What Makes an Investment “Impactful”?

Until early 2000s, investors have historically drawn a clear distinction between their investment activities and philanthropy. Recently, the impact investing industry is growing rapidly. The idea of impact investing came about from Christian ministries in the United States in mid-1700s when moral responsibilities of commercial enterprises came up against profiting from slavery, and boycotts.

Investors saw that “impact” based portfolios were much less affected by the 2008 financial downturn, and found that impact investment was a method to mitigate short-term risks for long-term value creation.

According to the Global Impact Investing Network (GIIN), a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing across funders, it defines it as “investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return.

Impact Investing includes investments that range from producing a return of principal capital to offering market‐rate or even market‐beating financial returns…Impact investors actively seek to place capital in businesses and funds that can harness the positive power of enterprise.”

Impact investing is quite simple. It attempts to solve our social problems by mobilizing capital. While traditional investments lie on the spectrum without regard to social impact, philanthropy does not regard financial returns.

Impact investing lays in a space where financial returns grow with impact. Impact investing can expect financial return or choose to accept a lower return. Investors and funders would have a range of expectations based on the risk continuum of financial and impact returns.

Impact investing ideally has the following mechanisms:

  • It is value-aligned: Transactions are mostly private debt or equity investments. There are publicly listed impact investments, but they are categorized under a screened socially responsible investment, in which investors seek to minimize negative impact than a proactive positive impact. An investor’s intention to have a positive social or environmental impact through investments is essential.
  • It has impact returns: The model of the business should be designed with intended effect on the target population may be much broader than the consumers. Values should be ideally integrated into the business model.
  • It has financial returns: Impact investments are expected to generate a financial return on capital or, at minimum, a return of capital. Range of return classes and expectations: Target financial returns that range from below market (sometimes called concessionary) to risk-adjusted market rate, and can be made across asset classes, including but not limited to cash equivalents, fixed income, venture capital, and private equity.

These investors operate across multiple business sectors, including agriculture, water, housing, education, health, energy and financial services. The impact objectives may vary such as mitigating climate change or providing assets for poor people. It can also take the form of different finance structures, such as debt, equity, or other like social innovation bonds. According to the Rockefeller Foundation and J.P. Morgan, they provide capital, expect financial returns to business designed with the intent to general positive social or environmental returns.

Impact investors could range broadly across sectors and objectives – private wealth managers, commercial banks, pension fund managers, boutique investment funds, companies and community development finance institutions. Essentially, there exist the funders (government, foundations, family offices, high net worth individuals, and other socially responsible investing) that fund impact investing intermediaries (microfinance institutions, social banks, social venture capital/private equity firms, and pension funds) that invest in social enterprises for beneficiaries.