Impact investment is a powerful way to make a positive difference in the world while earning financial returns. With Sopact, it's easy to get started.
Impact investment is the practice of investing in companies, organizations, and funds to generate measurable social and environmental impact alongside a financial return. By using a range of strategies, impact investors seek to address pressing social and environmental challenges while also achieving their investment goals.
Investing for impact can benefit both investors and society as a whole. It can help drive positive change, create new markets, and promote sustainable development. However, impact investing also presents unique challenges, such as measuring and managing impact and finding investment opportunities that align with one's values and goals.
At Sopact, we make impact investing simple and actionable. Our SAAS-based software includes an impact strategy app that provides a step-by-step guide to developing a personalized impact strategy. We offer strategies, training, and examples to help investors get started and stay on track. Whether you're new to impact investing or a seasoned pro, Sopact can help you make a real difference while achieving your financial goals. Watch our impact strategy video and start your journey today.
Impact Investment: Investing for a Better Future
In recent years, impact investment has gained traction among investors looking to make a positive difference. Impact investment is an approach to investing that seeks to generate both financial returns and positive social and environmental impacts. In other words, it's investing in businesses or projects that aim to create a better future for all.
This article will explore the concept of impact investment, how it works, and why it's essential. We'll also look at some examples of impact investment in action and some of the challenges that impact investors face.
What is Impact Investment?
Impact investment refers to investing in businesses or projects that aim to achieve positive social or environmental outcomes and financial returns. The goal of impact investment is to impact society and the planet while also generating profits positively. Unlike traditional investing, which focuses solely on financial returns, impact investment considers investments' social and environmental impact. Impact investors evaluate businesses based on their potential to create positive social and environmental change and their financial viability.
How Does Impact Investment Work?
Impact investment provides capital to businesses or projects that aim to create positive social or environmental impacts. These businesses can be for-profit or non-profit, but they all share a common goal of positively impacting society and the planet. Impact investors typically seek businesses or projects aligning with their values and investment goals. They may also look for businesses operating in areas with a significant need for social or environmental change.
Once an impact investor has identified a business or project to invest in, they provide capital in exchange for an ownership stake or a share of the profits. The impact investor then works with the business to help it achieve its social and environmental goals and financial goals.
Why is Impact Investment Important?
Impact investment is crucial because it creates positive social and environmental change while generating financial returns. By investing in businesses or projects that aim to create a better future for all, impact investors can help address some of our time's most pressing social and environmental challenges.
Impact investment also offers a way to support innovative solutions to social and environmental problems. Many impact investors focus on businesses or projects using new technologies or business models to address social and environmental challenges creatively.
Finally, impact investment can help drive systemic change. Impact investors can help create a more sustainable and equitable economy by investing in businesses or projects challenging the status quo.
Examples of Impact Investment in Action
There are many examples of impact investment in action around the world. Here are just a few:
- Solar Home Systems in Africa: Impact investors are supporting companies that provide solar home systems to households in rural Africa. These systems provide clean energy and reduce the need for expensive and polluting kerosene lamps.
- Sustainable Agriculture in Latin America: Impact investors are supporting small-scale farmers in Latin America to transition to more sustainable and regenerative farming practices. This not only improves farmers' livelihoods but also helps protect the environment.
- Social Enterprises in the United States: Impact investors are supporting a growing number of social enterprises in the United States, such as companies that employ formerly incarcerated individuals or that provide affordable housing to low-income families.
Challenges of Impact Investment
While impact investment offers many benefits, it also comes with its own set of challenges. Here are some of the most common challenges that impact investors face:
- Measuring Impact: One of the biggest challenges of impact investment is measuring the social and environmental impact of investments. Unlike financial returns, social and environmental impact can be challenging to quantify and measure.
- Finding Opportunities: Another challenge of impact investment is finding businesses or projects aligning with an investor's values and goals. Impact investors may need to spend more time and resources identifying investment opportunities.
- Managing Risk: Impact investments can be riskier than traditional investments, especially if they involve investing in new or untested business models or technologies. Impact investors must carefully evaluate each investment opportunity's risks and rewards.
- Balancing Financial and Impact Goals: Impact investors must balance their financial and impact goals. While it's essential to generate financial returns, impact investors must also ensure that their investments create positive social and environmental impacts.
Who can be an impact investor?Anyone can be an impact investor, from individuals to institutional investors like pension funds or foundations.
