Introduction to Impact Investing

By Jessica Dosseh

Philanthropy and investing have mainly been seen as two different disciplines, and the combination of both can be cause for concern as one advocates for social change and the other for financial gain. However, doing good and making money are not mutually exclusive.

Impact investing is an investment strategy seeking to generate financial returns while creating a positive social, environmental, and economic impact.

This definition leaves much room for uncertainty when determining the investments that classify as having a positive impact; nevertheless, at its core, the two key elements that reflect impact investing are intentionality and measurement. Every investor should consider the intention and metric analysis of both social impact and the fundamental structures of financial returns on investment (ROI) when making decisions.

Impact Investing balances commerce and global empathy.

The GIIN (Global Impact Investing Network) has a broad and deep explanation of impact investing that we recommend for a deeper dive.

Key Takeaways

  • Impact investing reflects your personal values.

  • It's possible to focus on social impacts while also making competitive financial returns.

  • Socially responsible (SRI) and environmental, social, and governance (ESG) investing are two different approaches to impact investing.

  • It's important to do your research and select investments that have clearly identified intentions to avoid greenwashing.

The key differences between SRI, ESG, and impact investing.

Before we dive into impact investing, it's important to look at the major categories under the broader umbrella of sustainable investing. This includes socially responsible investing (SRI); environmental, social, and governance (ESG) risks; and impact investing.

What is socially responsible investing (SRI)?

Social responsible investing is the elimination or curation of investments according to specific ethical guidelines (such as religion, personal values, political beliefs, etc.) This type of investment organization structure is mainly used in public markets and is accessible to all investors through SRI mutual funds to promote responsible investing. A SRI investment structure might exclude companies associated with tobacco, high levels of waste and carbon emissions, use of unfair labor, firearms, or even the promotion of alcohol.

What does it mean to consider environmental, social, and governance (ESG) factors?

ESG refers to a framework used to evaluate metrics that measure companies' risks outside their traditional financial analysis. ESG estimates a company's environmental risk (the consumption and emission of natural resources), social risk (the health of a company's labor force), and governance risk (the way the company is managed over time). Data related to these factors can be useful in analyzing the true worth of a company. This method of analysis considers factors that would most often not show up on financial statements but are essential when considering the lifespan and sustainability of an organization across a range of asset classes.

How is impact investing different from ESG and SRI?

Social responsible investing filters out organizations for consideration. Environmental, social, and governance risk analysis allows each investor to understand, recognize, and evaluate the various factors of risks that lie beyond the typical financial statements. Finally, impact investing combines the understanding of both social impact and traditional financial returns to create an executable strategy to manage investments to generate positive impact. To put it briefly, SRI and ESG are methods used to reach a successful impact investment strategy.

After doing your research through SRI and ESG, impact investing determines the target investments. (The process: Filter, Scan, Determine)

Types of Impact Investments

Impact Investing is prominent in private markets, which limits its overall access to only a small number of investors. It comes in different forms and spans several industries such as education, emerging markets, healthcare, agriculture, energy, waste management, and renewable resources.

For the wider public, the simplest way to get started with impact investing is by investing in one of the various ESG funds or donating to an impact investing nonprofit.

The idea is to:

  • Invest in mutual funds, exchange-traded funds (ETFs), or bonds that choose companies that align with values that matter to you.

  • Invest directly in private companies or funds with an explicit social mission.

  • Make a charitable donation or a charitable grant.

It's important to note that this doesn't necessarily mean you have to compromise financial returns.

Example of Impact Investing.

The underlying problem.

Despite the good intentions behind impact investing, a huge disconnect exists between investing sustainably and investing with purpose. Since there's no agreed-upon definition, the criteria for SRI and ESG end up being so broad that despite attempts at regulation, sometimes companies like Exxon Mobil Corp. and Philip Morris International Inc. (the maker of Marlboro cigarettes) tend to make the cut. Misinformation is sometimes used to gain investors' confidence regarding ESG claims.

This issue can be defined as greenwashing. "Because impact investing and its terminology can be confusing to investors, greenwashing shows up in the investment industry when a fund gets re-labeled as impact or when an investment manager repurposes it as impact." – Chad Burlingame, director of Impact Investing at U.S. Bank.

Does impact investing work?

In general, the returns from impact investing tend to be slightly lower than the market average and can sometimes outperform the market. That said, most impact investors are not seeing material losses in returns.

“More than 88% of impact investors reported that their investments were meeting or surpassing their financial expectations." – Investopedia. More than two-thirds of them indicated their expectation was to earn risk-adjusted, market-rate returns.

How can you get started with impact investing?

"Whether impact investing is a strategy you should consider will depend on your values and goals, and on how well you understand the opportunities before you." – Rockefeller Philanthropy Advisors 

Impact investing action steps.

  1. Define your Sustainable Development Goals (SDGs) – What are your priorities?

  1. Do your homework – Where do you land on the impact investment spectrum?

  • Determine and assess the relevance and scale.

  • Identify target social, environmental, and economic outcomes.

  • Estimate the economic value of those outcomes to society.

  • Adjust for risks and rewards.

  • Calculate social return on every dollar spent.

  1. Make your first investment – Choose an ETF, Mutual Fund, or other Investment Methods.

Resources

Good Luck.