investing activities in the UK, Sub-Saharan Africa, India, and Japan).
[30] Sustainable Finance (The middle Road).
[33] Id.
[34] GIINsight: Sizing the Impact Investing Market 2022 (GIIN). GIIN estimated that fund managers and development finance institutions represented 61% and 27%, respectively, of the assets under management, and reported that other organization types in the sector included foundations, diversified financial institutions, and family offices. 55% of impact assets under management were managed by organizations headquartered in Western, North, and Southern Europe, and 37% of impact assets under management were managed by organizations headquartered in the US and Canada.