Impact investments: The changing landscape of ‘purpose-driven’ finance

With the increasing consumer interest in sustainable investment and the increasing population of millennials who are socially and environmentally more aware, we are witnessing a fundamental shift in the financial investment sector that may accelerate the reallocation of capital to areas that contribute to sustainable development.

However, there is still confusion regarding the opaque definition of impact investing and the financial returns generated. In order for products to emerge at scale, investors will need clarity about what different funds actually achieve across sectors and geographies.

How viable is impact investment for business and governments?
Does Impact investment yield lesser returns?

The answer to these have developed some interesting dynamics amongst the new-age investors, social entrepreneurs, impact investors and development practitioners.

Since the recession of 2008, the image of financial institutions and Wall Street have deteriorated, as they were seen too focused on short-term returns and personal interests that resulted into a disaster.

In 2007, while Wall Street was in the heat of buying CDOs and mortgage-backed securities, the idea of making a positive impact on society without compromising financial return arose out of a conference held by a group of experts at the Rockefeller Foundation.

This concept of Impact Investing incorporated the environmental and social awareness of its ancestors, like Socially Responsible Investing (SRI) and ESG integration, but also realized that it needed to be profitable in order for financial institutions to adapt the concept of making investments based not only on financial return but also social impact.

In the past decade, the field of impact investing has mushroomed. J.P. Morgan’s 2015 survey of the sector found that 60 billion USD of impact investments are under management by the firms surveyed. 41 % of those investing were making long-term investments (over 10 years).

The sector is experiencing a 16 % growth rate with a full 45% of investors willing to forgo market rate returns for social impact. While 90 % of investment assets are invested by those in developed countries, over half of those investments are deployed in emerging and less developed markets.

The new age investors are sometimes seen using terms Impact Investing and Socially Responsible Investing (SRI) inter-changingly, however the two are not same. Infact, there is a fundamental difference between impact investing and socially responsible investing (SRI). Socially responsible investing typically applies a set of negative or positive screens to a group of publicly listed securities – for example, a mutual fund that avoids investments in tobacco, alcohol and firearms. Impact investing goes beyond a passive screen by actively seeking to invest in companies or projects that have the potential to create positive economic, social and/or environmental.

Whereas, socially responsible investing fund managers are generally passive and adopt a “do no harm” approach, impact investing funds typically not only seek to create positive impact, but measure and report their impact in a transparent way.

The investors today are also increasingly supporting impact investing as it allows asset owners or fiduciaries to make better decisions regarding their investment strategies and risk-and-return expectations.

The sector has attracted a wide variety of investors, both individual and institutional including:

• Diversified financial institutions
• Pension funds
• Private foundations making program- and/or mission-related investments
• Insurance companies
• Development finance institutions
• Family offices
• Fund managers
• Individual investors

The IFC, which coined the term “emerging markets” in the early 1980s, has proven that generating impact investing (investing with impact) does not necessarily require sacrificing return, achieving an annual internal rate of return of 18.3% on its investment funds portfolio between 2000 and 2011. Numerous surveys tell us that the venture philanthropy and impact investment sector is a dynamic and rapidly evolving sector. Many players are active in the sector, including foundations, impact investing funds, financial institutions, family offices and corporates.

Since 2001, the Goldman Sachs Urban Investment Group has committed approximately $5 billion to underserved American communities. They partner with local leaders and nonprofits, focusing on community development, social impact bonds and financing for small businesses.

The Group has invested in communities across the U.S., supporting a wide variety of development and revitalization projects. They’ve invested in affordable housing construction, job creation, quality education, healthcare facilities, small businesses and more as part of their ongoing effort to empower communities and promote long-term economic growth.

In 2013, Morgan Stanley announced the creation of the Institute of Sustainable Investing, whose goal is to advance market-based solutions to economic, social, and environmental challenges by bringing sustainable investments to a large scale. The institute offers retail investors a number of investment strategies that focus on ESG (environmental, social, and governance) integration and thematic exposure to sustainability-related challenges. As of 2014, more than 1-of-6 dollars under professional management in the U.S. is devoted to sustainable, responsible or impact investing strategies.

The $6.57 trillion total committed in this manner represents a two-year growth rate of 76%.

In the fall of 2012, Deutsche Bank announced the launch of the Essential Capital Fund, which intends to provide “first loss” loans to social enterprises and impact investors, in order to catalyze the participation of capital providers that are socially motivated and risk-averse. As per the analysts, there are many investors that have pent-up demand and are waiting for the right opportunities to deploy capital into impact investing.

There are funds and organizations that are trying to re-explain their business model in terms of “impact” given the excitement associated with the sector. Until funds demonstrate consistent clarity around the social and environmental impact that is actually achieved as a result of their investments, the term “impact investing” will continue to look blurred.

However, new age investors across the globe are looking at this as high hope solution for addressing the larger concerns of development and greater financial returns.