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Impact Investing: More Than Just Money

Impact investing aims for financial returns and a social or environmental influence.

As appeared in Wealth magazine

Impact Investing: More Than Just Money

Impact investing aims for financial returns and a social or environmental influence.

The concept of impact investing has been around for more than four decades, with the actual phrase coined in 2007 by the Rockefeller Foundation. But only recently has it evolved from disparate, uncoordinated activities to a recognized trend.

The number of impact investments increased 100% from 2010 to 2011. Approximately $4.4 billion in impact investments were made in 2011, according to a 2012 report from the Rockefeller Foundation. Research from Monitor Institute suggests the market could increase to $500 billion in the next decade.

Just what constitutes impact investing? “It involves investing in companies, organizations, projects and/or programs with the intent of generating financial returns and some type of measurable social and/or environmental impact,” says Marguerite Griffin, senior vice president and national director of Philanthropic Services at Northern Trust.

Why Impact Investing? Why Now?

The early days of impact investing were made up of private foundations that got involved in program-related investments, Griffin says."Impact investing is growing, consistent with the wealth transfer from baby boomers to younger generations. These younger generations tend to believe that environmental and other social issues are just as important as their financial well-being."

Its recent gain in popularity might largely be a result of investors realizing that philanthropy and for-profit investment don’t have to live in separate quarters. “In the past, investors wanted to make as much as possible to maximize the amount that could be given away,” Griffin says. “More people are starting to think that making as much money as possible isn’t as important as aligning investments with their mission and values.”

Supporting these investors’ realization is mounting evidence from the academic and investment communities that you don’t necessarily have to sacrifice returns by considering environmental, social or governance criteria. “They aren’t necessarily mutually exclusive, and more people are realizing that they can ‘have their cake and eat it, too,’” says John McCareins, practice lead, Multi-Manager Solutions Group at Northern Trust.

For example, in 2010, the United Way of the Bay Area set out to determine if its stock and bond investments could align with its mission to reduce poverty in the San Francisco Bay area without deviating from its fiduciary responsibilities. Its findings suggested its impact portfolio had a similar risk level to the broad market and similar expected returns.

Another possible driver is generational change. “Impact investing is growing, consistent with the wealth transfer from baby boomers to younger generations,” McCareins says. “These younger generations tend to believe that environmental and other social issues are just as important as their financial well-being.”

How to Get Involved

For investors interested in exploring impact investing, there are a number of ways to get involved, including:

Private Foundations: An impact investor who has a private foundation, for example, might ensure the 5% of funds given out in grants focuses on social and environmental good – and the 95% that stays invested in the endowment is invested in assets and companies that support that same mission, Griffin says.

Supporting For-Profit Organizations: Impact investors could make a loan or provide credit to for-profit organizations that provide affordable housing for low-income individuals, for example.

Social Impact Bonds: Social impact bonds are a contract in which a commitment is made to pay for improved social outcomes that result in public sector savings.

“A nonprofit might say to the government, for example, that it believes it can lower the government’s cost as it relates to ex-offenders by running a program that will help train ex-offenders,” Griffin says. “The government then goes out to private investors and says, ‘If you invest in this program, you save us money. And if the program reaches its goals, we will pay you back your principal and maybe some financial returns.’”

First introduced in the United Kingdom, social impact bonds now are offered in a few states, including Illinois, Massachusetts and New York.

Before You Invest

While impact investing is increasing in popularity, it’s not necessarily smooth sailing.

For one, few investment professionals are familiar with the concept of impact investing. “They may be talking about it, but very few of them have worked with it and gone through the due diligence and evaluation,” Griffin says.

On top of that, impact investing is less about buying stocks and more about funding projects that might have a financial return and also do social or environmental good. “As a result, the type of evaluation that is necessary is not what an investment manager would typically do,” Griffin says. “For example, you need people who understand what clean energy is and what types of projects are sustainable and should be invested in.”

Because the concept is so new, it doesn’t have a long track record or the availability of research databases over multiple decades that can be studied to determine performance and viability, McCareins adds.

In addition, quality impact investment opportunities might not always be easy to locate. “It’s easy to find a mutual fund or invest in the S&P 500,” McCareins says. “Generally the large, branded investment companies are not marketing impact investment strategies or portfolios. Rather, it tends to be small firms that may be regionally located or very mission-specific. As a result, you have to actively seek them out.”

And because these firms don’t have long track records, many questions arise, such as: How do you determine if they are actually as good as they claim to be? Do their organizations have staying power? Legally, is the ownership structure set up correctly?

Doing Your Due Diligence

Regardless of how you get involved in impact investing, due diligence is critical, as it is with any investment. “You have to look at the structure and strength of the investment, the expected returns, risk factors related to liquidity, organizational leadership and so on,” Griffin says.

McCareins suggests working with a professional advisor who has expertise in this area, and who can be a source of ongoing due diligence and validation that the investments you’re considering might achieve your financial and impact objectives. State and local governments, consulting firms and third-party audit organizations also might have information on potential companies focused on impact investing, as certain registration or audit requirements can apply to these organizations and investments.

Griffin says choosing for-profit companies or social enterprises in the second or third phase also can help reduce some of the risk that might exist with organizations in the startup phase.

“People interested in impact investing want to be part of a good thing and something that is innovative … but maybe they’re not willing to take on the level of risk that would be required to invest in some startups,” she says. “[Companies in the second or third phase have] been around for a while, so their mission is clear – and it’s easier to determine whether it is aligned with your personal mission.”