What is impact investing and how does it work?
Discover how aligning your financial goals with social and environmental factors creates meaningful change through impact investment. We reveal what you need to know about impact investing.
We explore how the strategic allocation of capital can have a positive social and environmental impact and lead to greater financial returns.
Summary
- Impact investing is grounded in the belief that socially responsible investing leads to positive change.
- Investors assess investment opportunities based on their potential for financial returns and their alignment with predefined impact goals.
- ESG investing involves evaluating a company's performance based on its environmental, social, and governance practices.
- Socially responsible investors (SRI) choose investments based on their alignment with specific social or ethical values.
What is impact investing?
Impact investing involves allocating capital to companies and funds with the aim of generating a positive social and environmental impact alongside financial returns.
The term ‘impact investing’ was coined in 2007 when The Rockefeller Foundation assembled a group of philanthropists, investors and entrepreneurs before the Global Impact Investing Network (GIIN), the leading network of practitioners, started in 2009.
The drivers behind impact investing are as diverse as the impacts it seeks to achieve.
One key motivator is an increasing awareness among investors of the profound influence their capital can have on society and the planet.
Beyond financial returns, individuals and institutions are driven by a desire to align their investments with their values.
This conscientious approach is particularly resonant for a new generation of investors who view profit as part of a broader picture and not the sole measure of success.
What are the different types of impact investments?
Impact investing isn't a one-size-fits-all concept. Capital is being directed in various ways around the world to make a positive impact.
Green investments that focus on environmental causes are a type of impact investment, but there are others, too.
Here are some examples:
- Sustainable agriculture in South America: Investment in agricultural projects that prioritise sustainable farming practices, biodiversity, and fair labour conditions.
- Microfinance in sub-Saharan Africa: Investment in institutions that provide financial services to small businesses and entrepreneurs in underserved communities.
- Renewable energy in India: Investment in projects that combat climate change and promote sustainable energy sources.
- Affordable housing in the UK: Investment in real estate projects that provide affordable housing solutions in urban areas.
One common distinction is between investments that focus on environmental, social, and governance (ESG) criteria and those that fall under socially responsible investing (SRI).
Environmental, social and governance (ESG) investing
ESG investing involves evaluating a company's performance based on its environmental, social, and governance practices.
Companies are rated on their commitment to sustainability, ethical labour practices, and the quality of their corporate governance.
- Environmental factors might include a company's carbon footprint, resource usage, and commitment to renewable energy sources.
- Social factors encompass labour practices, diversity and inclusion, and community engagement.
- Governance factors examine a company's leadership, transparency, and adherence to ethical business practices.
By integrating ESG criteria into investment decisions, individuals and institutions can actively support companies that demonstrate a commitment to responsible and sustainable practices.
Socially responsible investing (SRI)
SRI goes beyond ESG criteria by selecting investments based on broader social and ethical considerations.
This could mean avoiding investments in industries such as tobacco, weapons, or those with questionable human rights records.
While ESG investing focuses on a company's operational practices, SRI takes a more holistic approach.
SRI investors may choose investments based on their alignment with specific social or ethical values, irrespective of the company's overall ESG performance.
This approach allows investors to make a clear statement about the kind of businesses they wish to support and those they wish to avoid.
Learn more: ESG investing vs impact investing: which is best for you?
How does impact investing work?
The mechanics of impact investing involve identifying and supporting projects, businesses, or funds that align with an investor's values.
Essentially, impact investing is about intentional decision-making. It starts with an investor defining their values and specific social or environmental outcomes they aim to support.
This guides the selection of investments and ensures that financial decisions contribute to the desired impact.
The process often involves thorough due diligence, where the investor assesses socially responsible investment opportunities based on their potential for financial returns and their alignment with predefined impact goals.
This due diligence includes scrutinising the business model, evaluating the management team, and understanding the potential risks and rewards associated with the investment.
The investor remains actively engaged once green investment funds have been allocated or another investment has been made. Regular assessments are conducted to measure the investment's progress towards defined impact goals.
This ongoing evaluation ensures accountability and allows for adjustments to be made to the impact investing strategy where needed.
Let’s look at the rise of impact bonds as an example:
Impact bonds tie the return on investment to the achievement of specific social outcomes and represent a collaborative effort between governments, private investors, and social organisations.
They are structured to address pressing social issues, such as education, healthcare, or poverty, by creating a financial incentive for investors to contribute to positive change.
Suppose you invest in an impact bond supporting a programme aimed at improving education in underprivileged communities. If the programme achieves its goals, you get a financial return. This innovative approach not only attracts capital to critical social projects but also establishes a results-oriented framework for measuring success.
Is impact investing right for you?
Impact investing requires careful consideration, research, a solid strategy, and a commitment to the long-term vision of positive change.
Given that it is not a guaranteed path to financial success, it’s important to weigh up the pros and cons, which are below.
| Pros | Cons |
|---|---|
| You contribute to causes that you care about. | Financial returns are sometimes lower than traditional investments. |
| Your investment aligns with your personal values. | Quantifying the impact of investments can be challenging. |
| It gives you the opportunity to diversify your investment portfolio. | Finding suitable investment opportunities may limit the diversity of your portfolio. |
| You contribute to the development of sustainable and scalable solutions. | Investments may claim to have a positive impact without delivering tangible results. |
Want to learn more about investing?
Impact investing challenges the notion that profit and a positive impact on the world are mutually exclusive
It offers a unique opportunity to merge financial success with positive societal and environmental change. From supporting renewable energy projects to fostering social innovation, impact investments enable investors to be catalysts for a better future.
A financial adviser you can trust can help you learn more about investing and provide you with expert financial advice and tax advice.
Unbiased can match you with a financial adviser who can help you successfully manage your money and invest in the portfolio you want.
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