Impact investing is an investment strategy that seeks to generate social and environmental returns for investors. It involves making investments in companies whose products and services contribute to positive change in society.
Impact investing is a relatively new concept that combines traditional investment strategies with social responsibility. It allows investors to make investments that will have a direct positive effect on society. These investments are often made through socially responsible funds, which are organizations that manage money for individuals who want to invest in companies that are doing good things.
This often confuses potential investors with how that differs from ESG investing. While all of these are new terms, and it’s still being ironed out how we use them, I view impact investing as a part of ESG, which is broader.
ESG investing takes environmental, social, and governance factors into account, while impact investing seeks actual positive returns in these areas.
Examples of ESG vs Impact Investing
For example, some ESG investing strategies are called “exclusionary”. These are funds that cut out bad actors such as fossil fuel companies and human rights violators. Companies that are neutral are ok to remain viable for the ESG funds.
Impact investing would not put up with this kind of malarkey; a company needs to be specifically seeking positive change. Examples would be green energy or supporting the circular economy, like thredUP.
How Does Impact Investing Work?
Impact investing really works like any other investment vehicle – your money buys a small portion of ownership and you hope the business does well so you can cash in that ownership at a future date for more money than you originally bought it with.
The tricky part that is specific to impact investing is knowing whether or not your investment generated positive change.
Historically, measuring positive change has been largely guesswork. Many brilliant minds are working on creating a unified measurement to showcase positive impact to investors, but the complexity of defining “positive impact” means we are still far away from being able to measure impact returns in the same way we measure financial returns.
How Can You Start Investing In Social Enterprises?
Many investors in this space are venture capitalists – they have a big enough pool of money to make really risky investments in small companies.
The majority of us don’t have this luxury. I certainly don’t think I’ll hit a point in my life where I have enough money to risk putting the kind of capital a start-up needs into this kind of high risk scenario.
So for those of us who are not amongst the few, our best bet is probably to do our research on funds and companies that are seeking the kind of change we want in the world, and then do some serious due diligence to balance risk and reward.
And how can it help you achieve your financial goals?
According to the 2020 Annual Impact Investor Survey, there were $755B (USD) in impact investments in 2020. That’s a lot of money flowing into creating positive change, something I think is worthy of celebration.
That being said, I tend to view impact investing as a relatively risky venture. Most long term investment strategies are focused on risk reduction, and that means diversification. Nailing diversification becomes difficult when the pool of companies working for positive change remains small.
Currently, I have small amounts of money invested in a circular economy fund and green energy. I made these impact investments more for the environmental change I want to see than to fatten my portfolio. With such narrow goals, the funds aren’t as diversified as I’d like, thus with higher risk, I only invest as much money as I’m willing to lose.
That’s not to say that impact investing can’t be lucrative, but the choices you make are individual to your own specific financial situation.
Why Do We Need More Impact Investments?
In 2019 Project Drawdown estimated the yearly price of combating climate change to be $5.2 TRILLION dollars. The likelihood that the world’s governments will be willing and able to foot that bill is slim to none.
Instead, a private/public partnership is needed. As investors we can be a part of moving green and sustainable projects forward just as we can as voters.
On top of this, social issues and corporate governance issues continue to be complex and lag behind where many of us would like to be. Money tends to make things move faster than policy.
All of this being said, be careful with approaching impact investing. As mentioned, it carries higher risk than other strategies. Be sure to do your research.
If you’re not comfortable taking this approach, note that there’s nothing wrong with being a traditional investor. If it were up to me, everyone would receive education on financial management and investing and be able to make informed choices without the added expense of an advisor.
In closing…
Impact investments are meant to move forward a social goal – be it sustainability, diversity, or any other worthwhile endeavor. In today’s day and age, options are broader than previously, but remain narrow compared to ESG or traditional options. Do your research and make the right decision for you based on your risk tolerance before diving in.
