Impact Investing Defined

Socially responsible investments might be emotionally compelling investments, but do they necessarily have compelling financial returns?

The term "Impact Investing" has taken on many meanings in the past few years. I want to end the confusion and underscore that impact investing must by definition deliver impactful and compelling financial returns.

Impact investing has been labeled as a subset of socially responsible investing (SRI). But, it is not a subset of SRI.

The basic premise of socially responsible investing is to avoid investing in businesses that cause harm to the environment or society. Since SRI's approach to investing is narrow and passive, it is by definition often a niche investing strategy, which in many cases has delivered lukewarm returns.

SRIs don't necessarily impact an industry, impact investments necessarily do. Yet, many organizations still treat SRI and impact investing like synonyms - causing confusion.

For example, here is the definition of SRI from ecolife, a website that is an online guide to green living:

"Socially responsible investing is an investment strategy employed by individuals, corporations, and governments looking for ways to ensure their funds go to support socially responsible firms. The concept goes by names like sustainable investing, impact investing, community investing, ethical investing, and socially-conscious investing; it is a non-financial gauge that is used when selecting various investment options that takes into account factors such as environmental, social, and ethical values."

The reality is that some socially responsible investments can be impact investments, but not all impact investments are socially responsible investments. So, SRIs are really a subset of impact investing. According to the Monitor Institute's new report "impact investors want to move beyond 'socially responsible investment'."

All impact investments have the potential to move towards a new economy - an impact economy, not all SRIs will. In fact, most SRIs won't.

Why? Impact investing is socially responsible and must have compelling returns. Returns that make the professional investor consider it seriously as a critical piece in the portfolio. According to Dr. Arjuna Sittampalam, research associate with EDHEC-Risk Institute, "in other words, the investor makes an active decision to seek a social or developmental return alongside their financial return."

Since impact investments create compelling returns, they have a greater chance of attracting more serious professional investors than SRIs -- a necessity for creating worldwide social change and impact.

The Global Impact Investing Network (GIIN) defines impact investments as those that: "aim to solve social or environmental challenges while generating financial profit. Impact investing includes investments that range from producing a return of principal capital (capital preservation) to offering market-rate or even market-beating financial returns. Although impact investing could be categorized as a type of 'socially responsible investing,' it contrasts with negative screening, which focuses primarily on avoiding investments in 'bad' or 'harmful' companies - impact investors actively seek to place capital in businesses and funds that can harness the positive power of enterprise."

This definition is more on target with the real definition of impact investing, but to revise part of GIIN's definition: Impact investments only include investments that can offer market-rate or even market-beating financial returns.

So, my definition -- impact investing must achieve four significant goals:

1. Make an impact in solving a pressing problem of our time,
2. Generate compelling returns for investors,
3. Generate growth for economies, and
4. Generate prosperity for developed and developing nations.

An example is my own case-in-point. I founded SunEdison that created the power purchase agreement (PPA) model for the solar industry. This business model used net metering, streamlined interconnection standards, ways to connect to the grid, and actually provided a new solar power service to customers.

Investments in PPAs are delivering 7-12% unleveraged after tax returns. In today's financial environment; these are compelling returns given the low risks.

Plus, PPAs have lowered the use of fossil fuels to deliver electric energy; created thousands of jobs worldwide and are growing. They have impactful financial returns and impact a big problem.

According to the Monitor Institute's new report Investing for social and environmental impact: a design for catalyzing an emerging industry "it is certainly plausible that in the next five to 10 years investing for impact could grow to represent about 1 percent of estimated professionally managed global assets in 2008. That would create a market of approximately $500 billion. A market that size would create an important supplement to philanthropy, nearly doubling the amount given away in the U.S. alone today."

But that is only a start, a start to an "Impact Economy." To really make a difference - to leverage impact investing to create an impact economy, it must be larger. Some estimate that we need to invest over $1 trillion to combat issues like climate change, poverty, and lacking global health, to put the world back onto a stable more equitable footing.

So, let's put our money where the impact is. Stop selling impact investors short.

Jigar Shah is CEO of the Carbon War Room, a nonprofit that harnesses the power of entrepreneurs to implement market-driven solutions to climate change and create a post-carbon economy.

 

Comments

[CLK3RD]

11:14 PM on 09/01/2011

Great summary. Our firm launched a wildly successful Social Impact Funding initiative last year and kicked off our second just this past week See link http://bit.ly/r6krHo
We meet the four criteria of your definition keeping participants happy knowing that their funds are helping to get families into energy efficient Eco-housing while at the same time receiving a 16.7 % rate of return.

