2.2 Areas of Definitional Confusion
2.2 Areas of Definitional Confusion
Realizing that a definitional discussion of impact investing can lead to more questions than answers, this section is devoted to clarifying common areas of confusion.
Aren’t all investments impactful? Cynics often ask why the special impact distinction is required at all given that investment is the engine of business growth and economic expansion, and thus all investing is inherently impactful. While true, not all investing intentionally seeks to create positive social or environmental value on the onset, before the investment is made. Some degree of social or environmental value may be created as a result of all investing, but it is not always intentionally sought, which differentiates impact investing from traditional investing.
What is the difference between impact, sustainable and responsible investing? In short, responsible investing refers to a broad array of investment practices – including socially responsible, sustainable and impact investing – that “recognizes that the generation of long-term sustainable returns is dependent on stable, well-functioning and well governed social, environmental and economic systems.”13 Furthermore, socially responsible investing typically refers to the screening of investments that may have some sort of negative impact to society or to the environment (negative screen). On the other hand, sustainable investing refers to the active incorporation of ESG criteria into the investment decision (positive screen); sustainable investing prioritizes financial returns above social or environmental returns. While certainly impactful, these activities are not “impact investing” by definition given that they do not intentionally and explicitly set out to deliver the dual objective of social/environmental outcomes and financial returns (which may be below market, at market or above market).
Do impact investments generate below-market financial returns? Impact investing is unique in that the investor may be willing to accept a lower financial return in exchange for achievement of a social outcome; mainstream investors have thus often assumed that impact investments always generate below-market returns. This is not true.
Although it is too early to determine the realized returns of many impact investments, there are numerous instances when market returns are targeted in addition to social outcomes. Figure 4 illustrates that 35% of impact investment funds target internal rates of return (IRR) above 20%. Like other investments, the rate of return will vary based on various factors, such as sector, geography, financial instrument and investor type.14 Additional work needs to be done in order to quantify the actual returns that investors have achieved in impact investing.
Does impact investing conflict with an investment committee’s fiduciary responsibilities? Impact investing need not conflict with fiduciary responsibilities; investment committees must consider those responsibilities as they craft strategies and processes to manage investments that target financial returns and superior social performance. For most institutional investors, accepting social returns that imply long-term financial concessions will not be acceptable. However, as described above, impact investing does not imply a trade-off between social outcomes and financial returns, but rather supports the simultaneous dual objective of both social impact and financial impact.15 In certain instances, social objectives may in fact create long-term sustainable financial returns.
Some investors may well be willing, or indeed require, some trade-off between return and impact. Others will seek out opportunities where return fully compensates for risk. Both play important roles. While the former can provide higher-risk capital to fund early stage social ventures, small scale entrepreneurs, etc., the latter can provide capital at much greater scale to fund sustainable growth.
Manuel Lewin, Head, Responsible Investment,
Zurich Insurance Group, Switzerland
Spotlight on the Definition
Are there enough investable deals in impact investing?
One key area of debate among practitioners within the impact investing sector relates to whether investments made by mainstream investors should be considered “impact investments” at all. This point of view argues that it is the lack of commercial or mainstream capital that distinguishes impact investing from traditional investing, and that impact investors can be most catalytic by providing early-stage risk capital that helps entrepreneurs de-risk business models that may not be considered “investable” by commercial capital. Once these business models are de-risked, entrepreneurs can scale these models by tapping commercial capital (at which time, according to this point of view, the investment is no longer an “impact investment”).
This report broadens the lens and argues that impact investments are all investments that intentionally seek to create measurable social or environmental value, regardless of the stage of maturity of the enterprise. There are ways for investors to be catalytic in sectors and geographies and among populations where business models have already begun the process of being de-risked and where traditional investors may already be active or more likely to become active. Table 2 outlines a spectrum of business model risk and the generalized characteristics at each stage. Organizations with revenue models that have not yet been proven will likely not be able to attract commercial or mainstream capital and will likely require subsidized capital and technical assistance (Stage: High Risk).
On the other hand, organizations with proven revenue models and de-risked business models will likely be better equipped to attract commercial or mainstream capital (Stage: Limited Risk). This report includes all organizations across the entire risk spectrum outlined in Table 2 within the definition of impact investing so long as the investments are intentionally made to achieve social and environmental objectives and the progress towards achieving those objectives is actively measured and reported.
Note: This spotlight intentionally focuses at the firm-level; there is a case to be made for different types of capital to be provided at the sector-level as well. Omidyar Network makes a compelling case for the need for sector-level focus and investment in order to achieve the greatest reach and have the greatest impact. To learn more, reference: Priming the Pump (September 2012), Omidyar Network.
Table 2: Spectrum of Business Model Risk
Note: (1) 176 funds were assessed in April 2013 (2) Targeted returns are not necessarily an indication of realized returns, (3) The targeted returns above represent a significant range of investment instruments, including but not limited to private equity, venture capital, real estate, fixed income, etc.
Source: GIIN, ImpactBase, Deloitte Analysis