Before the advent of social impact investing, philanthropy and investments were considered separate disciplines. While one championed social change, the other focused on financial gain. The idea that the two could be integrated—that one could generate a financial return while contributing to the global good—was unheard of. Enter social impact investing.
What is social impact investing?
Social impact investing, or impact investing for short, is a type of investment strategy that allows investors to generate social or environmental benefits and financial gains.
The history of social impact investing
While it may sound like a relatively new type of investment initiative, impact investing has origins that date back 3,500 years ago.
In the United States, socially responsible investing began in the 18th century during the advent of Methodism, a denomination of Protestant Christianity that shunned smuggling, the slave trade, conscious consumption, and investments in companies that dealt with gambling, tobacco, or liquor.
This was followed by the Quakers, another Protestant denomination that eschewed investments in slavery and war. In 1928, a group in Boston established the Pioneer Fund, the first publicly offered fund with similar restrictions.
These old investment strategies had a similar goal: eliminating so-called ‘sin’ industries or businesses related to tobacco, liquor, gambling, war, weapons, or pornography. In the 1960s, socially responsible investing became even more popular, especially during the Vietnam War when protestors demanded that university endowment funds no longer support defense contractors.
These long-standing principles eventually came to represent a consistent investment philosophy that’s tied to investors’ concerns.
Finally, in 2006, institutional support for impact investing was gained thanks to the United Nations Principle for Responsible Investment (UN PRI), which led to over $45 trillion in signatories’ assets.
What started as an initiative to eliminate investments in products that conflicted with personal belief systems blossomed into an investing strategy determined to make investments in companies that create a positive impact.
Fast-forward to the present. In 2020, the Global Impact Investing Network (GIIN) discovered that the global impact investing market had reached $715 billion and was rapidly expanding.
What are the elements of social impact investing?
To better understand social impact investments, let’s go back to their most basic definition: social impact investments are investments in organizations, companies, and funds that generate environmental or social impact and financial return.
This definition is broad for the most part, but several key elements must be present in impact investment.
1. Social impact investments must have a positive social or environmental impact
Impacting investing utilizes investments to address various social and environmental issues, including hunger, climate change, homelessness, poverty, and the HIV/AIDS epidemic.
2. Social impact investments aim to deliver a financial return on capital
Since impact investing is a business activity, one of its main goals is to generate a financial return on capital, or at the very least, a return on capital.
3. Social impact investing is inclusive across asset classes
Impact investing spans various regions, sectors, and asset classes, from microfinance and cash equivalents to clean technology and private equity.
4. Social impact investing requires regular measurement
More metrics are available for the financial return of investment, but impact investors are also responsible for measuring social impact. While all types of investments impact society, be it positive or negative, impact investors must only pursue investments that generate positive social impact.
An impact investing deal involves two participants: the impact investee and the impact investor. Both parties aim to benefit from the investment. The impact investor intends to generate a financial return and measurable social impact, while the impact investee may be any mission-driven organization, whether for-profit, nonprofit, or hybrid.
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What makes social impact investing so attractive?
Social impact investing allows you to find a balance between compassion and commerce that appeals most to you, which is why it’s so attractive to potential investors. While some social impact investing strategies focus on financial return while benefiting society, others put social impact at the forefront, accepting below-market-rate returns or just principal repayment.
This balance between impact and financial return runs along a spectrum—you, the investor, decide which end you’d like to reach.
Social impact investments also run the gamut from straightforward to incredibly complex. They could be as easy as banking with a financial institution that aims to improve the economic opportunities for low-income stakeholders or as simple as supporting entrepreneurs in developing countries through micro-finance.
Other times, social impact investments can be very complex, from creating new arrangements between partners to developing new financial vehicles. These pioneering deals can be complicated for newcomers and often require the advice of an expert.
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Who can be an impact investor?
Anyone with as much as $5 can try to impact investing. Of course, there are several caveats. Just like other types of investments, social impact investments have risks.
You can select companies by carefully selecting ones that align with your values, but if you’re a newcomer, it’s best to seek the help of an expert or take an automated approach.
Social impact investing companies and apps such as Sustainfolio and OpenInvest will allow you to invest in socially responsible companies that support various issues, including fair labor, sustainability, LGBTQ rights, and female leadership.
Sofi Invest, which has one of the lowest barriers to entry, will allow you to make a minimum investment of just $5. Some tools can make the process easier. ImpactAssets, for example, is a searchable database of impact investing vehicles.
