Investors have long sought to steer capital toward investments that align with their beliefs.
For as long as there have been investments, there have been socially responsible investments, where an industry’s effect on the community is considered alongside profit.
Since the shift of capital out of the sin industries of tobacco, alcohol and gambling that began decades or even centuries ago, to the avoidance of unethical or damaging sectors like fossil fuels, munitions and uranium mining today; change is happening.
And now, responsible investing, also known as sustainable or ethical investing, has entered the mainstream investment world; as many as four in every five Australians expect their banks and super funds to invest responsibly and ethically.
However, sustainable investing, including the consideration of environmental, social and governance (ESG) factors cannot solve the highly complex, dynamic and interdependent systemic issues of inequality, social injustice, poverty, climate change and ecosystem collapse.
For that we need mainstream adoption of impact investing — the pursuit of net positive social and environmental impact, alongside financial performance.
Impact, ESG or sustainable investing…
But what exactly is impact investing? The definition is not clear cut and the lack of standardised terminology is creating confusion for investors given the nuances between sustainable, impact and ESG investing.
Simply put, impact investing aligns closest with philanthropy, targeting and delivering measurable social or environmental outcomes alongside financial returns.
In contrast, ESG investing concentrates on incorporating ESG metrics into investment decisions without necessarily aiming for a particular positive social or environmental outcome.
Then there’s sustainability-themed investing that specifically targets areas like sustainable agriculture and aligns with the United Nations’ Sustainable Development Goals.
So while 43% of investments in Australia — approximately $1.54 trillion — are categorised as responsible, according to the Responsible Investment Association Australasia, impact investing is believed to account for less than 1% of all funds under professional management.
That’s a start, but it is nowhere near enough. To drive real environmental and social change, impact investing must become mainstream.
But for impact investing to go truly mainstream, there are a number of factors to be addressed.
1. No financial trade-off needed
Perceptions must be countered that a financial trade-off is necessary when investing for impact. Investing for good need not come at the expense of financial returns.
On the contrary, impact investing may deliver investment alpha, or outperformance relative to benchmarks.
This 'impact alpha' may represent a fundamental insight that the rest of the market doesn’t yet fully value, negating the trade-off between impact and financial return and raising the possibility of market-beating returns.
And it makes sense: investments with sustainable business models and impactful products or services are at lower risk of government regulations and are increasingly more attractive to both talent, customers and investors.
Impact investing is still an emergent concept, and it requires longer-term proven track records — showcasing that positive social and environmental outcomes can go hand in hand with financial profitability — for it to be adopted by mainstream investors.
2. Mainstream access required
To date, the impact investment space has been dominated by institutional investors, foundations, high net worth individuals and family offices. It simply hasn’t been easily accessible to retail investors at scale.
To become mainstream, impact must be integrated into the existing financial system. This requires collaboration between impact investors, traditional financial institutions, and regulatory bodies, as well as lifting awareness to inform individuals and their investment advisors.
As more investors push for societal or environmental impact to be prioritised alongside financial returns, institutions and asset managers will further incorporate impact investing to their product offerings.
Further, to accommodate large-scale capital inflows, there must be more scalable investment opportunities that allow for substantial investments without compromising impact. Development of such scalable investment vehicles — impact funds or social enterprises with growth potential — will be crucial.
3. Effective outcomes measurement
If both financial and impact outcomes are to be upheld as key measures of investment return, accurate performance reporting of societal and environmental impact is needed.
Visibility is key for investors but there is a lack of consistency in how impact is defined and measured with no single generally accepted system to measure impact the way there is for financial reporting.
Several organisations have developed frameworks that continue to be improved upon, including the Global Impact Investment Network’s IRIS+ system which it is promoting as industry standard, while Impact Frontiers is currently trying to build consensus on a common set of measures to enable consistency of methodologies used by third parties.
These hurdles can each be overcome and, in time, as more investors recognise that positive societal and environmental impact can go hand-in-hand alongside financial returns, solutions will emerge and impact investing can become mainstream.
Until then, investors would be wise to look at the underlying investments of portfolios and carefully scrutinise product disclosure statements and sustainability charters to better understand their potential investments.