Understanding Impact Investment
Over the last couple of years, we have had lots of interest and many great conversations about “impact investing”, but the term has false precision. We wanted to share our definition of impact investing, and how we think about making great investments that also have a positive social and environmental benefit.
First, a few definitions.
There are countless definitions of ‘impact investing’, and the label continues to be applied to many different investment activities. To The Impact Fund an impact investment is one made to generate positive and measurable social and environmental outcomes, alongside a market standard financial risk and return. A couple of points here deserve clarification:
1. Investments are made to “generate” positive outcomes. We believe that the world should be a better place as a result of our investments. Our investments should add positive social and environmental impact to the status quo compared to if we hadn’t invested.
2. Investments should have a “market standard financial risk and return”. It’s critical that impact investors, pursuing their social and environmental goals, don’t compromise returns (or accept higher risks than they otherwise would). If we ever compromised our risk adjusted returns, we begin to blur the line between our work and philanthropy. There are already amazing philanthropists and charitable organisations in the world, and we don’t exist to substitute funds flowing to them. We require market returns so we are a substitute for investment portfolios, not philanthropy.
Much of the confusion with the ‘impact investment’ term comes from its similarity to other socially-minded investment strategies. We think about impact investing as a sub-set of a broader term — ‘responsible investing’ — which encompasses a range of different approaches to investing. Two popular responsible investing strategies are ‘negative’ screening and ‘positive’ screening:
- Negative or “ESG” screening: excluding certain investments, perhaps based on an investor’s ethical values. Imagine an investor selling their shares in coal or tobacco companies.
- Positive screening: investing into companies that score strongly on environmental, social and governance metrics. This approach might see an investor buying the shares of a mining company that scores well compared to its peers in carbon emissions, employee safety metrics, or governance measures.
Why does impact investing exist Part 1? Additionality
Impact investments are different from negative and positive screens because they aim to create additional, positive social and environmental impacts. This ‘additionality’ requirement can be a challenge for impact investors, because it requires deep thought and consideration about the full effects of an investment.
To illustrate the point — we have encountered investments that could have unintended negative consequences (despite having the best intentions). Renewable projects developed with little regard for the supply chain of their solar panels may inadvertently support poor labour practices. Affordable housing projects may see some of the most vulnerable members of society evicted from their cheap rental homes so land can be acquired for large residential developments.
At The Impact Fund, we focus on really, really investigating and testing ourselves on the full and deep social and environmental consequences of our investments. We owe it to our investors as fiduciaries for their capital. Applying this level of thought is why we exist.
Why does impact investing exist Part 2? Investor thought and focus
As fiduciaries of capital, and consistent with our stringent approach to impact investing, we don’t compromise our financial returns when making impact investments.
We are often asked whether impact investors can really have an additional positive impact if they are providing financing just like any other investor? (In some cases, impact investors can be more expensive forms of capital, such as when they come with large impact reporting requirements.)
The answer to the above is of course a resounding YES! As with any other form of investment, an investor adds value not only by providing the cheapest form of financing, but by turning over rocks, and finding investment opportunities that others don’t see. As impact investors, our investment universe is often smaller than other market participants (being limited to only socially and environmentally beneficial assets). It often also requires a level of expertise only gained through being solely focused on impact investment.
At The Impact Fund we get to know our investment universe incredibly well, build relationships, and when an investment opportunity arises within this universe, we do more work than others to assess whether it’s a good investment. An investor with the whole market to invest into may be tempted to find easier investment opportunities elsewhere. Just like any capable venture capitalist or property developer in their respective industries, by finding opportunities where others aren’t looking, an impact investor can create additional socially beneficial assets while earning attractive returns for investors.
Watch this space — The Impact Fund will be announcing great new impact investments shortly
