Impact Investing

Impact investing is an investment approach or strategy often opted for by individuals who want to contribute to society and the environment while making financial gains. Its main objective is to promote Corporate Social Responsibility (CSR) by companies and serve the community by making use of monetary investments.

Investors choose companies that are actively involved in serving society and wish to make an impact. Such investments mainly contribute to education, renewable energy sources, charity, etc. Therefore, governments can leverage and promote impact investing for the social and economic welfare of their people and the environment.

• Impact investing is a newly accepted type of investing where individuals make financial gains and contribute to society's welfare at the same time.
• Impact investments are commonly made with firms that have a good sense of corporate social responsibility and share the investors' enthusiasm to do good to the community.
• Socially Responsible Investing (SRI) and Environmental, Social, and Governance (ESG) are modifications of impact investments. 
• These investments are extremely important in today's world, where economic development takes place at the expense of the environment.

Impact investing as a belief appealing to investors' conscience has always been prevalent. But impact investments as a global trend started gaining prominence in 2007. Later, the Global Impact Investing Network (GIIN) was established in 2009 to bring the impact investors together and share knowledge and investment approaches. The GIIN also focuses on reducing investment barriers and identifying impact investing companies.

Now, let's focus on how impact investments work. First, investors can choose from firms with an attractive social responsibility level. Then, they can decide where to contribute – charity, environment, clean energy, etc., and rule out firms that fall outside their purview. Now, they can consider the financial performance of the companies and decide which one to invest in.

Some of the variations of impact investments include Environmental, Social, and Governance (ESG) and Socially Responsible Investing (SRI). All these investment methods go beyond traditional investing and commit to society and aim at delivering minimal negative impact to the environment and society, but with minute differences.

ESG promotes corporate social responsibility, but the focus is largely on the financial returns. At the same time, SRI involves selecting companies based on certain moral and ethical criteria which appeal to the investors' conscience.

Currently, there are many accepted measures to calculate the returns on investments (both financial and social). The method recommended by the GIIN is the Impact Measurement and Management tool. In addition, the GIIN has introduced an IRIS+ system to help investors measure and optimize their returns.

Another metric introduced by the Bridgespan Group and the Rise Fund is the Impact Multiple of Money to calculate the value of impact investments. Social Return on Investment (SROI) is another such measure. Investors can use any metric they find appropriate for their investment.

Let's look at some examples of impact investments to understand the concept better.

Example #1

John has been investing for almost two decades now. He wishes to contribute to society. Therefore, he decides to start investing in impact investments. As a first step, John becomes a member of the Global Impact Investing Network and studies the concept. Then he invested in the firm XYZ, known for conducting large-scale research on renewable energy sources. John was surprised to see that he got better returns. He was also satisfied with being a responsible citizen and serving the community.

Example #2

Consider this real-life case of how the Russia-Ukraine war disclosed the gap in the impact/of ESG investing. Before the war, several impact investment rating firms rated many Russian companies high. But after the war began, with increasing sanctions, many rating firms suspended the scores for the Russian companies. Also, investing in these companies has become a loss for many investors.

Heavy criticisms have been regarding the inability of ESG and impact rating firms to predict counter-productive events. But many rating firms argue that investing solely based on impact scores is not recommended, while others claim that it is impossible to predict such political events.

Social impact investing is a strategy gaining prominence today, and for very obvious reasons:

1. Win-win situation – It gives investors financial returns while helping them give back to society.
2. Promotes CSR – It encourages corporate social responsibility and pushes companies to contribute more than just making profits. It also reduces the negative externalities of economic activity on the environment.
3. Develops sustainable businesses – It ensures that impact investing companies are ready to commit to society's develop and profit; their continued growth can constantly benefit the community.
4. Benefits society – It encourages social welfare, sustainable development, and environmental protection.
5. Better ROI – It is proven that impact investing funds give better returns in 88% of investments, according to a GIIN survey conducted in 2020.

This has been a guide to Impact Investing and its definition. We explain how impact investment works, examples, types and why it is important. You may learn more from the following articles -

• Contrarian Investing
• Factor Investing
• Ethical Investing