What types of businesses or projects are suitable for impact investment?Any business or project that aims to create positive social or environmental impacts can be suitable for impact investment. This can include businesses in sectors like renewable energy, sustainable agriculture, affordable housing, or social enterprises.
How do investments contribute to the achievement of impact?
Trillions of dollars are invested worldwide without considering environmental, social, and governance (ESG) issues and how their risks are directly related to investment performance. Although there's evidence on the financial materiality of ESG issues to portfolio value, poor investment decisions are continuously being made.
Investment consultants and managers are now starting to consider ESG in their investment decisions and pursuing ESG opportunities. Still, they don't have the systems and processes necessary to support these risks' implementation and management. To achieve high-impact solutions, it's necessary to make use of suitable measurement and management solutions.
Sopact has developed Impact Cloud® to better report against these non-financial goals.
Contribute to Solutions
Impact investments, by definition, are intentional and contribute to social and environmental outcomes.
According to GIIN Core Characteristics of Impact Investing, investors should set transparent and long-term financial and impact goals and design a clear investment thesis and measurable actions to achieve those goals. On top of that, the investments selected should align with the defined strategy.
IFC's Operating Principles for Impact Investing require investors to define strategic impact objectives consistently across the portfolio.
Impact investing landscape is changing rapidlyFind out key players in impact investing ecosystem and how are they changing
Impact investing examples
Impact investors can be individuals or various organizations and range from the person or entity holding the asset to the people making and/or managing investment decisions. Apart from individual investors, the following (while not an exhaustive list) are organizational types that might pursue impact investing strategies:
While less common, a growing number of private foundations are making impact investments. They do this both as a way to fulfill their mission through those investments and as a way to protect/grow their endowments.
Development Finance Institutions (DFIs)
While each DFI may have its definition of impact investing or where it falls on the spectrum of impact investing strategies, its focus tends to be the deployment of catalytic capital in emerging markets or simply in markets lacking private investment flow.
The private banking sector is also growing its foothold in the impact investing worlds impact areas such as agriculture, education, and social finance. Like Beneficial State Bank, other banks have created foundations that own 100% of the bank's economic rights and use that profit to make community-related investments.
Another newer actor in the sphere of impact investing, pension funds are beginning to take the impact investing market more seriously. According to the World Economic Forum, only 6% of the United States' pension funds have contributed to impact investment. However, that number is expected to rise dramatically -- 64% say that they plan to do so in the future.
Non-Governmental Organizations (NGOs)
With more and more donors moving from philanthropy to impact investing, NGOs are also seeking to diversify funding sources by structuring impact investment opportunities. According to KPMG, NGOs can look to source and mediate deals between local constituents, impact investors, or design new interventions and seek impact investments themselves.
Type of impact investments
The spectrum of impact investing is a dynamic one, but attempts have been made to break down the range of impact investing approaches. One of the most notable comes from Sonen Capital and is pictured below.
At one end of the investing spectrum we have traditional investing, which seeks financial returns with no impact lens whatsoever. At the other end we have philanthropy, and impact first approach with no financial return expectation. In between is where it gets interesting, and is where impact investing lives.
ESG Screening and Sustainable Impact Investing
The first two categories on the spectrum after traditional investing are still driven primarily by financial performance. But an impact lens is beginning to take form. Negative ESG (Environmental, Social, and Governance) screening, for example, is an approach that attempts to keep capital from being allocated to assets involved in “harmful” sectors of business. How that is defined is up to the investor or the fund, but some examples are given in the image above.
What follows is Sustainable Impact Investing, which takes those ESG factors into account alongside the expectation of the financial returns. Capital is allocated to assets that contribute positively to one or more of those ESG elements (even if somewhat indirectly) while also performing well financially. The idea is that investment opportunities that have good ESG scores will improve overall financial performance, and those with poor ESG scores will have poorer financial returns.
Thematic Impact Investing
Thematic impact investing directs capital towards pre-defined impact areas (defined by the investor), while financial returns are also sought as a parallel priority. It is common for impact investors to have impact areas that they are more passionate about and thus have their portfolios constructed around this impact-seeking ambition.
Such investors seek specific solutions to this impact need. For example, an investor may see a lack of access to drinking water as one of the greatest threats to humankind and seeks to invest primarily in solutions addressing this need. Themes could also be broken down by region, for example, focusing investments in Southeast Asia.
