How much should we value social impact in our investments?
Impact investing can be defined as making investments that have a positive social or environmental impact on the world, while also making a profit. There is almost always a trade-off between making an impact and making a profit, though not necessarily a direct correlation, but how much does impact matter, and what’s more important, impact or profit?
I would argue that you can’t make impact without profit. To be impactful means you must also be sustainable, and to be financially sustainable you must continue to make a profit. Philanthropic organizations certainly make an impact on people’s lives, but if you can continue providing services year after year, growing as an organization and reaching more people, without relying on donations, that is an even better success.
Social impact is not easy to define. When you try to start, you run into all sorts of problems. Does breadth or depth of impact matter more? Is it more important to deliver a service to many people on a cost-efficient basis, or to a few people for whom the service would be truly life-changing? A good example of this is impact investments that claim to create jobs. While increased employment opportunities are good for the community, is job creation enough to be considered an impact investment? Can it be any job creation, or does it have to be meaningful, full-time, well-paid jobs? What if it occurs in a place of high unemployment?
How much does impact matter?
Impact investors have so far defined impact in their own words, using their own metrics (more on this later). Although there are many definitions of impact, to understand the importance we must consider the risk in impact investing. Considering risk in an investment portfolio paved the way for impact investing, as investments in renewable energy, smaller enterprises, and developing countries are now considered effective ways to diversify your portfolio. As you begin to account for risk, you weigh up more than just the financials of an investment and try to understand what’s going on behind the scenes.
Impact can help mitigate risk
Considering the impact of an investment by applying an Environmental, Social and Governance (ESG) screen can also help mitigate the risk of investments that don’t pass a basic social impact test. Forbes explains how a high ESG performance translates into above-average financial performance as well. ESG tests can extract risks and opportunities that may have otherwise been overlooked if we were to just rely on financial measures. While most investors make ESG investments to align their investments with their values, there is a risk-benefit as well.
Investors are increasingly convinced that financial returns exist in the impact market and feel comfortable with where their money is made, though they are waiting for the long-term performance data to arrive that backs up what they already know to be true.
Do we need a common understanding of impact?
Impact investing goes one step beyond screening investments and ranking them per ESG parameters. Impact investors make investments that intentionally have a positive impact, rather than those that just happen to not have a negative one. But as an industry, we need a new definition of what constitutes impact, and guidelines on who can call themselves impact investors to avoid the problems that arise from "impact-washing".
Impact-washing, like "green-washing," refers to companies who profit from claiming to make investments with a positive impact, when their real intention is to make a larger profit rather than have an impact. Often times large corporations with shady track records will try and clean up their public image by impact-washing some of their portfolio. One suggestion to combat this problem is third-party certification, though this would make due diligence processes even more expensive and make it even harder to achieve returns from investments.
So, defining impact does matter, because otherwise, what’s the point if anyone can do anything and call it “impact”? If you claim to be having an impact but are actually no different from a normal profit-seeking investor with no care about the consequences of their investments, the whole industry loses validity. Further, one of the biggest challenges now is proving that we are not crazy for believing that you can have a positive impact while achieving significant financial returns on investments.
To solve the biggest social challenges, the world needs to close the funding gap, and only private investors have the funds necessary. Before more capital is freed up we must prove that it is a wise decision financially as well as aligning with investors personal beliefs and values.
A Successful Attempt at Measuring Impact
The most comprehensive attempt at a standardized impact measurement system comes from the Global Impact Investing Network (GIIN). IRIS, created by GIIN is a set of performance indicators, that could be widely used, but unfortunately have not yet been universally adopted by impact investors. Instead, most firms use in-house impact performance managers who report on impact to their stakeholders against a set of criteria that has been drawn up internally. Following a more widely adopted measurement system would allow for comparison between impact investors and help tackle some of the impact-washing that is starting to emerge.
As we see more companies claiming to be impact investors, we may see the pioneers of the industry come together to adopt a clearer understanding of how to measure impact. GIIN and other organizations have built impact measurement guidelines that are particularly useful for smaller funds who are exploring how to move into impact investing but still don’t have enough collateral to be used widely.
Clearly defining impact is important for the industry and crucial to proving that the impact investing model works. As an investor as you embark on the decision to invest to match your values, we need to make it easy to identify who is having an impact and who is just saying they are. When it comes to making wise investments, ESG screens and impact-first investments can highlight opportunities or issues that would be clouded if we took a financials-only view. If we aren’t clear about impact, we’re going to lose out on those additional metrics either way.
More than anything, true impact is important for the investees. While we can’t argue that one social cause is better than another, we owe it to those organizations that are working hard to develop a business plan that puts vulnerable people first to be true to our promise when we say we’re in it for more than just the money.
Choosing Your Own Impact Value
Now it’s time to ask yourself, what is social impact worth to me? If you average a 6% return with an impact-conscious portfolio, but you could average 9% with a traditional approach, is that worth it to you?
What is it worth to you to provide jobs to unemployed people in Cambodia? Or to provide families in Africa with home electricity for the first time? What is it worth to you to help an optical shop grow that can supply prescription glasses to its customers who otherwise wouldn’t have them? These are all tough questions.
A Scenario for Thought
Here’s something interesting you can see when you play around with Lendahand’s investment planner tool.
If you start with €2,500 and you invest an additional €250 per month for 4 years earning an average 4% return, you would have:
€15,800.00 at the end of 4 years.
That’s a nice chunk of change!
But what if you increased that average return to 6% over the 4 years? Then you would have:
€16,500.00 at the end of 4 years.
So now ask yourself, what is that extra 2% worth to you? That extra 2% only adds up to €700 over the course of the 4 years. Remembering that in impact investing every additional percentage point on your return most likely means you made just a little bit less impact with your investment, would you trade that €700 to make more impact?
I’m not saying you shouldn’t aim to generate a financial return. Far from it! But keeping in perspective the return weighted against the social impact is how we as impact investors can help transition the world to a financial system not solely focused on profit.
Just some food for thought!