Popular opinion has it that ‘investing for the common good’ has gone mainstream. Yet our research finds that only a small proportion of funds has consistently generated market rate return and measurable social and environmental impact at large scale – especially in capital-starved emerging markets’ small and medium enterprises (SMEs), often deemed as risky and unattractive by mainstream investors. With investing for return and impact, known as impact investing, only selected opportunities exist. And it takes particular leadership skills, professional expertise and organisational setup to tackle them.
What is impact investing?
The need for impact investing has arisen from the persistence of societal challenges and the inability of existing institutions to eradicate them. Yet despite growing enthusiasm for such goals, there is still no consensus on what impact investing is. This is reflected in the huge variations in the estimated size of assets under management, from $502 billion by the Global Impact Investing Network (GIIN), to $30.4 trillion by the Global Sustainable Investment Alliance. Such lack of conceptual clarity and rigour causes confusion and dampens investor expectations. GIIN defines impact investing as“investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return”.
Unlike socially responsible investment (SRI) or environmental, social and governance (ESG) investing, impact investing is not just about avoiding “sin stocks”or “do-no-harm”, but also actively deploying capital to address social and environmental objectives while generating financial returns for investors. It requires intentionality: portfolio companies must proactively track, measure and report on their social and environmental impact. If successful, impact investing can unlock substantial capital from mainstream investors.
Challenges and opportunities for impact investing
We conducted extensive research of institutional investors and their portfolio companies. The result, however, has been disappointing. Most funds can deliver return or impact, but very few deliver both consistently at large scale. ‘Impact washing’ (particularly ‘green washing’) is rampant. According to Confucius, “he who chases two rabbits catches neither.” The challenge for impact investing is first to demonstrate that it is indeed possible to catch two rabbits at the same time, and then develop robust methodologies to identify and seize such opportunities.
For impact investing to scale, products must be capable of addressing a range of institutional needs, including the ability to absorb large pools of capital, adequate liquidity and robust risk management practices while generating measurable return and impact. These have traditionally been met through investment strategies targeting blue chip securities. Such an approach, however, results in channelling funds where it is harder to proactively generate impact, as bondholders and minority shareholders have limited opportunities to directly influence senior management teams of large corporations. Furthermore, blue chip securities are concentrated in mature markets, while the greatest need for impact capital is elsewhere. The IMF estimates a $700 billion unmet credit demand globally in terms of debt financing to emerging markets SMEs, a niche where every $1 invested contributes a further $13 to the local economy.