Impact Investing 101: A Comprehensive Guide

Impact investing is a game-changer for those who want to make a difference while growing their wealth. By investing in companies or projects that aim to solve social or environmental problems, you can earn returns while doing good.

Impact investing is not just a feel-good approach, it's a smart investment strategy. According to a study, 90% of investors believe that impact investing is a good way to make a positive impact on society.

You might be wondering, what kind of investments can I make? Impact investing encompasses a wide range of sectors, from renewable energy to education. For example, investing in solar panels can reduce carbon emissions and earn you a return on investment.

Impact investing is not just for individuals, it's also a growing trend among institutional investors. In fact, $1.2 trillion was invested in impact investments in 2020, a significant increase from previous years.

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Impact investing challenges the idea that social and environmental issues should be addressed only through philanthropy. It offers a new way to address these issues through investments that also produce financial returns.

The impact investing market is growing, with some estimates valuing it at nearly $9 trillion in the U.S. alone. This market offers diverse and viable opportunities for investors to advance social and environmental solutions.

Impact investing seeks to generate social and/or environmental benefits while delivering a financial return. This approach is expanding as a promising tool for both investors and philanthropists.

The amounts of capital available for impact investing are staggering. In the U.S., philanthropy is approximately $390 billion, government spending is $3.9 trillion, and capital markets encompass $65 trillion. On a global scale, total investments are estimated at $300 trillion.

A 1% shift in global capital markets towards impact investing could cover the estimated outstanding $2.5 trillion annual funding gap to achieve the United Nations' Sustainable Development Goals (SDGs). This shows the potential for impact investing to have a huge societal benefit.

Common investor motivations in the impact investing market include:

Impact investments can take many forms, but they all share a common goal: to create positive social or environmental impact while generating financial returns. Mission-related investments (MRIs) are one type of impact investment that involves making loans to mission-aligned non-profit organizations.

MRIs can also include investments in for-profit social impact companies, such as charter schools, hospitals, or research centers, which are expected to pay back loans with interest. These investments are designed to have a positive social impact and contribute to the endowment's long-term financial stability and growth.

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Investments can be made in a variety of sectors, including sustainable agriculture, renewable energy, conservation, microfinance, and affordable and accessible basic services.

These sectors address some of the world's most pressing challenges, such as providing housing, healthcare, and education to those in need.

Impact investments can target a range of returns, from below market to market rate, depending on the investor's strategic goals.

Investors can choose to invest in emerging or developed markets, depending on their risk tolerance and investment objectives.

The growing impact investment market provides capital to support innovative solutions and businesses that drive positive change.

Mission-related investments (MRIs) are investments made from endowments into mission-driven organizations that generate market-rate financial returns. MRIs are designed to have both a positive social impact and contribute to the endowment's long-term financial stability and growth.

These investments can include loans to non-profit organizations, such as charter schools, hospitals, or research centers, that are expected to pay back loans with interest. MRIs can also include investments in for-profit social impact companies, social impact funds, and socially responsible fixed income funds.

MRIs are designed to have a dual purpose: to generate financial returns and to create positive social impact. This approach can be appealing to investors who want to make a difference in the world while also growing their wealth.

Examples of MRIs include impact-oriented private equity funds and public equity portfolios that invest in companies with a positive social mission.

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Impact investments can be structured in various ways to achieve specific goals. Mission Related Investments (MRIs) are risk-adjusted, market-rate investments made by foundations to further their philanthropic goals.

MRIs have a positive social impact while contributing to the foundation's long-term financial stability and growth. The Bill and Melinda Gates Foundation uses MRIs to complement its traditional grantmaking and scale social enterprises that serve the poor.

The structure of the transfer of money itself also has a range of possibilities, including private and public debt or equity, real assets, or other innovative instruments. Private debt is the most common investment structure, as shown by the 2017 GIIN Annual Survey.

Hybrid corporate forms have developed to prioritize public benefit over financial performance, such as benefit corporations, which have been enacted in 33 states since B Lab began its work in 2006.

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Investors are increasingly looking for companies that not only generate financial returns but also create positive social and environmental impact.

The structure of investees is evolving to reflect this shift in priorities. More nonprofits are generating revenue through the sale of products or services, while for-profit companies are integrating social good into their business models.

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Hybrid corporate forms have developed to accommodate these blended corporate aims. For example, since the organization B Lab began its work in 2006, 33 states have enacted legislation for incorporation as a "benefit corporation", in which a company prioritizes public benefit over financial performance.

Over 2,000 organizations in over 50 countries have taken up a non-legal designation of B Corporation, which requires them to meet rigorous standards for social and environmental performance.

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Program-related investments (PRIs) are a type of investment made by foundations to achieve charitable or "programmatic" objectives rather than financial objectives.

Foundations use PRIs to invest in below-market rate or concessionary investments.

PRIs include recoverable grants, below-market-rate loans, R&D or seed stage equity investments, loan guarantees, and volume guarantees.

For private foundations, PRIs count towards the required 5 percent annual payout.

