What is Impact Investing?
What is Impact Investing? Impact investing is the practice of investing in companies, organizations, and funds with the intention to generate social and environmental impact alongside financial return. Impact investments can be made in both developing and developed countries, in both public and private markets. Impact investments are a relatively new field, but they are growing rapidly. In 2013, global impact investment assets totalled $36 billion; by 2017, that number had grown to $228 billion. The most active sector for impact investors is healthcare, followed by microfinance, energy, and food and agriculture. Why Invest in Impact? There are a number of reasons why people might want to invest in companies with social or environmental impact. Some people see it as a way to make a positive difference in the world. Others believe that sustainable businesses can create better financial returns than traditional businesses over the long term. And still others see impact investing as a way to hedge against risk: when traditional investments such as stocks or bonds fall in value, sustainable businesses may be less likely to suffer the same fate. How Does Impact Investing Work? There are many different ways to invest in impact. The most common approach is through so-called “mission-aligned funds”—funds that invest specifically in companies or organizations with social or environmental impact. There are also public equities (stocks) exchanges dedicated to impact investing, such as the NASDAQ OMX Impact Exchange. And finally, there are venture capitalists who specialize in funding start-ups with social or environmental missions.
Hedge fund managers have been sluggish to accept impact investments, but as the sector struggles with performance, it may be time to reconsider how this type of investing might help generate alpha. Not only will it raise hedge funds’ social standing, but impact investments may also allow hedge funds to differentiate themselves from the competition. Impact investment is a long-term strategy that combines environmental, social, and corporate responsibility.
The value of impact investments for hedge funds
Because there is no clear leader in impact investment, there may be room for early movers to acquire a competitive advantage. The most compelling benefit of this strategy is that a rising number of investors wish to include these items in their investing portfolio. The value-add to managers is not only in terms of generating interest in a certain fund, but also in terms of bringing in new clients and deepening connections with existing ones. Given the strong competition, each opportunity to demonstrate responsiveness to investor demands while being first to market in an untouched market is critical.
Considerations for impact investing by hedge funds
We recommend the five considerations below for managers considering impact investing or those who are already involved in the social sector:
1 . Defining meaningful impact measures
A major difficulty for impact investment managers is the absence of standardisation for impact performance measurements. The variety of effect measuring methodologies and indicators makes it challenging for investment managers to integrate impact measures into investment decision making. A increasing evidence base of impact disclosure will better enable the market to evaluate impact investment as an investment strategy as transparency surrounding impact measurement and reporting increases.
2. Solutions for intentionality, additionality, and differentiation
Before actively engaging in impact investing, hedge fund managers may need to clear a few more conceptual hurdles than other types of investment managers. While a comprehensive study of these is beyond the scope of this report, three aspects stand out:
Intentionality
This technique suggests that a portfolio manager’s purpose to be good, whether social or environmental, distinguishes impact investing from other methods that may only analyse performance after the fact.
Additionality
Another success metric is that an investment must have a measurable social benefit. However, there may be no new value-add or impact from this expenditure above what was previously available.
Differentiation
As the market matures, fund managers will aim to differentiate their approaches to decision making and demonstrate the benefits of the algorithms and trading/investing philosophies that underpin impact investing.
3. Obtaining equivalent results
Investors will want to compare the success of impact investing to recognised benchmarks and compare it to the opportunity cost of other investments that were not chosen. In one solution, Cambridge Associates (CA) and the GIIN collaborated in 2015 to establish an impact investing benchmark that evaluates the performance of 51 private investments. The preliminary results have been favourable. Across all vintage years, funds in the Impact Investing Benchmark had an internal rate of return of 6.3 percent, compared to 8.6 percent for funds in the Comparative Universe. These preliminary data suggest that reaching comparable performance—or, at the very least, returns near enough to satisfy regulatory standards for institutional investing by foundations—might be a legitimate expectation for impact investments. Although hedge funds were not included in the benchmark, managers considering entering the market may find these outcomes encouraging.
4. Maintaining fiduciary compliance
Recent ERISA (Employee Retirement Income Security Act) recommendations could pave the door for broader use of social methods, such as impact investing. In essence, a 2015 Department of Labour bulletin clarified that plan fiduciaries may invest in socially oriented funds as long as the investment is “economically equivalent—in terms of return and risk to beneficiaries over the appropriate time horizon—to investments that do not provide such collateral benefits.” As the market matures, fund managers must ensure that their investment strategies and disclosures keep up with the evolution of regulatory monitoring.
5. Increasing demand in a difficult market
The demand for impact investments may not yet be sufficient to justify the introduction of a dedicated impact strategy. To make matters worse, the hedge fund industry has recently suffered market issues that may have a negative impact on the existing traction for impact investing initiatives. As social awareness grows in the marketplace, especially with millennials demonstrating a strong interest in impact investing and their power growing as assets expand, it may only be a matter of time before demand rises. If this occurs at the same time that managers achieve equivalent financial returns employing impact approaches, a new and positive sort of demand issue may emerge identifying opportunities to deploy capital effectively.
Conclusion
As a conclusion, impact investing can have a real, positive impact on the world. By choosing to invest in companies and funds that focus on social and environmental issues, we can make a difference. Not only does this help promote sustainability and responsible business practices and cater to millennials with growing interest in preservation , but it can also lead to overall higher portfolio gains.
