Impact investing is a strategy that seeks to create both financial return and positive social or environmental impact. Impact investments can be made in both publicly traded companies and private companies or funds, and can take the form of equity, debt, or other assets.
In recent years investors have become increasingly aware of potential adverse societal effects to which their investments may contribute. These can include effects on health, the environment, and human rights. As such, large firms and foundations have increasingly decided to put capital to work to minimize these negative effects. For investors, it helps to be aware of the growing trend of impact investing to determine whether it is a suitable wealth-building strategy for a portfolio.
How Does Impact Investing Work?
Impact investing is usually done by large institutional investors and private foundations, though individual investors can do it as well. These organizations invest in various areas, including affordable housing, clean water, and renewable energy. Impact investments in these areas can benefit both developed and emerging markets.
The term “impact investing” is relatively new, but the concept of investing for both financial return and social good is not. Impact investing began in the early 1900s, as numerous philanthropists created private foundations to support their causes.
Over time, the assets of these foundations grew, and the foundation trustees began to look for ways to invest the assets to support their charitable activities. Many of these early foundations were created to support causes such as education, health care, and the arts.
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The concept of impact investing has expanded to include a broader range of investors and investment vehicles. Impact investing is now practiced by individuals, foundations, endowments, pension funds, and other institutional investors.
The growth of impact investing has been fueled by several factors, including the rise of social media and the increasing availability of data and analytics. Impact investing is also being driven by the growing awareness of businesses and investors’ role in solving social and environmental problems. Individual investors can take this new knowledge and consider index funds that focus on various causes.
Characteristics of Impact Investments
As outlined by Global Impact Investing Network (GIIN), the following are considered characteristics of credible impact investments:
• Investor intentionality: An investor must intend to make a measurable positive impact with their investment. This requires a certain level of transparency about both financial and impact goals. The investor’s intent is one of the main differentiators between traditional investments and impact investments.
• Utilize data: Impact investments must use data and evidence to make informed decisions to achieve measurable benefits.
• Manage impact performance: Specific financial returns and impact goals must be established and managed.
• Contribute to the growth of the industry: The goal of impact investments is to further social, economic, or environmental causes. Impact investing toward these goals must be intentional and measured, not just guesswork.
Impact Investing vs Socially Responsible Investing
Impact investing is often associated with “socially responsible investing” (SRI). Both SRI and impact investing seek to generate positive social or environmental impact, but they differ in some ways.
SRI typically focuses on actively avoiding investments in companies involved in activities that are considered harmful to society, such as the manufacture of tobacco products or the production of weapons. SRI also typically focuses on promoting corporate policies considered socially responsible, such as environmental sustainability or gender diversity.
In contrast, impact investing focuses on making investments in companies or projects that are specifically designed to generate positive social or environmental impact.
Impact Investing vs ESG
The main difference between impact investing and ESG (environmental, social, and governance) is that impact investing is focused on investments that are expected to generate a positive social or environmental impact. In contrast, ESG considers a range of environmental, social, and governance factors in investing decisions.
Why Is Impact Investing Important?
There are a few reasons why impact investing is important. First, it allows investors to put their money into companies or projects that they believe will positively impact society or the environment. This can be an excellent way for investors to make a difference while also earning a return on investment.
Second, impact investing can help attract more capital to social and environmental causes. When more people invest in companies or projects that aim to make a difference, it can help to increase the amount of money and resources available to make positive change happen.
Finally, impact investing can help create jobs and support businesses working to improve society or the environment. This can have a ripple effect, as these businesses often provide goods or services that benefit the community.
Examples of Impact Investing
Impact investing is usually done by institutional investors, large asset managers, and private foundations. Some of the largest foundations and funds focused on impact investing include:
• The Bill & Melinda Gates Foundation: This foundation has a $2.5 billion Strategic Investment Fund. This fund makes direct equity investments, provides low-interest loans, and utilizes other impact investing tools in promoting global health and U.S. education.
• The Ford Foundation: The foundation has committed to invest up to $1 billion of its endowment to address social problems while seeking a risk-adjusted market rate of financial return. Its mission-related investments are focused on affordable housing, financial inclusion, and other areas in the U.S. and across the Global South.
• The Reinvestment Fund: The Philadelphia-based nonprofit finances housing projects, access to health care, educational programs, and job initiatives. With about $1.2 billion in assets under management, it operates primarily by assisting distressed towns and communities in the U.S.
Types of Impact Investments
There are various impact investment areas, including but not limited to microfinance, renewable energy, sustainable agriculture, and affordable housing.
Impact investments don’t have to be equity investments either; they come in many different investment vehicles, like bonds and alternative investments.
Is Impact Investing Profitable?
Impact investing may be profitable, though it depends on several factors, including the type of impact investments and the specific goals and objectives of the investor. Nonetheless, a 2020 GIIN study noted that 88% of impact investors reported that their investments met or surpassed their financial expectations.
In general, impact investing can be a good idea if investors approach it thoughtfully and strategically. As with any investment, there is always a risk of loss, but the profit potential is considerable if the investor does their homework and carefully selects their assets.
The bottom line is that you may not have to sacrifice your financial goals to make a positive impact with your investments. In fact, it’s possible that impact investments might be better for both your pocketbook and the world.
Evaluation Methods for Impact Investors
There are many ways to measure impact investments. The United Nations Sustainable Development Goals (SDGs) are a popular framework for measuring impact. The SDGs are a set of 17 goals that the United Nations adopted in 2015.
The SDGs include goals such as “no poverty,” “zero hunger,” and “good health and well-being.” Each SDG has a specific target to be achieved by the year 2030.
Impact investors often seek to invest in companies or projects that will help achieve one or more of the SDGs. For example, an impact investor might invest in a company working on a new technology to improve water quality, contributing to the SDG goal of ensuring access to water and sanitation for all.
Another popular framework for measuring impact is the Impact Management Project (IMP). The IMP is a global initiative that seeks to develop standards for measuring and managing impact.
How to Start an Impact Investment Portfolio
Though foundations and institutional investors are the heart of the impact investing world, individual investors can also make investments in companies and funds that positively impact society. It doesn’t take much to start an impact investment portfolio.
1. Decide what type of investment you want to make, whether that’s in a stock of a company, an exchange-traded fund (ETF) with an impact investing strategy, or bonds.
2. Next, research the different companies and funds, and find a diversified selection that fits your desires.
3. Finally, make your investment with a brokerage and monitor your portfolio to ensure that your investments have a positive impact.
In order to become an impact investor, it’s wise to consider both the financial potential of an investment, as well as its social, environmental, or economic impact.
Some investors have a higher risk tolerance than others, and some might be willing to take a lower profit in order to maximize the positive impact of their investments.
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The Takeaway
There is no one-size-fits-all answer to how to balance financial return and social or environmental impact. Impact investors must make investment decisions that are aligned with their values and objectives.
Not all impact investments are created equal. Some impact investments may have a higher financial return potential than others but may also have a lower social or environmental impact. Similarly, some impact investments may have a higher social or ecological impact but may also have a lower financial return potential. Impact investors must consider both financial return and social or environmental impact when making investment decisions.
If you’re interested in investing in individual companies or a socially conscious ETF, SoFi Invest® can help. With SoFi’s active investing and automated investing tools, you can research various companies and investment funds. Once you decide what type of impact you’d like to have and your financial goals, you can trade stocks and ETFs with as little as $5 in the SoFi app.
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