On Tuesday, the World Economic Forum published a report discussing the rising potential of impact investing. As the report described, impact investing is the “investment approach that intentionally seeks to create both financial return and measurable positive social or environmental impact.” While $8 billion of capital was committed to this double bottom line strategy in 2012, the number is expected to rise to $9 billion in 2013, according to a recent survey by JP Morgan.
The 13% uptick of commitments is thanks to the success of the impact investments. The survey also uncovered that “the vast majority of surveyed investors report that their impact portfolio performance is meeting or exceeding social, environmental, and financial expectations.” 84% of respondents indicated that the impact of their investments were in-line with their expectations; 89% indicated that the financial returns were in-line or above expected performance.
Although the $9 billion is still a relative drop in the bucket of committed capital, the satisfaction reported by impact investors and the variety of social and macro factors will likely accelerate the strategy’s adoption over the next several decades.
Growth Factors Behind Impact Investing
One of the most critical drivers of the strategy is the transfer of wealth from Baby Boomers to their children. While this transition is likely to benefit private equity firms, it is also likely to shift greater emphasis to impact investing. As explained in the World Economic Forum’s report, “Asset management is in a state of flux. Over the next 40 years, Generation X and the Millennial Generation will potentially inherit an estimated $41 trillion from the Baby Boomer Generation.”
The movement of wealth is important because the inheriting generations have a predisposition for social good and have “grown up in a culture that calls on businesses to play a more active role in society,” explained the report. “In fact, in a recent study of 5,000 Millennials across 18 countries, respondents ranked ‘to improve society’ as their number one priority in business.”
The interest in doing good is being matched by “a set of driving forces — population growth, increasing demand for natural resources, environmental pressure, people living longer, chronic public health challenges, etc.,” explained Fran Seegul of Impact Assets. As these macro-factors come to fruition or worsen in the next several decades, they will provide Millennials a variety of opportunities, causes, and means to distribute their newly inherited capital for impact purposes.
In addition to their want to “improve society”, Generation X and the Millennials will be the first full generation equipped with the internet. The increased global connectivity allows the new generation of investors to overcome the informational and logistical challenges that previously deterred investors from exploring opaque, non-traditional markets.
“The digital age and subsequent availability of information has been a game changer for investing,” explained Nate Suppaiah of Alternative Emerging Investor. “While quality investment information is still superficial, immediate access to emerging market professionals, contacts, and vehicles opens the door to these regions for many investors. As a result, the number of LPs looking to invest in emerging markets is certainly growing.”
The Hurdles to Further Adoption
Although there are many favorable trends supporting impact investing, the road ahead is certain to contain struggles and bumps.
One of the biggest challenges is creating a uniform definition and understanding of ‘impact investing’. As it turns out, “in a survey conducted by the CFA institute, 66% of financial advisers claimed to be unaware of impact investing,” explained the World Economic Forum, For the investment strategy to reach any scale, a core understanding and common definition will need to be established for investors to begin appreciating the concept.
In addition to defining the asset class as a whole, impact investing is currently subject to extremely subjective definitions of success. Seegul explained, “The challenge is that there is a heterogeneity of returns in impact investing: we have jobs created over here, gallons of water saved over there, tons of greenhouse gases avoided, etc. – so the portfolio accounting is very hard for an investor or fund manager to say across all these investments my impact return on investment is ‘x’. It’s inherently more complicated.” The inability to standardize the social ROI makes it extremely difficult to convince an investor to take on the additional risk.
For there to be a real acceleration of impact investing, there needs to be a standardization of success. “If we can rally around industry standards such as IRIS (Impact Reporting and Investment Standards) and GIIRS (Global Impact Investing Rating System) we can start to measure impact in a more coordinated way,” added Seegull.
A clear standardization of success will require firms to hold their investments and their companies accountable for true impacts. If there is no industry-wide rallying or adoption, most investment firms or intermediaries will likely “greenwash” their investments to appear more socially impactful — without actually changing many of their strategies.
Preparing for the New Strategies
If these hurdles can be overcome and the appeal of impact investing continues to develop over the next several decades, the investors currently adopting the strategy will have a distinct competitive advantage in future fundraising efforts and sourcing efforts. With appropriate experience and reputation, any fund manager — public or private — will be able to cite their track record to attract new LPs and investors. While it would be unwise — and annoying to current LPs — to immediately adopt an impact-based model, firms should have important conversation during their next fundraising effort if they believe in the rise of impact investing.
As investors begin looking for more social investments, investment banks and small companies may need to shift their strategies as well. In addition to selling the financials and growth prospects of a company, the firm may need to sell their social and environmental impact as well — maybe there will even be a new chapter in the pitch book citing social metrics as well as financial metrics. It could become critical to have the right relationships with the right companies and position them correctly as you go to market.