As the name suggests, the impact area is the driver of investment decisions. Financial returns are still a factor, though not a dominating one. This category often demands a higher risk tolerance on the financial side, for example, targeting early-stage solutions with less commercial validation but highly scalable impact potential. Or, the investment could be structure as an injection of patient capital into an asset, where priority is the social or environmental success of the impact-seeking endeavor and financial returns are either likely to be below market rate (this is a known factor) and/or paid back over long periods.
Impact investment ecosystem
There is a major alignment breakthrough required between impact ecosystem layers
Three layers are:
- Asset Owners: Take nonfinancial considerations - like impact - into account when making investment decisions. Build a robust process to manage and measure impact through the use of standard and bespoke indicators.
- Asset Managers: Assess investor contribution and understand portfolio weights on avoiding harm, benefiting stakeholders, or contributing to solutions. Measure investment and portfolio performance and report to asset owners.
- Assets: Enterprises that work on innovating environmental footprint or improve stakeholder outcome
- Impact Advisory: Support impact portfolio construction for every client with a disciplined impact management process. Demonstrate environmental and social impact, in addition to financial returns based on IRIS, GRI, SDG, or other standards.
For a better Impact Capital flow, impact thesis alignment is critical. Impact Cloud® is designed to improve impact data management at each layer. In addition, data pipeline allows to aggregate data between each layer in a trustable manner
Impact Measurement and Management
Impact measurement and management (IMM) is a process that assesses the social, environmental, and economic impacts of an organization's activities. It helps organizations identify the outcomes and results of their actions and how these impact different stakeholders, including employees, customers, shareholders, and the wider community.
For impact investments, IMM is a critical tool for measuring and managing the impact of investments. Impact investors seek to invest in enterprises that are making a positive impact on society and the environment, and as such, they require accurate and reliable data on the impact of their investments.
Working with enterprises that have robust IMM processes in place can provide a more accurate picture of the outcomes and results of their investments. By following best practices and involving stakeholders in the process, enterprises can effectively measure and manage their impact, and provide impact investors with the data and insights they need to make informed investment decisions.
Some of the benefits of IMM for impact investments include:
- Improved decision-making: Impact investors can use IMM data and insights to make informed investment decisions and prioritize investments that have the greatest positive impact.
- Increased transparency: By measuring and reporting on their impact, enterprises can demonstrate their commitment to social and environmental issues and enhance their transparency with impact investors.
- Enhanced stakeholder engagement: IMM can help enterprises engage stakeholders in the decision-making process and better understand their perspectives and needs.
- Stronger brand reputation: By demonstrating their commitment to social and environmental issues, enterprises can build a stronger brand reputation and attract customers and employees who share their values.
To effectively implement IMM for impact investments, enterprises should follow best practices such as:
- Setting clear goals and objectives for impact measurement and management.
- Involving stakeholders in the process to ensure their perspectives and needs are taken into account.
- Using a mix of qualitative and quantitative data to provide a comprehensive view of impact.
- Regularly reviewing and updating impact measurement and management strategies to ensure they remain relevant and effective.
In conclusion, IMM is a critical tool for measuring and managing the impact of investments for impact investors. Enterprises that have robust IMM processes in place can provide impact investors with the data and insights they need to make informed investment decisions and achieve their impact objectives. By following best practices and involving stakeholders in the process, enterprises can effectively measure and manage their impact, enhance their transparency, and build a stronger brand reputation.
Challenges and improving IMM in different types of funds
At our firm, we recognize the importance of impact measurement and management in the private equity space. There has been a growing interest in environmental, social, and governance (ESG) data among investors in recent years, but there are still many barriers to its adoption. This article will explore different impact measurement management approaches and their current challenges, including barriers to ESG data in private equity and differences in impact measurement practices among financial, blended, and social impact funds. We will also discuss strategies to improve equity firms that do not align with ESG metrics or surveys, such as ILPA, and ways for social impact funds to build enterprise social impact data management capacity and address gaps in funding and knowledge for impact measurement and management.
Impact Measurement Management Approaches and Challenges Impact measurement management approaches are used to measure and manage investments' social, environmental, and economic impacts. There are various approaches to impact measurement management, including:
- Standardized Frameworks: These frameworks provide a standardized method for measuring and reporting impact data, such as the Global Reporting Initiative (GRI) or the Sustainability Accounting Standards Board (SASB).
- Customized Approaches: These approaches allow the creation of customized impact measurement and management systems based on the specific needs of a particular investment or organization.