[pberliner]

05:21 PM on 09/01/2011

To add to the mix, don't overlook the growing number of foundations and other organizations that are making targeted investments in order to accomplish their mission. These include both "mission-related investments" that result in both a social and a "compelling" financial return, and "program-related investments" for which the rate of return is secondary. Both MRIs and PRIs are sometimes identified as a subset of "impact investments." . Terminology aside, its exciting to see that investors of all types have more opportunities to do good, and do well, on terms that make sense to them.

[Birju Pandya]

04:51 PM on 09/01/2011

Excellent post Jigar, thank you for sharing! In reading the post, one thought came to mind that we use at our fund - instead of 'generate growth for economies', we seek to 'generate real growth for economies.' This becomes a key distinction in a world where resource usage externalities are easy to mask. Consequently, we've increasingly been looking into nature-based, or 'low tech', solutions that would create growth even in a resource-based economy rather than the system in place today.

[John Fullerton]

09:16 PM on 08/31/2011

Having thought deeply on these issues, what strikes me is our collective denial that ALL investments have impact. So we need to shift from a binary "good - bad" mentality (SRI vs impact or otherwise), and away from the "alternative to philanthropy" mentality, to focus on the quality of all investments across all asset classes as Jigar rightly points out. We must not succumb to the reductionist thinking that we can "allocate 1% (or 20%) of our portfolio to impact" and address the inherent conflict between our material growth based economic system and a finite planet.

[Tim Nash]

10:37 AM on 08/31/2011

I think we often get too lost in language, when we should be giving investors compelling reasons (emotional AND financial) to shift their assets in this direction. GIIN and SunEdison are fantastic stories! Impact investments hedge against things like systemic risk and carbon pricing. Every portfolio in the world should contain at least some.

Speaking of trillions, I want to point you to the Green Transition Scoreboard® (http://greentransitionscoreboard.com/) which shows more than $2 Trillion flowing into the global green economy!

[Eugene Ellmen]

09:37 AM on 08/31/2011

Jigar makes a good case for impact investing, but the attack on SRI makes no sense. Quite simply, SRI involves any strategy that incorporates environmental, social and governance considerations into investment. It is not, as Jigar claims, restricted to narrow exclusionary screening. Jigar's attack on SRI is one of many recent critiques of SRI by impact investing advocates who claim to position impact investing as somehow apart from and superior to SRI. Let's not divide those of us who want to see a more sustainable and responsible investment agenda. The real target of our criticism should be conventional investment which makes no effort to incorporate human or planetary values into investment.

[Jigar Shah]

05:11 AM on 08/31/2011

Great comment! I agree that "compelling financial return" is in the eye of the beholder. For me that number is actually not that "high". I am more interested in "safe". What I am frustrated by though is all of the folks in the space that are trying to convince family offices and others that this is "throw away" money to make a difference. That if you get your principal back that you should consider yourself lucky. Throughout all of the asset classes (VC, private equity, project finance, debt, etc) there are impact investments available. I would say over $1 Trillion in product in available. I want people to choose impact investments over destructive investments with their core capital. There is no need to sacrifice returns. Whatever your goals are, you can find impact investments that match them -- even for those folks wanting a high return.

[Suzanne Biegel]

07:16 PM on 08/30/2011

Thanks. Want to add that "compelling financial return" can be in the eye of the beholder...& one can view their investments along a spectrum. In the impact investing network I'm part of, Investors' Circle, some have high financial expectations and only do those deals, and some are excited about a 6% financial return but high social/enviro return. An investment in an enterprise with a cooperative structure or nonprofit/for-profit hybrid isn't necessarily going to bring me big financial wins, but the economic/social benefit may outweigh that for that particular invstmt. What is a "living return" for an investor these days... It needs to be financially viable & I'd love to see us continue to refine a definition of success. Also ...it is not one asset class, we're talking about many. And a portfolio approach in my book means that i can make choices about return expectations, investment by investment. Also...scale matters but sub-scale can be impt to demonstrate a new idea, or support a local living economy, as long as it is financially sustainable. I don't want to leave those out of my definition or my set of choices within a portfolio. Of course I want to attract a lot more capital to this space... but I also want to keep evolving what a "fair" return for investors looks like in 2011 and beyond. I'm glad you're driving for high returns AND I think there's room for a spectrum.