Impact Investing

More than $700 billion is now invested in impact funds, according to the Global Impact Investing Network. That number is over five times higher than it was in 2017, showing just how quickly impact investing is growing. Broadly, impact investments have outperformed the broader stock market in recent years, so it makes sense that investors are paying more attention to the space. Let’s take a closer look at what impact investing actually is and how you could get involved. 

What is impact investing?

As well as making money, many investors want their investments to have a positive impact on the world – or at the very least, not a negative one. That’s where impact investing comes in. While ESG is a broad term that generally focuses on how companies conduct themselves, impact investing is about sustainable outcomes.

An impact investor usually wants their money to contribute to positive change in the world, often secondary to the goal of growth or income. There are several ways to analyse whether an investment will have a positive impact, and we’ll discuss them here. We’ll also look at some of the big myths around impact investing, and show you how to get started.

By the end of this article, you’ll hopefully know:

• What impact investing is, and how it differs from other types of sustainable investment
• How to evaluate the impact of any investment you make
• Common misconceptions about impact investing
• What to look out for when making impact investment decisions

Getting into impact investing

There’s more than one way to make an impact with your investments. Here, we’ll focus on impact investing as it relates to the stock market: that’s buying shares of publicly listed companies. This might not be something that’s appropriate for everyone’s risk profile, as it is generally higher risk than investing into something like funds. However, as individual stocks often make up funds and are the underlying to a lot of other investments, it’s the easiest way for us to look at it. It doesn’t mean you too have to undertake these investments, rather understand the strategy that other professional managers may follow. As always, if you’re in any doubt about your investment choices, it might be worth speaking to a qualified financial professional to assist. 

Based on the UN’s Sustainable Development Goals, there are two key aspects that your investment in a company can affect: people and the planet. Work conditions, wages, and social security are things that will affect people. As for the planet, it’s more to do with use of natural resources, the environment, and so on.

But assessing the impact of any investment on those two aspects isn’t necessarily straightforward. Take an airport, for example: given it enables planes to fly, and they’re major global pollutants, you might argue an airport has a negative impact on the planet. You could say it’s therefore a bad fit for an impact portfolio. But this particular airport is a huge local employer – one that pays its workers a living wage, makes generous pension contributions, and has great benefits. In other words, its impact on people is positive.

This trade-off between the positive people impact and the negative planet impact is something you’ll come across a lot in impact investing, and it isn’t easy. There are various ratings agencies out there that can help assess and give companies various scores based on their activities. 

If you’ve ever looked into sustainable or impact investing, you’ll already be aware of the complexities. You’re probably wondering how everybody else measures and assesses impact investments to navigate the trade-off. Unfortunately, that’s done with great difficulty: there are no global standards, a lot of competing definitions and no perfect solution.

That being said, one leading measure is IRIS, which considers what an investment will do, how many people it’ll help, and by how much. But quantifying these things is tricky. Some governments try to put an “economic value” on a human life (it’s around $10 million for US citizens). But measuring the relative impact of activity in different parts of the world is no mean feat. It’s worth looking at the criteria different firms use to measure impact though, and seeing how much you agree: there is no answer that’s right 100% of the time.

Ultimately, this means that there are many investment funds seemingly doing the same thing – but exactly what’s going on is calculated differently at every turn. The sheer range of definitions, categories, and methodologies might suit institutional investors just fine – some of them are partly to blame, after all – but retail investors are often left confused. So let’s dive in to the myths and misconceptions to straighten some things out.

Impact investing myths

Myth #1: Impact investing and ESG investing are the same

Impact investing is not ESG investing: they aim to do different things. Impact investing is all about positive sustainable outcomes, while ESG is an investing framework that takes into account risks to the financial value of an investment from environmental, social, and governance factors. Taking ESG into account doesn’t mean that an investment is just making a positive impact, but it can help move things in the right direction.

Myth #2: Impact investments are clearly labelled

Unfortunately, that’s not the case – which has led to companies and funds being incorrectly labelled as impact-friendly. Transparency issues are partly to blame: investors looking at Boohoo, for instance, may have focused on the details the online fashion company disclosed around its social and environmental targets. But they might’ve missed the ones it didn’t disclose about its supply chain, including workers’ conditions. The practice of “greenwashing” reflects another transparency problem – that’s making investments sound environmentally or impact friendly to attract capital.

Myth #3: Impact investing means avoiding companies that “do bad”

Sure, one way to ensure your investments have a positive impact is to avoid those that might have a negative one. But it’s not the only option: some of the biggest investors in the world use an “engagement” strategy. That’s where a fund, rather than selling off or avoiding companies that might be poor employers or high polluters, takes a big enough stake in those companies to have an influential seat at the table – and uses that influence to push them toward positive change. This is another example of ESG, which is why you might sometimes see the ‘big nasties’ in ESG funds- as they’re not all about pure impact.

Myth #4: Impact investing has poor returns

Impact investing today has returns than almost ever before, given that climate change is becoming a bigger and bigger topic. Some funds may intentionally invest for below-market returns if that lines up with their strategic objectives, but two-thirds of them pursue competitive and market-beating returns. The reason that they may underperform is because their goal is the impact rather than the growth, which might still appeal to some. Nonetheless, impact investing and poor returns don’t go hand in hand – far from it.

Making impact investments

Hopefully you’re picking a fair amount up about impact investing and assessing if it might be a strategy that you want to introduce in some way to your investing. The next step is to consider what you might want to look out for when making impact investment decisions.

Investing in an impact fund could be a smart move: you’d be putting your money into a basket of companies that are making the world a better place all at once. Many of these funds are relatively easy to access, offer large amounts of diversification and should detail their strategy in their key information documents. It’s worth noting that they might come at a higher cost than individual stocks. 

Different funds have different criteria for investment: you might find one that focuses on solar energy firms, while another invests in recycling companies. Of course, it’s up to you to pick funds that invest in areas you care about and that align with your investing knowledge and risk appetite.

When it comes to selecting impact investment funds, keep the following in mind:

• It’s important to identify funds that are accessible, trustworthy, and offer control and choice
• It’s equally important to identify transparent funds – where you understand what they’re investing in and why, so you can decide whether that aligns with your values
• As with all investing, a rating or investment view might change over time as companies shift and funds refocus: it’s worth regularly revisiting your impact investments to make sure they’re still doing the good you want
• Lastly, make sure that your finances (including an emergency fund) as well as research are all in place before going forward with impact (or any!) investing