Impact investments can be structured in various ways to achieve specific goals.

Mission Related Investments (MRIs) are risk-adjusted, market-rate investments made as part of a foundation's endowment, which have a positive social impact and contribute to the foundation's long-term financial stability and growth.

The structure of the transfer of money itself can incorporate cash, private and public debt or equity, real assets, or other innovative instruments. Private debt is the most common investment structure, according to the 2017 GIIN Annual Survey.

Program Related Investments (PRIs) are below-market rate investments made by private foundations designed to achieve specific program objectives, and have a legal definition in the U.S.

The Bill and Melinda Gates Foundation uses PRIs to complement its traditional grantmaking and to scale social enterprises that serve the poor.

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Institutional investors and large corporations are increasingly using impact investments to create shared value and positively impact their operations. This approach is being driven by companies that seek to develop new products and services that align with their core values.

Impact investment "accelerators" are also emerging as a mechanism for social enterprises, providing smaller amounts of capital and business development services. These accelerators are often nonprofits, raising grants from donors to support their work.

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The traditional philanthropic vehicle of choice has been the foundation, but innovative structures are now being used to match impact goals with available opportunities. Laurene Powell Jobs, for example, used an LLC as her primary vehicle in running the Emerson Collective.

The Chan Zuckerberg Initiative has implemented a combination of LLC, DAF, private foundation, and 501(c)(4) structures, forgoing tax benefits to optimize flexibility and maximize impact.

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The impact investing market has seen considerable growth in recent years, with the GIIN estimating its size to be $1.164 trillion in 2022. This is a significant increase from previous years.

The market is spread across various organisations and geographies, with diagrams on pages 3-4 of the GIIN's 2022 market sizing report providing a useful visual breakdown of how impact investing is distributed.

The European impact investment market sizing exercise estimated the size of the direct impact investment market in 2022 to be €80 billion. This is a notable figure, reflecting the growing interest in impact investing across the continent.

The UK impact investing market has seen a remarkable growth, with the estimated size valued at £7.9 billion in the most recent figures. This represents a nearly ten-fold growth over the past ten years.

The GIIN's 2020 Annual Impact Investor Survey details the investment activity of 294 leading impact investors, collectively managing USD 404 billion. This survey highlights the growth in depth and sophistication of impact investing over the years.

Here's a summary of the estimated sizes of the impact investing markets:

Impact investors are optimistic about the future of the market, expecting increased scale and efficiency in the years to come.

Impact investing strategies involve three stages: prepare, build, and refine. A comprehensive resource like the one mentioned by Mhairi Littlewood is a great place to start, as it explores how to set up an impact investing strategy with useful case studies and accessible language.

Impact investors can use the IMP's framework, which classifies investments according to three types of impact: avoid harm, benefit stakeholders, and contribute to solutions. This framework is particularly useful for understanding the data required to understand the impact of investments and classifying the impact of a portfolio.

To mainstream impact investing, various agents within the impact ecosystem, such as capital providers and financial intermediaries, need to take specific actions. For example, financial intermediaries can create liquidity, reduce risk, and lower transaction costs to facilitate a more fluent payment mechanism.

Policy makers can also play a crucial role in catalyzing the impact ecosystem through various policy tools, such as regulatory frameworks and tax incentives.

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The impact investing market has attracted a wide variety of participants, both individual and institutional. These participants include fund managers, development finance institutions, diversified financial institutions and banks, private foundations, pension funds and insurance companies, family offices, individual investors, non-governmental organizations, religious institutions, and corporations.

Impact investing is a collaborative international effort to accelerate the development of a high-functioning market that supports impact investing. This market is still relatively new, but investors are optimistic about its development and expect increased scale and efficiency in the future.

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Impact investors have managed around $114 billion in impact investing assets as of 2015, according to the GIIN's 2017 Annual Impact Investor Survey. The largest sectors by asset allocation were microfinance, energy, housing, and financial services.

Impact investments occur across asset classes and investment amounts, including private equity or venture capital, hedge funds, and private equity funds. Large corporations are also emerging as powerful mechanisms for impact investing, employing impact investments through their value chain, particularly their supply chain.

The following list highlights the various types of organizations receiving impact investment capital:

Philanthropy can play a significant role in advancing impact investing by providing risk capital, early capital, or patient capital to promising investments that don't yet attract pure investment capital.

The GW SRIF offers a unique learning experience for students, where they get to decide on investments in socially responsible firms with funds raised for SRIF.

Students lead the SRIF, making decisions on investments, which provides them with valuable exposure to the perspectives and experience of practitioners.

The SRIF invests in socially responsible firms, using funds raised for this purpose, and profits from these investments are committed to the ICR for student scholarships.

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The Student Advisory Group is a vital component in mobilizing private finance towards the Sustainable Development Goals (SDGs).

This group is led by students who aim to support nonprofits and projects that were unable to receive government funding.

They work as advisors to provide a space for collaboration, new partnerships, and the development of accountability and measurement frameworks.

One of the key aspects of Compass is that it consults on real projects, allowing students to gain hands-on experience in the field.

