Investing for a diversified portfolio is probably the most critical ingredient to building and preserving wealth. In today’s blog, we want to talk about a specific type: social impact investing. We have written about a similar topic before: ethical, or socially responsible, investing. Oftentimes these two investment styles get conflated, but there are some key differences. Nevertheless they are certainly related.
In this article we will discuss some of the differences between ethical and social impact investing, but we will also define, describe, and delve into this special kind of investing. It is gaining popularity at a rapid speed, and for a good reason. Social impact investing is a fantastic way for investors to both generate money and foster positive, socially responsible changes.
What is Social Impact Investing?
Social impact investing is a relatively new term; it was coined in 2007, but the basic concept has been around for much longer. Essentially, social impact investments are a category of investments meant to achieve positive social and environmental impacts alongside a financial return.
What distinguishes social impact investing from, say, socially responsible investing is that impact investments aim to provide measurable impacts.
Other than the key criteria of achieving a financial return and generating positive impacts, much of the rest of social impact investing is up to the individual investor. These investments can be made in developed or emerging markets. And they can target a wide range of market rate returns, depending on the specific goals of the impact investor or impact investing fund.
Social impact investing occurs in many sectors.
Common sectors seeing impact investments are those that address some of the world’s most pressing issues, such as:
- renewable energy
- sustainable agriculture
Traditionally, financial support in many of these areas was provided mainly by philanthropic donations. Social impact investing seeks to turn these traditional – and some might say out of date – ideals on their head.
Instead, social impact investing proposes a sort of win-win scenario. Why not focus on responsible investments that will lead to positive social and environmental changes, while also generating revenue?
Not just niche investing
Let’s dig a little deeper into the characteristics of social impact investing.
The Global Impact Investing Network (GIIN) has probably done more than any other entity to define, describe, and document social impact investing. By the end of 2019, the GIIN estimated that 1,720 organizations managed $750 billion in impact investing.
This is evidence that the impact investing industry has grown from a small, niche branch of investing to a popular and lucrative investment strategy.
How is Social Impact Investing Different?
The Global Impact Investing Network has identified several key tenets that separate impact investing from more traditional forms of investing.
The first is intentionality, which is what we have discussed already. To truly be an impact investor, one must be purposely seeking out positive social or environmental impacts through his or her investments.
Equally important, though, is the expectation of a financial return. Too often impact investing is confused with philanthropic donations. It is important to recognize that impact investors are still investing; they are both seeking financial gain and social and environmental gain.
Range of return
We briefly touched on this earlier, but another important component of impact investing is the range of return expectations and asset classes that they allow for.
Impact investors can be seeking financial returns anywhere from below market rate to a risk-adjusted market rate, and investments can be made across many asset classes. This flexibility insures that impact investing is not an exclusionary field.
Hence, unlike private equity or venture capital it provides an opportunity for many interested investors (and investment firms) to seek financial returns while making socially and environmentally impactful investments. As evidence to this, the millennial age range has proven to be one of the groups most interested in impact investing.
Perhaps the most important – and unique – tenet of impact investing is its focus on measurement. The commitment by investors to measure and report the social and environmental performance of their investments is the central point. And this tenet sets impact investing apart from ethical investing or socially responsible investing.
This focus on accountability and measurements insures that impact investors are not simply investing in socially conscious companies just to feel good about themselves. Rather, they want concrete evidence that their investments really are making a difference.
The process of measuring investment impacts therefore not only gives impact investing transparency and accountability. But it also sets the investment up for future success by creating a database of knowledge and documentation.
Key Factors in Defining Social Impact Investing
Impact measurement sounds valuable, but how exactly does one go about conducting these important measurements?
First, an impact investor must have established social and environmental objectives that they hope that aid in accomplishing through their investment. In most cases, the investor will state these objectives to interested stakeholders.
Next, the investor should set benchmarks and metrics for achieving these established objectives. Once the investment is in motion, the impact investor must be sure to monitor their chosen companies’ performances as related to the objectives, benchmarks, and metrics they set forth.
And lastly, the investor will report back to the stakeholders on the social and environmental impacts resulting from their investment. Of course, they will include how the results measure up against their objectives.
None of this is rocket science: businesses have undergone similar processes when creating and maintaining strategic plans for years.
The difference is that such a regimented, follow-through heavy process is not always used for investments. The use of this measurement criteria for investments creates a dynamic field that has set itself up well to achieve actual socially, environmentally, and financially positive impacts.
How Investors can Measure their Investing Impact
This is the basic process recommended for impact investors to measure the efficacy of their investments. Additionally, there are two distinct types of impact that they have to measure: product impact and operational impact.
Product impact, as the name implies, is applicable to companies that produce an actual product. The presence of a product (or service) makes it fairly easy for impact investors who invest in these companies to measure its impact.
So, an investor might ask, “is:
- a good or service being delivered at the rate at which it should be?
- its quality up to standard?
- the company over or under achieving at delivering its product?”
The answers to all of these questions and more will fold into the investors objectives and metrics.
The second type of impact in question is operational impact. This one is less tangible than product impact and thus can be slightly harder to measure.
Operational impact refers to the impact of a company’s operations and practices. This can be in relation to their employees, customers, the environment, etc.
A company with great operational impact might not produce a good or service that necessarily provides a positive social or environmental service. However the nature of their operational practices might provide the desired impact.
For example, maybe they donate money to community members in need, offset their carbon emissions, use only recycled materials – the possibilities are endless.
It may take a little more forethought on the impact investor’s part to hone in on a company with positive operational impact. Once an investor establishes a relationship with a company with positive social and environmental operational impact, though, the possibilities for impact measurements and metric can be quite large.
Anyone Can Make a Positive Impact on the Future
We have made several references to impact investors, without actually defining who exactly it is that does the impact investing. The reason for this is that it can be also anyone. Individual investors certainly participate in impact investment opportunities, but so do private foundations and investment fund managers.
Other, more unlikely institutions, such as religious organizations and non-governmental organizations have been known to carry out impact investing as well. And then of course banks and diversified financial institutions are common impact investors, as are small (or large) family offices and pension funds.
The reason there is such a diverse group of impact investors is that it offers a rare opportunity that appeals to many of us. Namely, it offers the ability to make a positive social and environmental impact while still experiencing high financial performance on a portfolio. And this is just what we need right now for portfolio diversification in 2020.
We Can Help
There are few things that affect as many areas of your life as your wealth. Thinking about retirement, estate, or financial planning? Or will you use your wealth to provide for legacy or charitable purposes? Proper wealth management is what will make it happen.
At Saddock Wealth, our years of wealth management experience can help guide you toward financial prosperity. Schedule a meeting here, and we’ll discuss your best options.