That’s without doubt as good a definition as any, but it still leaves a lot of room for interpretation.
Fortunately, the United Nations Development Programme (UNDP) has provided three guiding principles which help to define and differentiate impact investments.
- The expectation of a financial return;
- The intention to tackle social or environmental challenges;
- A commitment to measuring and reporting against the intended social or environmental impact.
So what do these actually mean?
1. The expectation of a financial return
Traditionally the view was that there was a price to be paid for impact investing in that the returns to be made would not be as generous as from investments made purely with an eye to financial gain.
In fact, there is a mounting body of evidence to suggest impact investments can give returns which are as good as, if not better than, non-impact investments.
Recent research shows that, of more than 2,200 academic studies, more than 90% of them have found environmental, social and governance (ESG) factors have a positive or neutral impact on financial returns. There has also been a survey by the GIIN and JPMorgan which found that 55% of impact investment opportunities result in competitive, market rate returns.
Simply put, whilst it may have once been the case you had to forgo strong financial performance if you wanted make an impact with your investments, that's no longer the case today, and the two can go very much hand-in-hand.
2. The intention to tackle social or environmental challenges
In the words of UNDP:
"In addition to a financial return, impact investors aim to achieve a positive impact on society and/or the environment"
Here, again, there has been a shift in understanding.
UNDP points out that supporters of inward investment challenged the view that development is achieved only by social assistance or philanthropy, and that business and investment are important drivers for achieving more inclusive and sustainable societies. Therefore, they argue that impact investment can achieve both a positive social or environmental impact and a financial return - or, at minimum, a return of capital.
In a recent article, Mark Haefele, chief investment officer of UBS global wealth management, makes the point that traditional criticism of sustainable and impact investing was mistaken in comparing non-impact investing with “exclusion” investing or the exclusion of ethically questionable investments.
But, he argues, impact investing is now about far more than merely avoiding certain socially harmful activities. It can also be about funding good things; in businesses or projects that have a positive social impact. As Haefele points out, when impact investments are added to the definition of impact investing, the returns available to the investor look far more attractive.
According to GIIN, the mean internal rate of return for the Impact Investing Benchmark is 5.8% and is higher in emerging markets at 6.7% than in developed markets (4.8%). Their report shows top quartile returns above 9.7%, while a Wharton study found a gross internal rate of return of 9.2% and a McKinsey study found an average return of 11%. These rates are comparable to market rate returns.
3. A commitment to measuring and reporting against the intended social and environmental impact
Impact investors commit to measure performance using standardised metrics.
Profits and rates of return can be calculated according to internationally agreed standards, but how do you objectively measure the positive social or environmental impact of an investment in such a way that it can be measured against other investments?
UNDP makes a number of points here:
- A commitment to transparency and rigorous reporting is essential;
- The resources devoted to demonstrating impact should be proportional to the liabilities;
- Reliable metrics should allow investors to understand if the performance of the investment is consistent with its impact mission;
- Setting industry standards for measurement can help establish trust and compare products, such as the Impact Reporting and Investment Standards (IRIS) and the Global Impact Investment Rating System. IRIS metrics are selected or developed through a formal and open process that includes review and inclusion of existing third party standards, input from expert working groups and advisors, and feedback from users and the public.
The importance of agreed standards by which impact investments should be judged has been underlined in recent weeks by a new study, which says that many large-scale hydropower projects in Europe and the US have been disastrous for the environment.
Such projects would have been considered perfect examples of impact investments, with the prospect of providing developing countries with much needed power, and doing so without using fossil fuels and contributing to global warming.
However, research has revealed a different story. The authors of the report ‘Sustainable Hydrpower in the 21st Century’ fear that the unsustainable nature of these projects – thousands of which are now being planned for rivers in Africa and Asia - has not been recognised in the developing world.
More than 90% of dams built since the 1930s were more expensive than anticipated, have damaged river ecology, displaced millions of people and have contributed to climate change by releasing greenhouse gases from the decomposition of flooded lands and forests.
The building of dams in Europe and the US reached a peak in the 1960s and has been in decline since, with more now being dismantled than installed. Hydropower only supplies approximately 6% of US electricity and dams are now being removed at a rate of more than one per week on both sides of the Atlantic.
Regarding hydroelectric projects planned for the developing world, the report says:
"The sustainability of these undertakings is commonly insufficiently scrutinised by those promoting them. The priority in large dam construction is to generate energy to serve growing industries and urban populations—these two things often overwhelm socioeconomic and environmental considerations. Left behind are local communities saddled with socio-environmental damages and loss of livelihoods."
This must serve as a salutary warning of the crucial importance of assessing social and environmental impact against agreed and common standards.
Impact investing is becoming mainstream and it’s coming of age. It’s important at this stage of its development that there should be a general consensus as to what makes an investment qualify as a true impact investment. As part of this it’s essential – in considering the strengths and weaknesses of a proposal - that the positive impacts can be accurately measured and that any potential negative impacts are also taken into account.
This will prevent any potentially damaging loss of faith in what promises to be, and is increasingly recognised to be, a valuable tool for improving the world in which we live.
Exploring the world of impact investing
Making impact investments is something more investors than ever are wanting to explore. Having been a possibility for many years now, it's only in recent times that it's truly started to head towards the mainstream.
With the United Nations involvement alone showing the importance and wide-scale promotion of such investments, there has arguably never been as good of a time as now to discover the immense potential of impact investing.