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Impact Investing: What You Should Know

4 Mins read
Illustration showing impact investing

Key takeaways

  1. Impact investing is an investment strategy that aims to contribute to social impact growth and development.
  1. Creating impact for social good while intending to make financial returns is the distinguishing factor between impact investing and other forms of investments.
  1. The investment strategies that apply to other kinds of investments also apply to impact investing.

What is impact investing?

Impact investing according to Wikipedia refers to investments made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return.

It is an investment strategy that aims to contribute to social growth and development while looking at a possible financial return.

Characteristics of impact investing

  • Measurement of impact: Impact investing is generally expected to measure the impact it’s creating to foster transparency and accountability. It is also a way to give feedback to stakeholders.
  • Return on investment: Impact investing is not totally a philanthropic gesture, investors still aim to have a return on their investment, at least on the capital as part of the way to measure growth.
  • Intentionality: The consistent difference between impact investing and any other form of investing is the intention behind the investment. Impact investing is driven by the desire for social good.

Benefits of impact investing

  1. Return on investment: There is a promise of return on investment. Investors are looking to raise capital for investment plans that will create social impact while ensuring the profitability of the transaction. Impact investing provides an opportunity for investors to create lasting social impact while making money.
  1. Positive social impact: Impact investing as the name suggests is an avenue to create a positive social impact on society through investing. Investors who are looking to build legacies or raise capital that will uphold social good use it as a means to achieve their goals.
  1. Job creation: One benefit of creating a social impact through investing is the creation of job opportunities. Social impact doesn’t just create room for infrastructural development, it also provides opportunities for people who are beneficiaries to replicate this impact in their environment.
  1. Balance of risk and reward: The balance of risk and reward is a motivating factor for impact investing. As with other kinds of investments, knowing that there is a possibility of reward alongside the risks involved is one of its benefits. It is not just an investment for financial gain, but also for social impact.
  1. Diversification of portfolio: With impact investing, investors are able to diversify their portfolios across different sectors and industries. This provides them with the experience and expertise to make informed decisions that affect people in different stages of life. 

How does impact investing work?

  1. Identifying Impact Goals: Impact investors begin by identifying the social or environmental challenges they want to address. They may focus on areas such as climate change, poverty, access to education or healthcare, or sustainable development.
  2. Identifying Investment Opportunities: Once they have identified their impact goals, impact investors search for investment opportunities that align with those goals. This may involve evaluating companies, organizations, or funds based on their social or environmental impact, as well as their financial potential.
  3. Making Investments: Impact investors then make investments in the opportunities that align with their impact goals. These investments may take various forms, such as equity, debt, or other financial instruments.
  4. Measuring Impact: To ensure that their investments are generating the desired social or environmental impact, impact investors measure and evaluate the outcomes of their investments. This may involve tracking metrics such as carbon emissions reductions, poverty alleviation, or increased access to healthcare or education.
  5. Balancing Financial and Impact Objectives: Finally, impact investors balance their financial and impact objectives, seeking to generate a financial return while achieving their social or environmental impact goals. This may involve trade-offs between financial return and impact and requires ongoing evaluation and management of their investments.

Mutual funds, ETFs, hedge funds, etc can be used as the investment vehicle to push impact investing.

What are the challenges of impact investing?

  1. Financial loss: With impact investing, the effort to make an impact alongside making a return on investments poses a lot more risk for investors. There are chances that decisions that will create positive social impact might not necessarily bring more profit and this can lead to financial loss in the long run.
  1. The underachievement of social impact: Since the goal of impact investing is to create social impact, it is expected that there will be metrics put in place to measure this impact. When the level of impact does not measure up to expectations, it can affect subsequent investment decisions.
  1. Negative reputation: As with all things connected to people and social good, a good reputation is important. In cases where things do not go as planned or when the desired impact estimated is not reached, it might begin to have a negative influence on the reputation of the investors. This can affect subsequent interactions with the public.
  1. Policy regulation: When government or regulatory agencies make decisions that are not in line with the goals of an impact investing firm, it influences their plans and investment strategies. Inconsistency in policy regulation or the inability to predict policy changes can also affect how impacting investing works.
  1. Change in mission: Having established that the main goal of impact investing is to create social impact through investing, what happens when the mission of a firm changes? How will they create a balance between creating impact and making a profit? A change in the mission of a firm will affect impact investing in the long run.

Is impact investing profitable?

Although the main goal of impact investing is to contribute to social growth and development, it still aims to make profits. Like any kind of investment, there is the risk of loss involved. If you intend to be an impact investor, rest assured that you can make a profit from it. 

What’s the difference between ESG and impact investing?

ESG investing is a screening approach to investing, where investors seek to avoid companies that do not meet certain environmental, social, or governance criteria, while impact investing is an intentional approach to investing, where investors seek out opportunities to invest in companies that are intentionally working to create positive social or environmental impact.

Bottom Line

Impact investing goes beyond making profits, it is creating a lasting impact in society. Despite the fact that it is aimed at social good, it is still a kind of investment. Hence, you still need to conduct due diligence on the options available to you and seek professional advice from your financial advisor.

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