Author Topic: Impact Investment: How does it work?  (Read 2581 times)

Maliha Islam

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Impact Investment: How does it work?
« on: March 16, 2018, 10:07:11 PM »
Impact Investment: How does it work?

Impact investment is described (and differentiated from other forms of investment) by three guiding principles:

1. The expectation of a financial return: impact investors expect to earn a financial return on the capital invested, below the prevailing market rate, at the market rate or even above it.

2. The intention to tackle social or environmental challenges (i.e. the impact or intentionality): in addition to a financial return, impact investors aim to achieve a positive impact on society and/or the environment.

3. A commitment to measuring and reporting against the intended social and environmental impact: impact investors commit to measure performance using standardized metrics.

Impact investors have traditionally challenged the view that development is to be reached and guided only by social assistance or philanthropy. On the contrary, the implied theory predicts that business and investment are important drivers for achieving more inclusive and sustainable societies. Therefore impact investors aim to demonstrate that investment can achieve both a positive (social or environmental) impact and a financial return (or, at minimum, a return of capital).

Impact investment is not limited to a specific asset class or sector: it includes, for example, fixed income, venture capital, private equity and social and development impact bonds. Private equity and private debt are the most common products adopted, with the latter taking the largest share in value terms. Impact investors often–but not exclusively–invest in innovative businesses and enterprises in sectors such as sustainable agriculture, affordable housing, healthcare, energy, clean technology, and financial services for the poor. A few examples: a fund investing in microfinance in Africa and Asia; a non-profit financial institution providing finance to farmers in Latin America; a platform that allows individual investors to make loans to women in developing markets to access clean energy; a foundation endowment’s investment policy focusing on sustainable food; or an individual investment in a company that provides healthy and nutritious school lunches.

Impact investors include endowments, high net worth individuals, foundations (e.g. Bill & Melinda Gates Foundation, Gatsby Charitable Foundation), pension funds, institutional investors (e.g. JP Morgan, South Africa PIC) and retail investors that invest capital directly in social enterprises or in impact investment funds (e.g. Acumen Fund, Bridges Ventures, Elevar Equity, Ariya Capital) and instruments (e.g. Social Impact Bonds).Impact capital has been raised mostly from banks, pension funds, and Development Finance Institutions (DFIs).

In terms of investees (receivers of the capital), impact investment can be directed both to for-profit and non-profit ventures, as long as they can produce a financial return. A number of intermediaries can connect impact investors with these impact-driven enterprises with tailored services, such as research, fundraising, certification, evaluation and impact measurement, business incubation, business acceleration and legal services.

Enablers, such as DFIs and the government, provide the enabling environment in which the market transactions can materialize, and, in certain instances, direct incentives and co-financing. An example of supportive legislation is the possibility to register benefit corporations (B-corporations) in the US. This form of incorporation allows a business to balance its fiduciary duties between its shareholders and stakeholders legally. B-corporations can also be privately certified in addition to the legal registration. Moreover, it is expected that the financial market will establish benchmarks for impact investment based on previous attempts to develop Environmental, Social and Governance (ESG) market indices, e.g. the S&P Environmental & Socially Responsible Indices, which tracks companies that meet certain environmental and social sustainability criteria, or the MSCI Low Carbon Indices, which focuses on low carbon businesses. DFIs (e.g. the International Finance Corporation, the African Development Bank, and the European Investment Bank) have spearheaded the movement, developed performance standards and often have interacted with impact investors through blended finance and risk-sharing formulas.


    Impact investor(s): provide the capital and include individual investors, high net worth individuals, foundations, DFIs, and a wide range of institutional investors such as pension funds and insurance companies.
    Investees: for-profit enterprises and non-profit ventures that along with running profitable businesses, are able to generate measurable social and environmental impacts. Investees include multinational spin-offs, social enterprises, microfinance institutions, small and medium-size enterprises (SMEs), cooperatives, etc. The term benefit corporation (or B-corporations) has been introduced in Europe and the US, while the term impact-driven organizations had been used in G20 discussions.
    Intermediaries: link investors, investees and stakeholders providing them with innovative solutions and services. They can also facilitate the emission of structured financial products and help to reduce the costs of impact investing. They provide advice as well as help in structuring deals and in managing funds. Intermediaries can be commercial banks, investment banks, independent financial advisors, brokers, dealers, international organizations, consulting firms, etc.
    Enablers: governments can help by creating an enabling regulatory environment and by the provision of direct or direct incentives. The cost of capital can be reduced with tax reliefs, guarantees or subsidies aligned with government programmes and priorities. Regulations can be enacted to recognize impact investors (e.g. European Social Entrepreneurship Funds in the European Union), encourage transparency, produce and share information, establish peers’ working groups, etc. Besides governments, international organizations, DFIs, and development agencies can also play a supporting role and enter into impact investment deals with co-financing or credit enhancement.
    Beneficiaries: stakeholders that benefit from the investment through improved social and environmental conditions.

Potential in monetary terms (revenues, realignment or savings)

The volume of impact investment cannot be officially recorded due to the unclear definition of the term, but there are estimates. The Global Impact Investing Network (GIIN) estimates a market of US$114 billion in impact investing assets, of which US$22.1 billion committed in 2016. The expected growth in commitment in 2017 is of 25.9 percent. The supply of impact capital is expected to rise but, as yet, impact investment’s share in global financial markets is estimated to be at around only 0.2 percent of global wealth. If this share rises to 2 percent, it could mean over US$2 trillion invested in impact-driven assets. Larger definitions of sustainable or responsible investment (including ESG compliance and managers applying investment exclusion lists) encompass an estimated total of US$21.4 trillion. Finally, over 1,500 asset managers, with combined assets of over US$62 trillion, have signed up to the six United Nations Principles for Responsible Investment.

Impact investment has also become widespread across the globe. A GIIN Investor Impact Survey reported that 40 percent of investment was in U.S. & Canada, 14 percent in WNS Europe, 10 percent in Sub-Saharan Africa, 9 percent in Latin America. Overall, more surveyed investors plan to increase funds propotionally more in developing and emerging markets like sub-saharan Africa and Latin America than any other geographical region. Several leading financial firms have also entered the market in recent years with the creation of dedicated units or platforms dedicated to impact investment, including BlackRock and Goldman Sachs.

The above trends in the supply and management of capital are supported by polls covering the preference of the millennials as new job-seekers or investors: many believe that the number one purpose of business is to benefit society and they want to work for a business pursuing ethical practices. Another survey reports that wealthy millennials are almost twice as likely as Gen X to regard their investments as a way to express social, political, or environmental values. These millennials – i.e. those born after 1980 and the first generation to come of age in the new millennium – will soon experience an unusual intergenerational wealth transfer that has been estimated at US$41 trillion in the United States alone, thus creating additional expectations for a growing number of impact investors.

There are also patterns connected to the impact’s theme or sector: whereas one-third of socially-focused impact funds expect below market returns, environmentally-focused funds overwhelmingly expect market rate returns. On average impact investment in the environment is also found to be as much as five times larger in volume than in social sectors. According to the last GIIN survey, microfinance, energy, housing, and other financial services (excluding microfinance) attract the greatest allocations. Among environmental themes, the focus is on renewable energy, energy efficiency, and clean technology.