You can also try assembling a virtual portfolio of social impact companies with tools like MarketWatch’s Mockfolio. This allows you to experiment with options while seeing how they perform over time.
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What are the challenges involved in social impact investing?
Before we discuss why one should dabble in social impact investing, it’s best to understand the challenges it poses.
1. There may be a significant risk in impact investments
Just like traditional investments, social impact investments have various risk levels. You’ll quickly discover that several social enterprises that seek impact investment operate in underdeveloped markets. Here, nonprofits and businesses face the challenge of providing a service and helping to create infrastructure.
2. You may encounter a lack of deals and strategies
Impact investors may sometimes find the supply of investment opportunities offering impact, scale, and financial return lacking. This is why many impact investors become frustrated with finding deals that align with their philanthropic ideals and investment criteria.
After investing in a social enterprise, you may also find it challenging to find an attractive exit strategy.
Note that the first IPO of a benefit corporation was only created in early 2017. From a global perspective, an investor who puts his money in markets with government currency controls may find it challenging to get his cash back.
3. There is a lack of experts in the field
Investors seeking expert advice may find it challenging to find one with the requisite knowledge. Many financial advisors lack the chops to deal with the social aspects of impact investing.
On the other hand, many philanthropic advisors lack expertise in making wise financial investments. Since advisors with knowledge of investments and philanthropy are only just emerging, building a team with the required expertise can be challenging.
4. Impact can be hard to measure
While there are thoroughly implemented standards for impact investment performance, the industry standard for impact measurement is still in the gray area. As a result, social impact and assessment approaches are still very investor-specific.
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Why should you start social impact investing?
There are many ways my impact investing makes sense. Here’s why investment banks, venture capitalists, foundations, and individuals should ride the trend and start investing for social and environmental impact.
1. It helps support global issues.
The world is rife with challenges. Some of the most critical problems, including poverty, climate change, access to education, and healthcare, cannot be single-handedly solved by government grants. From social impact real estate investing to social impact investing education, using your money to ease global hardships and challenges allows you to contribute to a better future.
For developing countries to meet the UN’s Sustainable Development Goals (SDGs), an estimated annual $2.5 trillion is required. Private capital can provide a solution for this. ‘
2. You can earn from it.
One of the most common critiques of impact investments is that they perform poorly compared to traditional investments.
On the contrary, according to Global Impact Investing Network data, most of the estimated $15 billion impact investment market produced market-rate returns.
3. Impact investments can stabilize your portfolio
A Morgan Stanley study on over 10,000 equity mutual funds discovered that social impact funds displayed lower volatility over the past seven years than traditional funds.
This means that impact investing can be a beneficial complement to your portfolio’s collection of investments.
4. It allows you to make the most of your capital.
It’s easy to meet your individual or company’s social responsibility goals with investments in health, social, and environmental causes. Impact investments also yield much better ROI than grants or donations that require merely handing out money.
With smart impact funds, investors can grow the recipients sustainably, whether it’s a health startup, a small-holder farmer, or a company with energy challenges. Impact investments allow investors to build an inclusive circle of progress.
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5. It allows you to align your values with your investments.
Impact investing doesn’t choose between people, profit, or planet – you can simultaneously put your money where your values align and earn from it. Social impact investing allows you to become a responsible investor without sacrificing returns.
6. Clients demand impact investments.
If you’re an investment firm, know that today’s socially conscious, trust-based investing climate requires that you offer impact investment products to stay competitive. Studies have already proven that client demand is one of the main reasons investment firms provide this type of service.
7. Connect with diverse thinkers.
Social impact investing allows you to connect with various big thinkers you wouldn’t have met otherwise with non-impact investing.
From leading social impact entrepreneurs and human rights activists to development experts and NGO leaders, impact investing can bring together people from diverse backgrounds with a single goal – to make the world a better place.
8. It can change the culture of investments.
Most funds dedicated solely to investing in social change were created in the past decade, meaning that impact investing is becoming increasingly popular. If you’re an aspiring impact investor, you can ride on this energy to bring impact investing into the mainstream.
9. Drive positive change.
Investors are often known for becoming focused only on their financial bottom lines. Investing is, after all, a business activity. Social impact investing allows investors to broaden their horizons while having the opportunity to drive positive change.
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10. We have a moral responsibility to change the world.
As social entrepreneurs and investors, we all have a moral responsibility to unite, transform our economies, and redefine what we find valuable. Social impact investing allows us to fuel social change and make a difference for future generations.
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