What is impact investing?

Impact investing is a responsible investment strategy that focuses on advancing particular social or ethical causes and generating financial returns. It is a guilt-free form of investing, where adherents seek investments that deliver the most benefit to themselves and society.

As the name suggests, 'impact' investing is an investment strategy that tries to make a positive impact on society. 

It involves investing in companies or organisations committed to delivering positive social or environmental outcomes, like renewable energy companies, education and healthcare providers, or companies that provide affordable housing.

It's important to point out that impact investors still seek a financial return from their investments. However, they will also consider the social benefits companies deliver when making investment decisions.

How has impact investing come about?

Impact investing has grown in popularity in recent years as investors become more socially and environmentally conscious. This is particularly true for younger investors, who increasingly want to put their money into companies that are seen to be benefiting society. The COVID-19 pandemic and other recent global events have only accelerated these trends.

The ultimate goal of impact investing is to bring about real, far-reaching changes to society and business practices. By investing their capital only in companies that prioritise particular social and environmental causes, impact investors hope to provide a financial incentive to other companies to be more socially and environmentally responsible.

You can even think of impact investing as similar to philanthropy. Just as you might donate money to a charity that advocates for a cause you believe in, you can also invest in companies that aim to deliver specific benefits for society and the environment.

How is it gaining momentum in this changing world?

Although impact investing is a decades-old investment strategy, it has gained significant traction in recent years. This is because a seemingly never-ending chain of global crises, conflicts, and disasters is forcing investors to seriously consider the negative impacts certain business activities have on the planet.

Right now, the world is still dealing with the tail end of the COVID-19 pandemic. 

The Russia-Ukraine conflict has disrupted global energy and food supplies. Rampant inflation is pushing up the cost of living and increasing poverty around the world. And we are seeing the effects of climate change in more frequent droughts, floods, hurricanes, and other extreme weather events.

All these factors increase the sense of urgency many investors feel about their investment choices. Investors don't want to feel like the companies they are invested in are contributing to the problems they see in the world around them. Now — perhaps more than ever – investors want to feel good about how they invest their money.

For their part, companies have also noticed this trend in investor behaviour. Most companies now have detailed environmental, social, and corporate governance (ESG) frameworks in place, and many large corporations have partnered with charitable organisations to give something back to the communities they operate in.

What are the main features of impact investing?

Four key elements underpin a successful impact investing strategy. They include:

1. Intention

Social change doesn't happen by accident. If you adopt a social impact investing strategy, you must do so consciously and with purpose.

Before investing, carefully consider which social, environmental, or other causes you care most about. This way, when you start selecting your investments, you will do so with a clear set of goals.

2. Evidence-based investing

Companies can't just say they're doing good for society and the environment – they need to be able to prove it with actual data.

Investors who want to follow an impact investing strategy should be as objective as possible and track the data. That way, they will invest their money in companies, projects, and other organisations that deliver on their promises.

3. Impact management

As an impact investor, you must continually monitor your investments to ensure they have the desired impact on society. This is particularly important with companies seeking to disrupt industries. Many product iterations may be required, not all of which will be successful.

Impact management requires you to assess both positive and negative company results and, where necessary, adjust your investments to ensure you continue supporting the companies with the most significant potential.

4. Contribution to industry growth

Some investors can be quite guarded about their investment strategies – particularly if they are successful. This might make sense if you are a growth investor or value investor, because you're searching for the hidden gems other investors miss. 

However, impact investors are trying to bring about social change – and enacting meaningful change can require a whole community of investors and activists. Therefore, impact investors are encouraged to share their failures and successes to help other like-minded investors make better decisions and grow the impact investing industry.

Are there different types of impact investing?

