Last updated on October 8, 2020
Although the concept is not new, the term impact investing is. Crucially, the basic definition of impact investment is still debated.
In general, 3 points are not debated. Impact investors
- expect a financial return on their capital
- expect social and/or environmental impact
- want to be able to measure their impact
Currently, as HBR explains, impact can mean anything from venture investments in new health technologies to microfinance loans in Peru; from affordable housing to renewable energy; from social impact bonds to private equity funds that create jobs.
In reality, every investment ever made has a real-world effect. What makes an investment an “impact investment” is the intentionality: the investor has thought about what values they find most important, and invests in projects they think will make the biggest impact on those values, taking into account their risk-reward preference, with the express idea of trying to measure the outcomes in the same way as the financial result.
Eco-investors might focus on projects that tackle food waste or marine ecosystem restoration, while feminists could consider female-led businesses or girl’s education. The scope of impact investing is very wide.
Because of the need to deliver a real-world change, impact investments tend to be concentrated in private equity and debt investments, tools that in the past were only open to big institutional investors with deep pockets.
However, the financial landscape is opening up, and year after year there are more options for everyday investors looking to add more values to their money. We are here to help you find your way in that new world.
What’s the problem? Funding gaps!
A funding gap is when an organisation needs more money to fund its future operations than it is currently earning, and no one is willing to lend or donate them the cash.
The UN Environment Programme Finance Initiative indicates that in developing countries, the annual investment gap for fulfilling the Sustainable Development Goals is around $2.5 trillion.
The striking fact is that funding is available, but it is not flowing to where it is needed. The total investment available is approximately $98 trillion.
Evidence shows that investing in the SDGs makes economic sense, though, with estimates highlighting that achieving the SDGs could open up US$ 12 trillion of market opportunities and create 380 million new jobs, and that action on climate change would result in savings of about US$ 26 trillion by 2030.
This lack of rational behavior has a number of reasons. On the side of the projects, there is
- conflict and the impacts of climate change and ecological degradation
- weak financial systems, local currency volatility
- difficulties in measuring and reporting on sustainable investments
The more fundamental causes are situated on the money side, though.
While solar parks or wind farms are large-scale projects with predictable revenue streams and risk-return profiles that are sexy to private investors, many other social and environmental projects are small-scale and require long-term commitment at less attractive risk-reward ratios.
Until instruments like carbon markets or tax systems that reflect environmental costs are put in place, unsustainable activities are simply too profitable for the blindsided logic of the market, where the focus is towards short-term, speculative, high-risk-high-return financial investments.
Impact investment can fill part of the funding gap.
But I don’t have any money!
While it is true that the richest 10% have their greedy claws jealously guarding more than 80% of the world’s wealth, the rest of us also have some. How much? 62 trillion dollars. That’s 20 times as much as is needed to fund the annual SDG funding gap.
In other words, don’t blame the rich. Well, do definitely campaign and vote for fair taxation if you live in a place that allows you to express your opinion. But what we mean is: even counting out the rich and the ultra-rich, there is still a lot of money available to fund a world that might sustain human life a little while longer, with a little less abject misery to boot.
And while it’s true that a few measly pennies won’t make much of a difference, if you vote, cycle, eat less animal products or buy anything “green”, you believe that your individual actions matter in the greater scheme of things. So then you must also believe your money decisions matter.
And if you really don’t have any money at all, perhaps you want to borrow some? Well, that can be impact investing too. Remember how the banks collapsed in 2008 because of reckless bets on shaky loans? Wouldn’t have happened if people would have borrowed from an ethical bank.
So even if you are completely skint with a big fat 0 on your account (and let’s be fair, you are not, or you wouldn’t be reading this), it’s important that you move your money.
Should I invest for impact?
Impact investing is a way of consciously choosing what to do with your savings. That means, just like considering your diet or your carbon footprint, it takes more effort than the average person is often willing to make.
And if you are serious about it, you will face certain constraints. Just like vegetarians won’t eat meat, impact investors won’t invest in certain types of assets.
But in the same way that new vegans or vegetarians suddenly discover a range of dishes and ingredients they previously had never heard of, aspiring impact investors will be pleased to find out there are many more ways to invest outside of the stock market than they thought.
So is impact investing for you?
Yes, it is, if
- You think a lot about how your actions affect other humans, living beings and ecosystems
- You buy fair trade, second hand or nothing at all, you consider your diet and your carbon footprint
- You believe that if everyone else is doing well, that is good for you too. You think we should all take care of each other
- You understand your position in life is largely based on chance: the country and family you were born in, your genes and upbringing
- In your short time here on Earth, you want to do something good for others.
- Favorite quote: “It’s nice to be important, but it’s more important to be nice”
No, it isn’t, if
- You are against “climate alarmists” and “social justice warriors”
- You don’t want to make any effort. You prefer convenience and believe in easy solutions
- You think everyone should take care of themselves
- You believe your position in life is completely down to your own hard work. Poor people are lazy
- In your short time here on Earth, you just want to relax and enjoy yourself
- Favorite quote: “The question isn’t who is going to let me; it’s who is going to stop me”
What are the tools for impact investing?
As we alluded in the previous chapter, investing in the stock market, even if it is in ESG funds, is not impact investing. To understand why, please read our article on investing in ESG funds.
Nonetheless, other people might be investing with your money. That’s the case for
- Pensions
- Savings accounts
- Checking accounts and credit cards
- Loans
- Insurances
With any of these, it is worth the effort to move your money to the most ethical supplier you can find.
When it comes to investing your savings yourself, the following instruments are all considered impact investing:
- cooperative shares
- microcredit funds
- green, blue and social bonds
- crowdlending
- equity crowdfunding
- private equity funds
- investments in
Does impact investing give a good return on investment?
Traditionally, investors have tried to maximise their returns while minimising their risk, while trying to maintain a large amount of liquidity.
A concept known as “the magic triangle”.
Investing always implies a trade-off.
Impact investors add a fourth dimension: impact. So there is one more element to consider.
Can you have a high financial return and high impact? Yes, but not without taking on a lot of risk. Want lower risk, but still high impact? You will have to settle for lower returns.
Start by making up an investor profile: where do you see yourself on the triangle? Then you can see which investments fit your style.
Looking forward to more posts on the instruments for impact investing you mention. :)