Impact Investing: The New Normal
Updated: Feb 25, 2021
No impact is too small when the goal is the greater good. How we choose to invest our time and money greatly impacts our future, and the world. In my previous post, we explored the concept of impact businesses and their role in the Impact Revolution. Today, I am going to introduce you to Impact Investing and how we must base our investment decisions on the new model of risk–return–impact in order to change the world and our thinking.
When BlackRock CEO Larry Fink, leader of the largest investment firm in the world, writes an open letter surging businesses to consider their environmental impact, people take notice. When employees say they want to divert their pension savings away from harmful companies toward socially responsible ones, pension funds pay attention. And when the world’s biggest fossil fuel companies are pressured by a group of several hundred prominent investors to reduce their carbon emissions, those companies are left with little choice but to comply.
What do these actions have in common? They were all initiated by investors who felt a growing sense of responsibility for the world we share, marking a shift in investor thinking about the companies in which they invest. Investors are increasingly recognizing that in order to improve the world, they must first change the way they do business.
In recent years, institutional investors have significantly increased their commitment to ESG (Environmental Sustainable Governance) investing, also known as Responsible Investment (RI). The main goal of these investments is to minimize harm to society and the environment. Investments are screened for negative impact to exclude bad actors, such as tobacco or coal companies or those that use child labor. Over the past two years, the ESG market has grown from $22 trillion to $31 trillion, representing 15 percent of all investable assets in the world and equivalent to more than a third of professionally managed assets.
Justifiably, investors are concerned about “impact washing,” which occurs when a company’s existing activities are simply rebranded as impact, and when they make impact-focused claims without truly having any demonstrable positive social or environmental impact. There is an urgent need to set the bar higher. We need to ensure that the intention to deliver impact translates into actual impact. The only way to achieve this is to mandate impact measurement. This is where impact investing comes in.
Impact investing goes further than ESG investing in two ways: firstly, it aims to direct investment in companies creating positive impact, rather than just avoiding those creating negative impact. Secondly, it insists on measuring the impact it creates. ESG investments do not employ any tools of measurement, but instead, typically assess the effects of a company’s policies in a qualitative and non-standardized way, resulting in inaccurate assessments of impact. In contrast, true impact investment removes the guesswork and replaces it with dependable impact data.
The demand for impact investment is already huge. Since 2016, the impact investment market has doubled each year. In 2017, it was estimated at $230 billion; in 2018 it was $502 billion; and now it is heading for the first $1 trillion.
The International Finance Corporation (IFC), a subsidiary of the World Bank, estimates that investor demand for impact now amounts to no less than $26 trillion, 50 times the size of the 2018 market. With such a huge level of unmet demand, we can expect the market to continue to grow quickly for many more years.
Impact Investment: A Smart Business Decision
The simple reason that some of the world’s largest asset managers and pension funds are prioritizing impact is that their clients are demanding it, especially younger ones. According to a study by the US Trust, “Millennials are investing in organizations that prioritize the greater good more than any previous generation.” A recent McKinsey report also revealed that millennials are twice as likely to invest in companies that have a positive impact on society. As millennials stand to inherit huge sums from their baby boomer parents over the next few decades—the sum is $30 trillion in the US alone—they will undoubtedly be a major force in shifting the way money is invested.
As impact investment managers begin to show how they deliver both significant impact and financial return, impact investment will become more than a moral choice – it will become a smart business decision. Investors will come to realize that we are able to increase returns not despite impact, but because of it.
To learn more about the Impact Revolution, order a copy of my new book, IMPACT, here.
How can this be? Well, as we discussed in a previous blog, when we optimize risk–return–impact, we lower risk in many ways. We avoid the risks that accompany investments that cause harm, such as the risk of future regulation, taxation and even the prohibition of activities that could put a halt to business altogether.
Irresponsible companies take even more risk: the risk that consumers, employees and investors will leave them for competitors whose values are better aligned with their own. By choosing to prioritize impact, investors duck these risks too.
But impact can do more than reduce risk—it can also boost returns, by opening the door to new sets of opportunities. For example, a company that provides lower-cost products for under-served populations may not sound like a great investment opportunity, but if it taps into a massive pool of latent demand, this may well allow its profits to grow more substantially than its competitors who serve more established markets.
As we saw in our discussion of impact ventures earlier, when we view the world through an impact lens and use the triple helix of measuring risk-return-impact when making business decisions, we discover opportunities to achieve higher returns and improve the world that would otherwise pass us by. In short, doing good can be excellent business. Are you ready to demand more from companies as a consumer? Read IMPACT: Reshaping Capitalism to Drive Real Change to learn more about how you can make an impact.