Impact Investing: How It Differs From SRI & ESG Investing And What You Need To Know To Get Started

Impact investors are willing to forego financial returns in favor of making a positive social or environmental impact with their investments

TLDR

  • Impact investing is a sustainable investing strategy where the primary goal is to make a meaningful, positive impact on a given social or environmental issue
  • The key characteristics of the strategy include clearly defined intentionality, reasonable return expectations, the possibility of investing in concessionary assets and a specific impact measurement framework
  • Impact-oriented investing is different from Socially Responsible Investing and Environmental, Social and Governance investing. It’s more targeted and focused than SRI and can sometimes forgo financial returns in favor of the impact, unlike ESG investing.
  • Impact investments can bring an average gross return rate of 7-18% and an average net return rate of around 5.8%
  • The most common ways to participate in impact-driven investing include Microfinance Investment Vehicles, pooled angel investments and impact-oriented index funds

There are over 1,340 organizations in the world that are managing around $502 billion worth of impact investing assets.

Just like other types of sustainability-oriented investing, impact-driven investing has grown more prominent in recent years.

And while all types of sustainable investing aim to make a meaningful contribution to social or environmental causes, each type is slightly different.

In this blog post, we will:

  • Define impact investing
  • Explore what makes it different from other sustainable investing practices
  • Examine the different impact-focused investing strategies
  • Suggest a few ways of participating in impact investing

 

What Is Impact Investing?

As the name suggests, impact investing is the practice of investing in companies, organizations or financial instruments with the goal of making a meaningful social or environmental impact.

Just like Environmental, Social and Governance (ESG) and Socially Responsible Investing (SRI), impact-oriented investing falls under the umbrella category of sustainable investing.

All sustainable investing practices share the same goal — to foster progress and positive change. As a result, distinguishing between the different practices can be tricky.

However, impact-driven investing has a few characteristics that make it stand out from other sustainable investing strategies.

More specifically, it rests on four key principles — as outlined by the Global Impact Investing Network:

  • Clearly defined intentionality: Impact investments cannot be unintentional or have vague goals. Any investor who chooses to participate in this strategy must clearly define the impact they wish to make with their investments.
  • Reasonable return expectations: Financial return isn’t typically the priority of impact investments — but it’s an important factor, nevertheless. It is generally accepted that impact investments should generate at least some return on your capital, or at least help you break even.
  • Concessionary assets: Since financial returns aren’t the main goal of impact-driven investments, many investors choose to invest in the so-called concessionary instruments — assets that deliver below-market-rate returns.
  • Measurable impact: The goal of impact investments is to bring tangible results — tangible meaning measurable. As such, a key element of any impact-driven investment strategy is a measurement framework that allows investors to quantify and assess the impact of their investments.
One of the most prominent impact investment opportunities are Microfinance Investment Vehicles — funds that provide loans to small businesses in developing countries.

How Is Impact Investing Different From SRI & ESG Investing?

Due to the similarities and shared goals of SRI, ESG and impact investing, the three terms are often used interchangeably.

This mislabeling is largely a result of the three investing practices having the same general idea behind them — making a meaningful social or environmental impact through strategic investments.

However, they are somewhat different in their respective approaches and specific tactics. To draw a clear comparison between the three practices, let’s first look at the specifics of SRI and ESG investing:

  • Socially Responsible Investing (SRI): SRI is the broadest of the three terms. Socially Responsible Investing is built on two key strategies for finding sustainable investment opportunities — positive and negative screening. These strategies involve actively seeking out or avoiding instruments that fulfill or don’t fulfill specific sustainability criteria, respectively.
  • Environmental, Social and Governance (ESG) Investing: ESG investing is sometimes regarded as a strategy within SRI. However, many investors consider it to be a sustainable investing practice in its own right, and that’s also correct. The ESG investing approach enhances the standard stock valuation process with a set of sustainability criteria. These criteria usually represent the environmental, social and governance practices of a given company and whether these practices satisfy the investors’ sustainability requirements. ESG is, to some extent, more flexible than SRI, as it gives investors the opportunity to evaluate any instrument against the sustainability framework, without having to purposefully seek out appropriate investment opportunities.