Impact investments have diverse financial return expectations, with some investors aiming for below-market-rate returns and others seeking market-beating returns. Most investors, however, pursue competitive, market-rate returns.

A report by the GIIN's 2023 Annual Impact Investor Survey found that portfolio performance overwhelmingly meets or exceeds investor expectations for both social and/or environmental impact and financial return. This is true across various market segments, including emerging markets, developed markets, and the market as a whole.

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Business model execution and management is the most common contributor to risk in impact investing portfolios, according to respondents. Very few investors report significant risk events in their impact investing portfolios.

Impact investors are becoming more sophisticated in their approaches to performance management and capital allocation, exercising a dynamic decision-making approach that considers impact objectives and impact risks alongside traditional factors. This is evident in the GIIN's 2020 Annual Impact Investor Survey responses of 161 impact investors seeking risk-adjusted, market-rate returns.

Here are some key findings on financial performance from the GIIN's research:

Strong environmental, social, and governance (ESG) practices can lead to financial outperformance in social good projects. This is a result of investors adopting a more strategic approach to investing that balances financial goals with social and environmental objectives.

Impact investing can be a great way to make a positive difference in the world, but it's not without its challenges. Investments can carry significant risk, just like traditional investments, and it's even more ambitious to aim for impact along two dimensions.

One of the biggest challenges is finding deals that fit both investment criteria and philanthropic orientation. Impact investors can experience frustration finding deals that offer scale, impact, and financial return.

Lack of expertise and market fragmentation is another issue. Many financial advisors lack experience in the social aspects of impact investing, while philanthropic advisors lack expertise in making financial investments.

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Impact investing offers several benefits that make it an attractive option for donors and investors.

A simple return of principal creates philanthropic leverage unattainable through traditional grantmaking.

Foundations are required by law to disperse at least 5% of their assets each year, but impact investing allows more of that philanthropic money to be leveraged for social or environmental change.

Donors can align more of their assets with their philanthropic goals through impact investing, which means they can make a bigger difference.

Impact investing is a complex and ambitious field, and it's not without its challenges. Investing in companies that aim to create both financial returns and social impact can be a high-risk endeavor.

Investments can carry significant risk, just like traditional investments. This is because social enterprises often operate in underdeveloped markets, where they face the challenge of creating infrastructure while providing a service.

The supply of investment opportunities that offer scale, impact, and financial return sometimes falls short of demand. As a result, impact investors can experience frustration finding deals that fit both their investment criteria and their philanthropic orientation.

Finding an attractive exit strategy can be a challenge once an investment is made. For example, the first IPO of a benefit corporation only occurred in early 2017.

Many financial advisors lack expertise in the social aspects of impact investing. At the same time, many philanthropic advisors lack expertise in making financial investments.

Philanthropy plays a crucial role in advancing impact investing. Philanthropy can provide risk capital, early capital, or patient capital to promising investments that don't yet attract pure investment capital due to higher risk, an unproven track record, or an uncertain return timeline.

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For over a century, philanthropy has honed the challenging task of impact measurement. This expertise can be used to coordinate with impact investors to evaluate impact, which can then be measured alongside financial return.

Philanthropy can also help develop, scale, and professionalize the impact investing field through education, training, research, and infrastructure building. The Rockefeller Foundation and the Case Foundation are two organizations that demonstrate the power of philanthropy in this space.

Here are some ways philanthropy is advancing impact investing:

The Rockefeller Foundation helped shape the impact investing space in the mid-2000s by assembling a group of philanthropists, investors, and entrepreneurs who coined the term "impact investing."

Impact investing is making a tangible difference in various parts of the world.

Acumen and Everytable are working together to bring good health into reach, improving the lives of people in need.

In Bolivia, impact investing is improving the lives of women, who are often the primary caregivers in their families.

Impact investors are also focusing on the environment, as seen in their efforts to benefit the people and environment of Mongolia.

LeapFrog and Bima are another example of impact investors making a difference, reaching the unreachable with their innovative solutions.

Patamar Capital and Kinara Capital are transforming lives, livelihoods, and local economies in various regions.

In Asia, impact investing is a growing sector with many funds in play. The region has seen significant investment, with US$904 million in impact capital deployed by Private Impact Investors (PIIs) in South East Asia alone from 2007 to 2017.

Development Finance Institutions (DFIs) have also been active, investing US$11.9 million in the same region during this time period.

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The impact investing industry has produced many success stories, with organizations like Acumen and Everytable working together to bring good health within reach for those who need it most.

Acumen and Everytable are a great example of how impact investing can make a difference. They're providing access to nutritious food and healthcare in underserved communities.

LeapFrog and Bima are another notable example, using impact investing to reach people who were previously unreachable. They're providing financial services to those who need it most.

Patamar Capital and Kinara Capital are also transforming lives, livelihoods, and local economies through their impact investing efforts.

These organizations are making a real difference in the lives of women in Bolivia, the people and environment of Mongolia, and bilingual communities in the United States.

Here are a few examples of impact investing in action: