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If investing according to your values is something that you care about, you’re probably already familiar with SRI (socially responsible investing) and ESG (environmental, social, governance) investing. But have you heard of impact investing?
The term impact investing is relatively new and is used less often in values-based investing discussions, but it’s a fast-growing segment. A 2020 survey from the Global Impact Investing Network (GIIN) found that impact investments have a current market size of $715 billion.
Impact investments tend to offer more impact benefits than SRI and ESG investing. But unlike charity donors, impact investors expect to receive a financial return. In this guide, we explain how impact investing works and its key advantages and drawbacks.
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The Short Version
- Impact investing allows you to invest directly towards a cause or project you care about and receive a financial return
- While not every impact investor experts market-rate returns, 90% say that the returns are what they expected or better, and 100% say that they are satisfied with the result of their investment
- Right now, most impact investments are only available to accredited investors through private equity or private debt opportunities that exist outside of publicly-traded exchanges
What Is Impact Investing?
Impact investing is an investment approach that seeks to produce a financial return while positively affecting society or the environment.
There are many different types of impact investments that fall within those two main categories, but here are just a few of the goals they may seek to achieve:
- Conserving energy
- Implementing sustainable agricultural practices
- Ending global food and clean water crises
- Building affordable housing
- Supporting education equality
- Creating accessible healthcare systems
- Providing financial services in emerging markets
Whatever the social or environmental goal impact investors contribute towards, they want to see measurable progress over time and receive a satisfactory monetary return.
While there’s likely always been some investors who have engaged in impact investing, the term has only been used in earnest since 2010, when the Rockefeller Foundation and J.P. Morgan labeled impact investments as an emerging asset class.
Impact Investing vs. Socially Responsible Investing (SRI)
If impact investing sounds a lot like socially responsible investing to you, you’re not alone. At first glance, it can seem like the two terms are just different ways of saying the same thing. But there are actually a few key differences between impact investing and SRI.
The most important distinction between SRI and impact investments is that the former uses negative screeners and the latter uses positive screeners. For example, SRI investors may exclude all companies from their portfolios that damage the environment with their energy practices. But an impact investor, on the other hand, may seek to only invest in projects that are improving the environment.
Another difference between impact investing and SRI is the available type of investments. Many publicly-traded companies may receive high SRI scores, but you won’t typically find impact investment opportunities on public exchanges. Instead, they tend to be made through private equity or private debt arrangements.
This leads us to the last major difference between impact investing and socially responsible investing. While anyone can follow an SRI investing strategy, impact investments are often restricted to accredited investors.
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Impact Investing vs. ESG (Environmental, Social, Governance) Investing
ESG investing strikes a middle ground between impact investing and SRI. With ESG, you invest in companies actively seeking to reduce their negative social or environmental impact. But unlike with impact investments, the core products and services of companies that receive high ESG scores are rarely related to these impact goals.
So how does this all play out? Well, an SRI investor may be happy with investing in any company that doesn’t produce fossil fuels. An ESG investor, meanwhile, may only invest in companies that are working towards using more renewable energy at their facilities. And finally, an impact investor may look to invest in funds focused on creating new green infrastructure, like Sunwealth’s Solar Impact Fund.
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Impact Investing vs. Charitable Giving
As you begin to search for impact investments, you may notice that many of them have goals that have traditionally been funded by philanthropy, such as solving world hunger. And that’s on purpose.
Advocates of impact investing point out that charitable giving alone can’t solve all of the world’s problems. But according to Rockefeller Philanthropy Advisors, just a 1% shift of invested funds from capital markets to impact investments would completely bridge the $2.5 trillion annual funding gap between donations and what’s needed to achieve the United Nations’ Sustainable Development Goals (SDGs).
But while impact investing can help us achieve objectives that have traditionally only been addressed by charitable giving, there’s a major difference between the two activities. It’s only with impact investing that you expect to receive a financial return in addition to non-financial benefits.
Expected Financial Returns for Impact Investors
With traditional investing, the primary goal is to achieve the highest returns possible. But it’s important to understand that impact investors have a wider variety of financial performance expectations.
Some investors are OK with earning a lower return than they would if they had invested their money in the stock market. These types of impact investments are sometimes referred to as concessionary.
Others, however, do have market-rate expectations. The image below from GIIN shows just how varied the return expectations for impact investments are.
Due to this diversity of expectations, GIIN prefers to focus on whether impact investors are satisfied with their returns. In its 2021 Impact Investing Decision-making: Insights on Financial Performance report, 90% of respondents said their impact investments were either in line or outperforming their financial expectations. And impact expectations satisfaction was even higher at 100%.
Still, it’s important to point out that multiple aggregate studies have found that impact funds tend to lag behind the returns of the S&P 500. Since its inception, the S&P 500 has enjoyed average annual returns of around 10%.
Meanwhile, a 2019 University of California study of 159 impact funds found their median internal rate of return (IRR) to be 6.4%. And an older 2017 GIIN study of 71 private equity impact funds found their net rate of return to be 5.8%.
Where to Find Impact Investments
As previously mentioned, impact investments are typically private equity or private debt opportunities that exist outside of publicly-traded exchanges. So unlike with SRI or ESG investing, you probably won’t be able to use stockbrokers or robo-advisors to participate in impact investing.
Instead, you’ll need to search for impact projects, funds, and asset managers on your own. Thankfully, there are resources that can help you begin your search for opportunities. One example is the Toniic Directory. It lists many impact investments that can be filtered by asset class, impact category, geography, liquidity profile, etc.
ImpactAssets.org, meanwhile, maintains a robust list of the best impact asset fund managers for each year. Again, several useful filters are available. For example, you can screen the results by the percentage of professionals at the company who identify as a woman or as a person of color.
Keep in mind that if SRI or ESG investing is actually what you’re looking to get involved with, there are many tools that can help you. For example, MSCI ESG Ratings can help you compare individual companies. And the Morningstar Sustainability Rating™ can help with evaluating mutual funds. Also, several robo-advisors today, such as Betterment and Wealthfront, make it easy to build SRI portfolios.
Pros and Cons of Impact Investing
- More impact-focused than SRI and ESG investing: If you want to invest in projects actively trying to do good rather than just avoiding doing harm, impact investing may be the right choice for you.
- More returns-focused than philanthropy: Unlike charitable donations, impact investments are designed to preserve your principal plus offer profits by appreciating private equity stakes or interest charges on debt repayment.
- Highly focused on measurables: The best impact investments provide clear metrics for investors to evaluate their financial and non-financial performance.
- Investments aren’t typically publicly-traded: Since most impact investments are private equity or private debt offerings, they can be more difficult to find than stocks and funds traded on public exchanges.
- You’ll also need to carefully perform your own due diligence as private funds aren’t required to disclose their financials to the SEC.
- Investor accreditation may be required: Most private equity investments are only open to accredited investors. Under federal securities laws, an accredited investor earned at least $200,000 in each of the past two years or has a net worth of at least $1 million.
- Potentially reduced financial returns: While many impact investments may keep up with or even outperform the general market, their average returns so far have been below the S&P 500.
The Bottom Line
For ages, most of us have considered investing and philanthropy to be two completely separate ways of allocating our funds. But impact investing is changing that paradigm by offering both financial and non-financial returns.
Unfortunately, most impact investments today are only available to accredited or institutional investors. But if that’s not you, you can still improve the alignment of your investments and values by investing in socially responsible companies.