Impact investing is a strategy that aims to deliver positive returns for both your portfolio and society as a whole. The impact investing approach is becoming ever more popular among investors today, especially Millennials and Generation Z.
What Is Impact Investing?
Impact investing is when investors pursue strategies that create positive environmental or social benefits, in addition to strong investment returns.
“[Impact investing] provides a way for investors to be more proactive with their investment dollars and partner together to make purposeful investments that can contribute to affecting real change across the globe,” says David Spika, president and CIO at GuideStone Capital Management.
It’s important to note that an impact investment is not an act of charity. Impact investors are always hoping to turn a solid profit and even beat the market. It’s just that they have additional goals that transcend the pursuit of maximum returns on investment.
Let’s say you had a choice between investing in a big oil company or a solar panel startup. If you took the standard investing approach, you’d only consider which choice offered the best financial return. An impact investor would also take into consideration the environmental impact of both businesses, together with their potential returns.
An impact investor would choose the solar panel company, especially if the expected return is similar. If the oil company offered superior ROI, an impact investor might still opt for the solar panel company, due to its positive environmental impact compared to oil.
Impact Investing Examples
Impact investing covers a range of different assets and investment strategies. Essentially, any investment that is trying to meet the goal of profit plus positive social or environmental outcomes could be considered a form of impact investing.
Some examples of impact investing include:
Investing in the stock of a technology company that’s looking to develop better water treatment and purification techniques.
Buying mortgage-backed securities whose goal is to fund affordable housing for low-income communities.
Setting up private investment notes to finance resources for low-income communities, like substance abuse treatment facilities and employment centers.
Offering loans to support small business owners in developing countries through a microfinance impact fund.
All these investments follow a goal to improve the world, but they also have the potential to generate a profit, too. To reiterate, it’s not charity.
Impact Investing vs Other Responsible Investing Strategies
Impact investing is not the only strategy for putting your money to work in support of positive social and environmental values. You might have heard of other responsible investing approaches, like SRI Investing or ESG investing.
Impact Investing vs SRI Investing
SRI investing stands for socially responsible investing. This approach looks to put your money in companies that support your moral values while avoiding those that do not.
“Compared to impact investing, SRI investing is generally more exclusionary in nature, meaning specific investments are restricted if they are not compatible with a defined set of principles or ethical guidelines,” says Spika. For example, an SRI investment strategy may aim to avoid putting money in oil, tobacco or gun companies, depending on the investor’s values.
“This approach tends to place greater focus on a more basic ‘do no harm’ philosophy and doesn’t typically take the overt step of seeking organizations that proactively attempt to be positive contributors to society,” he notes. Impact investors on the other hand are generally more proactive in finding investments that actually create positive change versus just avoiding ones that cause harm.
Impact Investing vs ESG Investing
Investors hoping to positively impact the world through their investments may also consider environmental, social and governance (ESG) investing. Under this approach, investors look to score investments based on the impacts companies have on the environment and society as well as how the company is run internally.
ESG investors aim to make investments that ESG ratings agencies judge as performing high in each of the three categories while avoiding those that do poorly. Compared to impact investing, once again the focus is more on avoiding poorly scoring investments whereas impact investors are more proactive in creating positive change.
Impact Investing, ESG and SRI Have a Lot in Common
Nevertheless, there’s a lot of overlap between impact investing, SRI investing and ESG investing, which sometimes creates confusion among investors new to the space.
“The issue in the U.S. lies in the fact there are currently no uniform rules or definitions around what this type of investing really means,” says Daniel Milan, managing partner and investment advisor at Cornerstone Financial Services. He notes that some bad actors also know these systems and try to game their ESG score.
“Making matters worse, some firms get crafty when it comes to SRI/ESG, with one of the biggest examples of this being “greenwashing.” This is when a company overstates or exaggerates their positive impact on sustainability, including sometimes even intentionally fabricating false information.”
Does Impact Investing Deliver Lower Returns?
Because socially conscious investing focuses on more than just purely turning a profit, you might think that its returns trail those of other investment strategies.
But by and large, impact investing hasn’t negatively impacted investor returns, according to a review of international investment studies by the Royal Bank of Canada. In fact, there are even some studies showing that impact/ESG investing can actually outperform regular portfolios, something SRI/ESG portfolio managers are eager to promote.
In Milan’s experience, this is perhaps too optimistic–or at least is missing the point. “On average and on a risk-adjusted basis, SRI/ESG funds perform about as well as their benchmarks, neither better nor worse,” he says. Rather than trying to outperform the market, “the primary motivation for using this strategy should be about doing good and the positive feeling you receive from that, not about generating superior returns.”
And as with all investments, though, what you choose to invest in will ultimately help determine your returns.
“Impact investing can run the gamut from philanthropic (i.e., the financial return is expected to be below market or nonexistent) to market-rate (i.e., the financial return is expected to more closely resemble broad-based investment exposures),” Spika says.
Regardless of their impact investing strategy, the vast majority of impact investors (91%) were pleased with their performance, according to the Global Impact Investing Network’s (GIIN) 2019 Annual Impact Investor Survey.
Is Impact Investing a Good Fit for You?
If you’d like to pursue purpose, passion and profit with your investing dollars, impact investing may be the right strategy for you.
Before you start making impact investments, though, make sure to research carefully to be sure that the organization or company you wish to invest in truly does deliver societal value.
This may be easier said than done given the lack of consistent standards regarding SRI, ESG and impact investing, which is why you may want to consult an expert, like a financial advisor, when navigating impact investing.