- Third-Party Verification: This approach involves third-party verification of impact data, which can increase the credibility and transparency of impact measurement and management.
Despite the benefits of impact measurement management, there are still many challenges in adopting these practices. Some of the key challenges include:
- Lack of Standardization: No universal standard for impact measurement and management can make it difficult to compare and analyze data across different investments or organizations.
- Data Collection: Collecting impact data can be time-consuming and expensive, particularly for smaller organizations needing more resources to invest in data collection and analysis.
- Data Quality: Ensuring the accuracy and reliability of impact data can be challenging, mainly when relying on self-reported data.
- Lack of Incentives: Organizations may need more incentives to invest in impact measurement and management, particularly if optional.
Barriers to ESG Data in Private Equity
While there are many challenges in impact measurement and management, there are also specific barriers to ESG data in private equity. Often many investors believe that most companies can provide data. But many find that many even need more basic policies. So standardizing or comparing with other companies or funds does not make sense when many don't even have such policies in the first place. Their main challenge is to persuade companies to have good ESG policies that the fund believes in - for example, gender equity, parental policy, racial equity policy, and many others. One key barrier is the need for standardized metrics for ESG data, which can make it difficult to compare and analyze data across different investments or organizations. Additionally, there may be little incentive for private equity firms to invest in ESG data, particularly if they do not see a direct financial benefit from doing so.
In contrast, more broadly, the barriers to collecting impact data include the need for standardized frameworks, data collection, quality issues, and a need for more incentives. However, impact data may be more important for social impact funds and organizations prioritizing social and environmental outcomes over financial returns.
There are also differences in impact measurement practices among different types of funds. Financial impact funds, for example, may prioritize financial returns over social and environmental outcomes, which can lead to different impact measurement practices than social impact funds, which prioritize social and environmental outcomes. Blended funds may use a combination of financial and impact measurements, which can create unique challenges in measuring and managing impact.
There are several strategies that equity firms can use to improve their impact measurement and management practices, even if they do not align with ESG metrics or surveys such as ILPA. One strategy is to use a customized approach to impact measurement and management that aligns with their specific investment goals. Another strategy is to focus on the impact areas most relevant to their investment thesis. For example, an equity firm that invests in renewable energy may focus on measuring and managing the environmental impact of its investments. Additionally, equity firms can use third-party verification to increase the credibility and transparency of their impact data.
Challenges for impact first funds
Motivating equity firms to invest in impact measurement and management can be challenging, but several potential incentives exist. For example, impact data can attract socially conscious investors who prioritize social and environmental outcomes over financial returns. Additionally, impact data can identify operational efficiency and risk mitigation opportunities, ultimately leading to financial benefits.
Building Enterprise Social Impact Data Management Capacity for Social Impact Funds Social impact funds may face different challenges in building enterprise social impact data management capacity. One challenge is more impact measurement and management funding, making investing in the necessary resources technically challenging. Additionally, there may be a need for more knowledge and expertise in impact measurement and management, particularly among smaller organizations.
To address these challenges, social impact funds can invest in training and education for their staff on impact measurement and management. They can also collaborate with other organizations or industry groups to share best practices and resources. Finally, social impact funds can prioritize impact measurement and management in their investment decision-making process, which can help to build a culture of impact measurement and management within their organization.
In conclusion, impact measurement and management are critical components of responsible investing, and various approaches and challenges exist. Equity firms can improve their impact measurement and management practices by using customized approaches, focusing on specific impact areas, and using third-party verification. Social impact funds can build enterprise social impact data management capacity by investing in training and education, collaborating with others, and prioritizing impact measurement and management in their investment decision-making process. By addressing these challenges and leveraging the benefits of impact measurement and management, organizations can create positive social, environmental, and economic outcomes for themselves and their stakeholders.
In conclusion, impact investment is a growing trend in the investment world, as investors seek to invest in enterprises that have a positive impact on society and the environment. Impact investment can be a powerful tool for driving positive change and addressing social and environmental challenges.
However, impact investment is not without its challenges. Impact investors must navigate complex social and environmental issues, as well as financial considerations, in order to make informed investment decisions. Enterprises seeking impact investment must also have robust impact measurement and management processes in place to provide impact investors with accurate data and insights.
Despite these challenges, impact investment has the potential to create positive change and generate financial returns. By working together, impact investors and enterprises can drive sustainable and inclusive economic growth, improve social and environmental outcomes, and build a more just and equitable world for all.