Impact investing aims to achieve the dual goals of positive social and environmental impact alongside financial returns. The concept was motivated by the desire to improve the distribution of capital for social and environmental benefits, and it has evolved from being an ideal to an increasingly mainstream investment strategy over the past decade.
Investing to promote socially desirable outcomes is not a new concept per se, and some may associate or use ‘impact investing’ interchangeably with sustainability and/or ESG (environment, social and governance) investing in recent years, although impact investing emphasises the reporting and measurement of the ‘double bottom line’ of financial return and social/environmental impact.
Impact investments have evolved and expanded to include a broad spectrum of asset classes across fixed income, venture capital and private equity.
Demand for ESG and impact investments broadened out over the past decade as investors started to recognise the materiality of risks to their investments when non-financial risks are ignored, as well as an increasing desire to influence social and environmental causes. With its roots in philanthropy, high-net-worth individuals, foundations and government institutions with socially focused mandates formed the earlier investors into impact strategies. Institutional investors i.e., pension funds, retirement funds, and insurance companies were next, as awareness and interest in ESG issues grew and broadened out across the investor base and consumers. The industry responded with supplying more funds and investment options dedicated to this theme to diversify their offerings and meet the growing amount of funds earmarked for more ethical and sustainable business practices.
The industry and global organisations (e.g., United Nations, World Bank) have developed a number of impact standards and metrics to help investors evaluate and benchmark investment opportunities. The leading frameworks adopted by the industry include the United Nations Sustainable Development Goals (UN SDGs), the IRIS+ system developed by the Global Impact Investing Network (GIIN) comprising fund managers and leading foundations, and the Global Impact Investing Rating System (GIIRS) developed by data analytics firm B Analytics.
The impact investment industry as it stands today is diverse and covers a broad spectrum of asset classes. Impact investments have evolved and expanded to include a broad spectrum of asset classes across fixed income, venture capital (VC) and private equity (PE). There are public market options for impact investing, but impact investing is most commonly done through private market limited partnership structures like PE and VC funds, and increasingly through debt. While the AUM estimates differ, the strong growth trends over the last 5 years have been undisputed.
VCs and PEs form the majority of impact investing funds measured by the number of funds and AUM respectively, which also suggests that most impact funds target market-rate, and hence potentially attractive, returns. This is likely due to the suitability of shaping sustainability-focused business models in early-stage companies as opposed to ‘retrofitting’ existing companies, as well as the emphasis on innovation for impact investment targets.
In terms of industry or business sectors, impact funds have focused most consistently on energy and financial services. Healthcare, food and agriculture are the next set of priority industries being invested.
Impact investing had met investors’ returns expectations ex-post. More investors focused on developed markets (DMs) report better-than-expected financial performance. Realised gross returns are the highest for private equity which is unsurprising, with emerging markets (EM) focused investments performing slightly better relative to DM, albeit with a wider range of outcomes.
As the global focus on sustainability and social issues like gender, diversity, and poverty continue to gain momentum, both the demand and supply for impact investments will continue to grow. The increase in awareness and demands for action in ESG outcomes will generate investment opportunities as well as additional risks for investors to consider. On the positive side, an increase in regulations or penalties related to undesirable behaviours e.g., CO2 emissions will lead to a bigger market for the mitigations required. This clearly presents a growth opportunity for companies that can offer ESG solutions, thereby rewarding their investors with both impact and financial returns. However, regulations and rules could also move to limit the level of profits permissible in producing what is deemed to be a social good or basic service e.g., healthcare.
Core PE/VC skillsets like the ability to identify the right companies and management, and having the expertise to manage liquidity, exit risks and macro risks are important contributors to financial performance and will remain so. Impact investors should continue to look for these core skillsets when choosing where to allocate capital.Disclaimers and disclosures
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