Are you passionate about a social or environmental cause? This could be ending child hunger, fighting climate change or saving endangered species. Did you know that you can tailor your investment strategy to help these causes? Impact investing allows investors to generate financial returns while focusing on prevalent social and environmental issues.
In this article, we’ll discuss the basics of impact investing, including its benefits, types of investments you can make, and real-life examples, helping you determine if this strategy is right for you.
What is Impact Investing?
Impact investing is an investment strategy that deliberately looks for a positive social or environmental impact alongside financial returns. Impact investing is available through a variety of asset classes, such as stocks, mutual funds, exchange traded funds (ETFs), microloans, real estate, bonds, and other alternative investments. The goal is to earn a return while generating a positive impact in communities on society as a whole or through environmental benefits.
Pro Tip: As you build your portfolio that’s focused on these social or environmental causes that are important to you, make sure you’re tracking your returns with Ziggma’s portfolio analysis tool. This will help you understand if your investments are generating the returns you need.
What are the Benefits of Impact Investing?
The Rockefeller Foundation first coined the term “impact investing” in 2007 to describe its commitment to intentional investing. Let’s explore some of the benefits of adopting impact investing.
Align Values with Investments
Impact investing allows investors to prioritize financial gains while making a difference. Your profit no longer needs to compete with your values. Instead, you can pursue investments that support your mission statement and still generate financial returns.
Alleviate Global Challenges
Some of the world’s top challenges, like climate change and poverty, can’t be solved through government funding alone. In fact, organizations committed to changing the world rely on outside investments. Impact investing allows you to contribute in a meaningful way.
Stabilize Your Portfolio
Companies that focus on ESG often have lower volatility and risk. Many studies have been facilitated to evaluate the correlation between risks and ESG investing, uncovering that lower ESG scores often translate to a higher cost of capital and volatility. Impact investing allows you to craft a portfolio with lower risks and volatility.
Types of Impact Investments
There are two main types of impact investment strategies: ESG and SRI. Let’s explore these two strategies in more detail.
Environmental, Social, and Governance (ESG)
Environmental, Social, and Governance investing, also known as ESG investing, involves targeting companies that prioritize the well-being of their workers, have the proper corporate social responsibility, and use sustainable business practices. For example, an impact investor interested in ESG might choose an energy company with a low emissions rate over a competitor with a high rating.
Socially Responsible Investing (SRI)
Socially responsible investing, known as SRI, takes ESG investing a step further by eliminating investment opportunities that don’t adhere to specific ethical guidelines. For example, an SRI investor might avoid companies that sell alcohol or firearms if they are passionate about lowering drunk driving or crime rates. SRI investors use ESG metrics as a baseline to screen investments and then select companies that align with their goals.
Making Sure Your Impact Investments Are Generating a Return
One of the primary goals of investing is generating financial returns. However, some impact investments focus more on the mission than the financial performance. This leads to two categories of impact investing: concessionary and non-concessionary.
Non-Concessionary Investing
Non-concessionary investing involves achieving a positive impact while still rewarding investors with a financial return. In fact, 80% of impact investors indicate returns exceed or meet expectations as they target risk-adjusted market returns. Many impact segments, such as renewable energy stocks, have done remarkably well. A non-concessionary investment strategy rewards you for your investment while supporting your underlying values.
Concessionary Investing
Concessionary investing accepts a lower financial return in exchange for progress toward nonfinancial goals. For example, a concessionary investment might only provide a 2% return on investment, but the funds are being allocated toward the social and/or environmental values that mean the most to you. While you can achieve a higher return through other investments, the lower financial return is acceptable because of how the capital is deployed.
Examples of Impact Investing
Impact investing is a strategy adopted by investors of all ranges, from small individual investors to large institutional investors. Let’s take a look at some well-known foundations that follow an impact investing strategy.
The Gates Foundation
Bill and Melinda Gates founded the Gates Foundation in early 2000 after merging the William H. Gates Foundation and the Gates Learning Foundation. The foundation’s primary goal is philanthropy, but it also has a strategic investment fund component. In 2023, the Foundation provided more than $7.75 billion in charitable support to various organizations.
The Ford Foundation
Another well-known foundation is the Ford Foundation, founded in 1936 by Edsel Ford. With $16 billion under management, the Ford Foundation is one of the largest private foundations in the United States. Due to its scale, the Ford Foundation is able to take on different initiatives surrounding social inequality, such as disability rights and free expression. This foundation is a great example of a non-concessionary impact investment strategy, generating $1,232,924,000 in investment returns in 2023.
Understanding if Impact Investing is a Good Fit for You
Impact investment is a great option if you want to make a positive difference in your community, the environment, or on a global scale. It’s more difficult to enact change on your own. By pooling your capital with like-minded investors, you can make a larger impact. For example, instead of helping one local community, your investment might be deployed to a dozen communities.
Additionally, supporting companies with values that you align with is an effective way to improve ESG practices. For example, if companies with a low ESG rating are constantly being passed up for their competitors with better scores, they would most likely take the initiative to improve their numbers.
The Bottom Line
Impact investing is gaining traction, especially as investors can support their values while earning a financial return. Although you might not be operating large-scale foundations like the Gates Foundation or the Ford Foundation, you can still make a difference by strategically allocating your capital to companies that align with your social and environmental principles.
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Frequently Asked Questions
What’s the difference between ESG and impact investing?
ESG and impact investing are two ways to approach socially responsible investing, but they have distinct differences. ESG considers environmental, social, and governance factors and your traditional investment analysis when choosing investments. However, impact investing prioritizes making measurable environmental and social change and financial profits.
Simply put, ESGs’ main goal is financial returns while helping create change, whereas impact investing’s primary goal is creating change with the hopes of generating a financial return.
Can you make money from impact investing?
When you invest in companies that seek to make a positive impact on society, you can make the world a better place and profit. Most investors now believe that there is no trade off between returns and impact. They expect to generate market returns or more through their investments. An increasing number of studies validate this expectation by showing that impact investments can actually outperform.
What are the problems with impact investing?
One of the biggest problems with impact investing is being able to measure how effective it is for society. Additionally, most investors struggle to balance the need for financial returns and positive social impacts.