Is Impact Investing Impactful?
By: Kyle Tang
Tags: Impact Investing, Finance, Money, Investing, Social Impact

Source: Philanthropic Foundations Canada

Impact investing is just like regular investing, but in addition to generating a financial return, impact investors also aim to create tangible, positive social or environmental impact. Impact investing allows investors who have specific social values to address their values by providing capital to companies that have the ability to carry out change towards them.

The history of impact investing

“Impact investing” is a relatively new term, being coined in 2007 by The Rockefeller Foundation. However, its roots from socially responsible investing date as far back to Biblical times, when Jewish law mandated ethical investing.

Socially responsible investing began in the U.S. during the 18th century, when the Methodists avoided investments in gambling, liquor, tobacco, and the slave trade. Modern socially responsible investing in the U.S. picked up as the investment management industry grew during the latter half of the 20th century. Values related to social issues like the civil rights movement, the Vietnam War, and climate change were all reflected in the industry.

It is important to note the subtle difference between impact investing and socially responsible investing. While the two share many principles, they differ in approach. Socially responsible investing focuses on the process, aiming to do no harm. Evolving from socially responsible investing, impact investing emphasizes the outcome, trying to actively do good. For example, a socially responsible investment might be a company that meets the majority of their energy needs with renewable energy, while an impact investment might be a company that develops a more accessible and efficient source of renewable energy.

Nowadays, impact investing is becoming mainstream. Some of the world’s largest investment firms — like Blackrock, which manages over $6 trillion — have committed to serving a “social purpose” as part of their missions. And as the industry has continuously grown over the past decades, the size of the industry is now (as of June 2020) estimated by the Global Impact Investing Network to be $715 billion.

Does impact investing have an impact?

Critics of impacting investing argue that impacting investing is not effective at actually making an impact. A report by Let’s Fund, a social impact crowdfunding organization, argues that donating will usually be more effective than investing at creating social impact.

Their report finds that truly impactful companies are hard to find. Because companies trying to make an impact have the difficult problem of balancing social impact and financial return, it is hard to identify whether or not social initiatives will be successful. Let’s Fund’s research suggests that impact investors do not carry out rigorous enough analyses on impact. As a Vox article about the same report says, “Articles about the marvels of social impact investment tend to emphasize the inspiring stories of the founders or the employees, not the expected benefits from the business.”

The report also argues that it’s difficult to provide “additionality” in companies, which cause them “to be more successful than [they] would otherwise have been.” If an impact investor merely displaces another a socially neutral investor’s investment in a company, then they are not providing any additionality to that company. This causes the need for financial sacrifice. In a big, public market, a company with the best-expected financial return will usually attract the most investors. Therefore, in order to provide additionality, impact investors usually have to sacrifice financial return to provide companies capital that they would not otherwise receive.

It’s not impossible to outperform the market with impact investing, though. According to a 2017 study by the Global Impact Investing Network, a group of 71 impact funds had an average annual return of 5.8%. While this is lackluster compared to the S&P 500’s approximately 10%, the top 5% of impact funds had a return equal to or greater than 22.1%. This shows that, just like conventional investing, stock picking/fund manager selection is very important.

The Let’s Fund report finds that philanthropic donations are “likely upwards of 10x more impactful” than impact investing. However, impact investing is not totally fruitless — the report identifies a few circumstances in which impact investing is a good approach. They are when an investor can accept a financial sacrifice, work on a problem neglected by other investors, invest in private companies to more easily provide additionality, or have an informational advantage to reliably identify impact opportunities.

Moreover, Let’s Fund acknowledges that money in impact or socially responsible investments will almost always be more beneficial to society than money otherwise not responsibly invested or donated. So, unless there is a day when investors would rather donate their money instead of investing it, impact investing will continue to serve a purpose by allowing investors to address their social conscience while also making a profit.