Impact Investing: Turning a Profit and Changing the World
Impact investing, a rapidly growing sector of socially responsible investing (SRI), represents the nexus of philanthropy and traditional finance: It expands the definition of return on invested capital to include both financial and social returns — and is a way to use the tools of finance and investing to create social change. If a survey of financial professionals conducted last year by the First Affirmative Financial Network is any guide, impact investing will likely be the number one growth area in the SRI field in 2013.
At the same time, awareness of this emerging area of finance is growing. In a 2011 survey, JPMorgan found that the number of institutions and high net worth individuals who were familiar with impact investing had doubled since 2010. JPMorgan predicts that by 2020 there could be between $400 billion and $1 trillion dollars directed toward impact investing.
So how does it work? The fundamental assumption underlying impact investing is that the creation of economic value and social value are not mutually exclusive. Therefore, a unified market-based approach can be used to develop long-term sustainable solutions to social and environmental problems. Impact investors include public pension funds, foundations, corporations, governments, and individual investors. Their common objective is to invest in companies or securities that will provide a return on investment while also alleviating poverty, creating affordable housing, building needed infrastructure, or conserving natural resources.
Of course, the concept of investing in a socially responsible manner dates back to biblical times, and faith-based investors continue to capitalize on their roles as shareholders to serve social causes. According to the Forum for Sustainable and Responsible Investment, the number of US mutual funds that use environmental, social, or corporate governance (ESG) criteria, grew from 12 in 1995 to 333 in 2012 (a 2,675% increase) while assets under management grew from $12 billion to $640 billion (a 5,233% increase) during the same period. The performance of these funds illustrates that it is possible to achieve both financial and social objectives. (Though it should be noted that a recent overview of studies on the returns for SRI found that results tend to be mixed.)
Impact investors have taken the concept of SRI one step further. Instead of just avoiding companies whose products and services are incongruent with their values, impact investors seek out and invest in companies, securities, and funds that are actually helping to combat societal issues of hunger, homelessness, disease, and environmental degradation. As a result, new and unique investment products have been introduced that not only address specific social issues, but offer competitive market returns.
The AdvisorShares Global Echo ETF (GIVE), for example, focuses on sustainable and impact investment opportunities. A portion of its management fee goes to the Global Echo Foundation, which provides funding to charitable organizations and development programs around the world.
Social impact bonds, also known as pay-for-success or social benefit bonds, are used to finance organizations that provide social services and programs to individuals and communities that were once provided by the governments. The government pays the interest and principle on these bonds out of the savings it receives, if the outside organization is able to provide the same services at a lower cost. Returns may also be contingent on social outcomes. In the United Kingdom, for example, the proceeds of a social impact bond are being used to fund an organization that provides comprehensive assistance to men released from prison. Bondholders will only receive interest and principal payments if the services provided by this new organization reduces recidivism to a specified rate.
Developments in recent years have addressed several critical challenges facing the impact investing industry — and should facilitate this forecasted growth. In 2009, for example, the Global Impact Investing Network (GIIN), an independent nonprofit organization, was formally established to foster the growth and effectiveness of impact investing by providing a forum to address “systemic barriers to effective impact investing by building critical infrastructure and developing activities, education, and research that attract more investment capital to poverty alleviation and environmental solutions.” One of its most important projects has been the development of Impact Reporting and Investment Standards (IRIS). These standards provide a “standardized taxonomy and a set of consistent definitions” that investors can use to measure and assess the social, environmental, and financial impact of their investments. In addition, IRIS maintains a database that contains performance data from funds and mission-driven organizations.
There has been a global trend among governments to support impact investing. In 2011, the UK government established Big Society Capital, a social investment bank with a mission “to catalyze the growth of a sustainable social investment market, making it easier for social ventures to access the finance and advice they need — at all stages of their development.” In the United States, the Overseas Private Investment Corporation (OPIC), whose mission is to “mobilize private capital to help solve critical world challenges,” provided $285 million in financing for six new impact investment funds. In Australia, the government provided $20 million to establish the Social Enterprise Development and Investment Funds (SEDIF).
Although some view impact investing as a new asset class or investment strategy, I believe that it will become an investment philosophy. Who wouldn’t want help the world and make money at the same time? After all, as Amy Domini says in her book, Socially Responsible Investing, “The way we invest creates the world we live in.”
Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.
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