Impact investing has evolved into a sophisticated investment and risk management strategy throughout the past few years. As a result, it now allows investors to incorporate environmental, social, and governance considerations into their investment portfolios without sacrificing return on investment.
Nevertheless, there is a widespread misconception among investors that impact investing entails a choice between a positive effect (return on social and environmental investment) and risk-adjusted financial return. Although the sector of impact investing has expanded at an incredible pace over the last decade, there are still questions about its capacity to provide enormous returns on both a financial and a social level. Moving forward, we will explore the dilemma between financial returns and impact investing.
Empirical Findings on Impact Investing & Financial Returns
Can investors have the positive social or environmental effect they want without compromising their financial objectives? From their point of view, the return on investment will be lesser the more important the effect emphasis would be. This view is reasonable when we consider that in the early days of impact investing, negative screening was the primary strategy, which might result in increased risk and worse returns. Nonetheless, existing research suggests that impact investments may perform as well as – and in some instances better than – traditional investments. This dispels the “trade-off fallacy” that investors must select between good influence or financial rewards.
According to the findings of a thorough analysis conducted by the Royal Bank of Canada, there is no evidence that socially responsible investing results in inferior investment returns. The research looked at over 40 important studies to get to this conclusion. Furthermore, this viewpoint was supported by the findings of the 2017 Annual Impact Investor Survey conducted by the Global Impact Investing Network (GIIN). The survey discovered that most respondents had achieved returns comparable to the market, with 91% claiming that their returns met or exceeded their professional expectations. However, to have a complete understanding of the situation, we must first investigate the arguments on all sides of the debate.
Source: NYU
Another study conducted by the Global Impact Investing Network (GIIN) and JPMorgan indicated that 55% of the possibilities for impact investing result in returns that are competitive with market rates. These findings were reinforced by a meta-study conducted by Friede and Busch, which looked at the relationship between ESG factors and the financial performance of corporations over the past four decades and included more than 2,200 separate pieces of academic research. It was discovered that over 90% of these studies demonstrated that ESG elements had a positive, neutral, or no influence on financial results.
Source: Friede, Busch & Bassen
Exploring the Overall Impact on the Bottom Line
At its most fundamental level, impact investing is an innovation in philanthropic funding that enables investors interested in social or environmental change to use it to grow the reach of their commitment while continuing to reap financial gains. This need is being met by an increasing number of ventures entering worldwide markets, which expands the pool of prospects available for investment.
Numerous organizations have realized that improved environmental and social elements management may save costs, alleviate risks, and offer revenue-generating possibilities. In specific industries, expenditure structures are dominated by environmental costs, such as extraction, procurement, transportation, and energy consumption for naturally occurring raw materials, as well as social costs, such as labour. For instance, in the pulp and paper industry, wood and transportation account for around 55% of expenditures, with chemicals, energy, and labour accounting for most of the remaining.
Source: Nasdaq
By tackling these environmental factors through various approaches, such as vertical integration and/or relocating manufacturing facilities closer to suppliers, businesses can cut emissions caused by transport and reduce some costs, thereby delivering environmental and financial benefits. Moreover, increasing resource effectiveness across operations and the supply chain may lower a company’s vulnerability to fluctuating commodities markets, growing insurance premiums, and hedging financial products.
Concerning the social dimension, human resource departments regularly rebalance the workforce to decrease recruiting and redundancy costs while preserving the appropriate amount of experience and youth. However, certain ESG risk-mitigation activities may need substantial capital expenditures, negating a portion of the potential advantages, particularly in the near term.
Impact Investing & Governmental Incentives
For investors in countries like the UK or other EU states, impact investing frequently presents the possibility of taking advantage of a broad range of tax benefits. These tax benefits frequently serve as an additional incentive to the positive target returns and the beneficial larger missions that impact investments strive to accomplish.
Source: GIIN
It is in the government’s best interest to incentivize convincing early-stage companies to create innovative, disruptive, and even transformative technologies, which frequently translate into impact investments. This is because these technologies can potentially have a significant positive impact on the economy. Consequently, tax-efficient investment options are often selected as the technique of choice to close this gap.
Bottom Line
Whereas impact investing aspires to bring about meaningful and lasting change, it presents investors with a significant challenge: discovering scalable, financially profitable, and socially sustainable business models. Once these possibilities have been discovered, it is necessary to seek out the most appropriate financial tools and creative market solutions to support the different goals of impact investors and social entrepreneurs. Overall, the popularity of impact investing has skyrocketed over the last few years, given that it provides a mix of good impacts, the possibility of large profits, and in certain instances, a layer of negative risk limitation. Doing good and producing great profits are not mutually exclusive. With impact investing, both objectives may be met.
However, the success of impact investment is dependent not only on the appropriate mobilization of resources and reporting of those resources but also on establishing the proper expectations and eliminating misunderstandings. Potential impact investors need the appropriate counsel to be steered along the correct route, and this is especially true when they are venturing into territory that is foreign to them.