Impact investing: Everything you need to know

The responsible investment market has seen rapid growth in recent years – becoming an alphabet soup of acronyms, each describing a slightly different approach.

Of all the different types of ethical investment, the fastest growing is “impact investing”.

What is impact investing?

Impact investments are those that target companies making a positive social or environmental impact, alongside a financial return for the investor.

Impact investing isn’t a new concept, but had previously been confined to institutional and high net worth investors. Today, it is making its way into the mainstream.

How big is the impact investing market?

A recent report from the Global Impact Investing Network said that the global impact investment market is now worth more than half a trillion dollars and is one of the fastest-growing areas of asset management.

Who is making impact investments?

The growth has been driven largely by younger investors, who want to ensure that their long-term savings are not supporting unethical companies.

Why impact investing?

Other than the obvious social benefits, there is also a compelling investment case for impact investment.

Companies whose products and services can solve some of the most pressing social or environmental problems should have a ready market and therefore strong growth characteristics.

At the same time, these companies may be supported by regulation as policymakers seek to bring about change with legislation. These may be companies that help recycling, or generate power from renewable sources.

How do you measure “impact”?

It is relatively easy to measure a company’s financial return. Investors can look at revenues or profits.

However, measuring their “impact” is less tangible and early attempts at impact investing struggled to show that they were really making a difference.

The cause has been helped by the development of the UN Sustainable Development goals. These 17 goals aim to address the key global challenges, including those related to poverty, inequality, climate, environmental degradation, prosperity, and peace and justice.

Many impact investment funds now use these as a framework to measure a company’s impact. Companies also use the Gates Foundation and World Health Organisation to inform their assessment of “impact”.

How do companies make sure they’re being ethical?

Many of the major UK investment management groups now offer impact investment funds. These will invest in a diversified range of “impact” companies. Most require that the impact should be intentional. In other words, it’s not enough to be ethical by accident – it needs to be part of the explicit goals of the company, built into its culture and its mission statement. It needs to be the majority of what a company does and make a material difference to the company’s fortunes.

Investors in this area may find that their portfolio has more smaller companies. As sustainable investing has entered the mainstream, the companies involved are now far bigger, more mature and profitable. However, the larger a company becomes, the more its impact may be diluted. As such, many fund managers will stick with smaller companies where the exposure is “pure”.

The UK is one of the best places to do it

The UK has been a notable pioneer of impact investment. In June of this year, it launched an impact investing organisation to help promote growth of this area.

The Impact Investing Institute is backed by the government and led by former Allianz Global Investors CEO and vice-chair Elizabeth Corley. It is designed to help direct capital to some of the major social challenges and ensure the UK leads the charge for impact investing.

Impact investing is likely to grow in popularity. New companies are launching all the time, giving investors more choice about where to invest. These companies have an important tailwind in growing their revenues and profits as the world wakes up to the need to address long-term challenges, such as climate change, poverty and education.

What about the rest of the world?

Equally, impactful companies may be concentrated in areas with more problems. For example, China’s pollution problem has led to real innovation in electric cars and alternative energy solutions.

Emerging markets as a whole tend to have more impact companies because that is where some of the world’s most pressing problems hit hardest. Equally, while banks in developed markets are considered distinctly unethical, in emerging markets they have an important social purpose – spreading financial inclusion and facilitating micro-lending, for example.

Those targeting impact investing may find themselves invested across the globe.