What is Impact Investing?
Impact investing is the sexiest term in the investment community right now. Arguably, there isn’t much competition for the title, but don’t let that stunt our appreciation!
I read about ‘impact investing’ in investment industry write-ups. I see it in advertisements targeting millennial investment dollars. I see it on on countless LinkedIn profiles (John Snow is a swordsman, a man of the Night’s Watch, a Wildling lover… and a passionate impact investor). I see it in articles on philanthropy. It’s everywhere.
I was talking with a non-profit executive the other day and he told me ‘impact investing’ is the hottest word in the industry right now. Hotter than philanthropy even.
I trembled a little when he said that. Philanthropy has had a long run of hotness. But you heard it here first, folks. Impact investing is hotter than philanthropy.
Recently, another contact and I were running through different terms used in the socially responsible investment realm - SRI, ESG, sustainable investing, conscious investing… And then I got to Impact Investing.
I felt his ears perk up.
Impact investing? Ooo, what’s that?
I said it's being used so ubiquitously that it is losing its meaning, so I tend to shy away from using it.
But it’s so actionable, he said. Maybe you should help define it.
Challenge accepted, good sir. Challenge accepted.
What is Impact Investing
Impact investing involves making an investment in a company, organization, or industry for the purpose of furthering along a desired social or environmental outcome in addition to any investment return expectations.
For example, a wealthy individual or a large foundation/endowment might invest in a startup that intends to make hydrogen fuel cells ubiquitous, thus making all carbon-based energy production antiquated. The investment is highly risky as it is unlikely the company will end-up with marketable product. Also, statistically speaking, most startups fail. However, the mission of the foundation or investor is to invest in companies with promising environmental missions in addition to any return considerations. This is an example of impact investing.
For those of us who do not yet have a million dollar net worth, there are other examples of impact investing. For many individuals, investing in the stock of a solar company is an impact investment. There is potential financial reward, if the investment is analyzed appropriately or with a little luck, but there is also the social ramifications of success. Commonly, wind and water investments are also seen in such light.
On a small scale, becoming a member of your local co-op could be seen as an impact investment. On one hand, you expect a return in the form of a discount on your food or an annual dividend. On the other hand, you may simply be content to support your local agricultural system.
Other examples may include:
- Buying into a solar garden that may lower your electricity bill while also reducing your dependence on fossil fuels.
- Using a city grant or subsidy to provide affordable housing at your rental property.
How does impact investing differ from socially responsible investment or sustainable investing?
Impact investing is a specific branch of socially responsible investment. Sustainable investing broadly includes environmental, social, and governance factors (ESG) in the fundamental assessment of a company or investment portfolio. Language, in this case, actually helps us understand this dynamic, as there is little social impact necessary for a company to be qualified for inclusion in an ESG-optimized portfolio.
Apple, for example, is included in most socially responsible indices, yet at this stage in its development, the largest company in the world hardly seems qualified as an impact investment (thought the title may have applied in the past). For more on socially responsible investment, see here.
In other words, an impact investment usually qualifies as a socially responsible investment, yet a socially responsible investment is not necessarily an impact investment. Sustainable investing is a broad description, while impact investing, is quite specific.
This brings us to another difference between impact investing and socially responsible investing:
Impact investment is not an investment strategy; rather, it is a small chunk of an overall strategy.
True impact investing involves a great deal of research, both upfront and ongoing, and a higher risk tolerance. The average investor, regardless of net worth, simply does not have the time, interest, or expertise to do this well. Of course, the research can be outsourced, especially for large investment portfolios measured in the tens of millions. Or, one could buy an ETF or mutual fund that invests in, for example, water or solar companies. However, this should only be a small portion of an overall investment portfolio (2-4%). The majority should be allocated to a broadly diversified portfolio aligned with your long-term goals and risk tolerance.
How Do I Become an Impact Investor?
Here are some questions to ask if you are considering making an impact investment:
- Are their any social or environmental causes that I care deeply about where there might be for-profit companies or businesses involved in the solution?
- Do I care enough to do substantial research on possible solutions?
- Do I have the time and resources to do substantial research on possible solutions?
- Are there any companies, funds, or ETFs that would help me achieve my impact investing goal?
- Do I have the time and resources necessary to research my options?
- How much of my overall portfolio am I comfortable allocating to this investment without irresponsibly damaging my long-term goals?
- In other words, do I have the capacity to take such investment risk?
- Am I comfortable not ever making a return on this investment or even losing some or maybe even all of the original investment?
- Will this harm my long-term goals? Like retirement, paying down debt, buying a house, etc?
- Will the investment performance (or lack of) give me anxiety or lead to any sleepless nights?
If you’d like further assistance, consider talking to an investment professional, preferably one who specializes in socially responsible investment. They may be able to help you get clear on your overall financial goals and assess whether impact investing is for you.