Now that we’ve covered the basics of SRI and ESG investing, let’s explore where impact-driven investing stands compared to these two approaches:

  • Impact Investing vs SRI: Impact-driven investing could be considered an adaptation of SRI’s positive screening approach, as it also requires the investor to find suitable opportunities. However, it is more focused than SRI. Unlike SRI, where the investors’ motivations and goals could be broad, impact investments tend to be more targeted and tangible. For example, where an SRI investor might aim to raise global awareness of climate change issues, an impact investor might consider supporting a solar power company in finishing a specific project.
  • Impact Investing vs ESG Investing: The main difference between ESG investments and impact investments is the expectation of financial return. At its heart, ESG investing is still largely a traditional investing approach that places a significant focus on the financial performance of a given instrument. Impact investing, on the other hand, treats financial returns as secondary and prioritizes the social and environmental impact of an investment opportunity — a quality that it shares with SRI.

What Financial Returns To Expect From Your Impact Investments

Even though impact investors are often willing to forego capital gains from their investments, impact investments can still bring considerable financial returns, along with supporting social and environmental causes.

A survey of impact investors conducted by GIIN found that 67% of respondents sought risk-adjusted, market-rate returns on their investments.

Moreover, 88% of investors said that those returns either outperformed or performed in line with their expectations.

According to the survey, the average annual gross returns an impact investor can expect range from 7-18%, depending on whether the investments were made at or below the market rate.

As for the net returns, an earlier study by GIIN found that the average internal rate of return for impact investors was around 5.8%, while the median rate was closer to 4.6%.

Somewhat surprisingly, the survey also found that investment funds with under $100 million in assets under management enjoyed the strongest mean return rate of around 8.9%.

 

Impact investors enjoy an average internal rate of return of around 5.8%.

How To Participate In Social Impact Investing

One significant benefit of impact-focused investing is that it offers investors several paths to take when putting their capital to work and fostering meaningful change.

Here are a few ways you can participate:

#1: Microfinance Investment Vehicles

Microfinance investment vehicles (MIVs) are the dominant solution among impact investors, with estimated total market size of $16.9 billion.

Supported by private investors, MIVs are investment funds specializing in providing small loans to individuals and small businesses, particularly in developing countries.

Other industries that are commonly funded by microfinance investments include agriculture, housing and renewable energy.

Investing in a MIV is one of the most straightforward ways for an investor to make a direct, measurable socioeconomic impact on the lives of people in developing parts of the world, who often lack access to local capital or banking services.

#2: Pooled Angel Investing

Angel investing is the practice of providing capital to early-stage start-ups or struggling businesses. In exchange for their seed capital, angel investors usually receive some type of benefit, such as a small stake in the company.

In turn, pooled angel investing is constructed by a group of angel investors who combine their capital and make impact investments as a group or syndicate.

While some angel investors choose to consolidate their capital in a fund, angel investing can also be done in a more informal manner, following the guidelines that the syndicate establishes for itself.

Impact-oriented angel investing can be very effective in helping tackle specific social or environmental impacts, as the syndicate participants tend to be experienced investors.

At the same time, it might not be a very suitable approach for beginner investors, as it requires considerable capital and deep understanding of the finance industry.

#3: Impact-Oriented Index Funds

Impact-oriented index funds are, by far, the most accessible investing strategy for individual impact investors aiming to make a meaningful contribution to a sustainability cause.

Investing in an index fund means indirectly investing in companies or organizations that the fund has holdings in.

Impact funds can differ in terms of their holdings and goals. Nevertheless, they uphold the key impact investment principles of having clearly defined and measurable goals, as well as prioritizing sustainable causes over financial returns.

As an individual investor, you have several ways of investing in an impact fund, with the easiest and most accessible being investment advisory platforms.

These platforms can help you define your investment strategy more clearly by relying on their expertise and automated advisory technology.