There are many different types of impact investing, depending on the cause you support. However, some of the key industries targeted by impact investors are:

  • Healthcare: The COVID-19 pandemic has raised public awareness about the importance of access to good-quality healthcare. Impact investors targeting the healthcare sector might choose to support biotech companies researching vaccines and new medications to fight emerging diseases. Or they may support organisations trying to make healthcare more accessible in developing nations.
  • Education: Another key sector favoured by impact investors is education because it can deliver far-reaching social benefits. Education improves a person's quality of life and can help lift whole communities out of poverty. Money invested in the education sector can be used to make education programs more available in poorer communities and to drive better learning outcomes for children from disadvantaged groups.
  • Renewable energy: One of the newer trends in impact investing is renewables. Impact investors focusing on the environment may choose to put their money behind green energy companies that are helping the world reduce its reliance on fossil fuels.
  • Agriculture: Another sector often targeted by impact investors is agriculture. Companies in this group may be helping to improve food security in poorer or more drought-prone regions.

Examples of impact investing

Impact investing is still quite a small, niche industry in Australia. However, there are a few local funds for impact investors to consider. Most are only open to institutional and wealthy investors and involve private equity, which may not be suitable for your average retail investor.

  • Conscious Investment Management – This investment firm specialises in impact investing in Australia and New Zealand. Its Impact Fund focuses on affordable housing projects, particularly for people with disabilities, and the green energy transition. The fund is open to new investors, although it is most suitable for institutional investors and foundations, as it requires a minimum investment of $500,000.
  • Impact Investment Fund – This fund manager focuses on the green energy transition, regenerating agricultural land and building better water and energy infrastructure. It has several funds in development, open to institutional and high net worth individuals. 
  • Inspire Impact – This fund manager also invests in Australian companies making a positive social impact. It focuses on disability housing with a broad investment mandate that covers companies involved in education, sustainable infrastructure and transport, climate change, agriculture, healthcare, and waste management, among others.

Impact investing versus ESG investing

Like impact investing, ESG investing is a responsible investing ethos that prioritises non-financial factors, like business sustainability and other ethical considerations.

However, where impact investing provides targeted financial support to specific companies, projects, and organisations that deliver a measurable social good, ESG investing focuses on mainstream and blue-chip shares.

ESG investors use a combination of quantitative and qualitative analysis techniques to assess the strength of a potential investment's ESG performance before making an investment decision. If a company performs poorly based on ESG criteria, an ESG investor will screen them out of their possible investment choices.

ESG investors may also actively engage with the companies they are already shareholders in to try and improve their internal governance, social or environmental policies.

Although they are similar in their generally ethical approach to investing, the key difference is that ESG investing is more of a screening process to apply when selecting possible investments. Impact investing is a targeted approach designed to deliver specific, measurable social benefits.

What do impact investors look for?

As we've already discussed, impact investors should invest with a clear purpose and always follow the data.

This often means looking for investments that have a demonstrated track record of success. Read up on the team leading the organisation and see if they have experience running similar projects.

For example, if the company hopes to improve food security in drought-prone areas, do they have a team with exceptional agricultural and climate knowledge? Or, if you are considering investing in an impact investment fund, do the fund managers have a history of successful deals?

Regarding the company or project itself, look for those with clear, measurable goals and a timeline for achieving them. For example, a waste management start-up might aim to divert a certain amount of food waste from landfills every year. Or perhaps an affordable housing company aims to provide a certain number of affordable homes to people who are currently homeless.

Just remember that the goal of impact investing is to make a real social impact. If you can't see your money at work, perhaps you should invest it elsewhere.

Benefits of impact investing

The primary benefit you get from impact investing is the knowledge that your money is being put toward a cause you believe in. And, because impact investing is designed to bring about measurable, positive change, you can often see tangible outcomes from your investments.

And the disadvantages

While you might feel better about your investment portfolio, you could miss out on better returns elsewhere. Not all impact investment projects will be successful or profitable; some can come with significant risks.

Also, it's worth remembering that capitalism cannot rectify all of society's problems. Many also require legislative action, different systems of regulation, or a fundamental change in social attitudes. This might mean that certain projects or organisations may encounter roadblocks preventing them from achieving their goals.

Is impact investing right for you?

Impact investing is still quite a small industry in Australia, meaning it can be risky and opaque. It is often open only to institutional investors, foundations, or high net worth individuals and family offices, with most retail investors priced out of the market.

However, if you have the means to participate, impact investing can be a particularly rewarding investment strategy. While it may not generate the same financial returns as other methods, impact investing gives you a sense of satisfaction from knowing that your money will help make the world around you a better place. 

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

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The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.