Impact investing has been described as the new frontier for socially responsible investing. The strategy, targeting a financial return and an (extra-financial) impact, can be implemented in listed as well as unlisted markets. Here is what you need to know.
What is impact investing?
In impact investing, investments are to contribute to a measurable positive social and/or environmental impact alongside earning financial returns. It is about investing in companies, projects and financial vehicles that have identified a social or environmental problem – limited healthcare access, poor housing or global warming – and that are working on addressing that problem.
An impact investor would help finance these solutions so as to accelerate their development and enable their scaling to maximise the impact.
Let’s take an example: digitalisation in the healthcare sector improves treatment quality, patient safety and access to care, helps contain costs and hospital stays, and avoid preventable mortality. To address these issues, an impact investor would invest in companies providing digitalisation services to hospitals for medical documentation, patient management, or emergency room workflows.
While impact investing represents the smallest sustainable investment approach in terms of assets under management, it is enjoying healthy annual growth (in terms of CAGR).
Impact investing capital can be allocated across asset classes. Traditionally, impact investing has particularly lent itself to private markets, especially private debt. However, we see impact strategies emerging in listed markets. In a future article, we will examine the specific application of impact investing to private equity.
In terms of impact performance goals, strategies can target the full range of sustainability objectives, ranging from social to environmental goals.
By sector, popular segments have included energy; financial services; forestry; food and agriculture; microfinance and healthcare.
Are impact investors sacrificing returns?
While numerous investors pursue responsible and sustainable goals through their allocations, many also find the financial attractiveness of impact investing relative to other investment strategies ‘at least somewhat important’, seeking risk-adjusted, market-rate returns for their assets.
This shows the notion of an inherent trade-off between impact and financial performance is not valid.
Impact investing offer a wide range of investment strategies, with different types of financial and impact risk and return profiles from which investors can choose, depending on their objectives – see Exhibit 1.
Exhibit 1: Target financial returns primarily sought (percent of respondents; n=294)
Source: GIIN 2020 annual impact investor report
What are core characteristics of impact investing?
Adding an impact objective to the investment process affects what you invest in and how you invest. It influences the nature of the investment process and requires resources and skills that are different from traditional investing.
There are three core characteristics that set impact investing apart from other investment strategies:
Capital should be invested with the explicit intention of solving an issue of sustainable development, that is, contributing to a positive social and/or environmental impact which is aligned with the UN Sustainable Development Goals (SDGs), or other widely accepted sustainability goals.
Impact should not be a by-product of the investment strategy, but at its core.
An impact investor should aim to make a specific, credible and direct contribution to the achievement of the impact; their investment actively adds to the impact, for example, through engagement, by providing technical assistance or helping to scale the impact by attracting other pools of capital.
An impact investor should be able to demonstrate that as a result of the integration of impact considerations in the investment selection process (through the use of impact metrics, for instance), the investment universe of the portfolio differs materially from a standard universe.
The investor should set measurable, realistic, evidence-based goals for what the investments should achieve over a defined time horizon before making the investment.
The goals are used to manage and measure impact performance throughout the investment process and are the basis for transparent, public and regular reporting.
Regarding embedding impact in investment processes, standards are emerging. One such standard is the Impact Principles, to which BNP Paribas Asset Management is a founding signatory.
We are currently working on developing an internal framework for impact investing based on the Impact Principles and the three core characteristics of impact investing outlined above.
What is behind the rise of impact investing?
More and more sustainability-linked risks can have a negative impact on countries or industries. These include extreme weather, environmental damage linked to human activities, infectious diseases and biodiversity loss.
Fortunately, these risks are increasingly being recognised by governments, the private sector, civil society, academia, etc. That recognition includes the awareness of the need for system-level responses involving multiple stakeholders and sectors.
Solutions are estimated to cost USD 5-7 trillion annually. It is clear that the public sector does not have the means to address these challenges. Investors have a role to play.
In parallel, since these sustainability challenges are transforming economic sectors, investors must take them into account from a risk perspective, including them not only in their scenarios and outlooks, but also in their assessments of the investment strategies, assets and issuers they invest in.
Apart from an awareness of the need for active asset selection, investors are also increasingly taking on the role of engaged stewards.
Addressing the sustainability challenges presents business opportunities. It is estimated that investment in the SDGs could unlock opportunities worth about USD 12 trillion and create 380 million jobs a year by 2030. There are economically viable and attractive ways to address these challenges. That also attracts investors.
Finally, on the demand side, there is growing appetite for responsible investment products, and more importantly, for products with a positive impact, from the general public. This is a sign of changing consumer behaviour, which is promoted by governments. All of this is driving the rise of impact investing.
 Compound annual growth rate; see GSIR-20201.pdf (gsi-alliance.org)