As the realities of a rapidly changing climate pair with an increasingly frayed social fabric, the case for impact investing has never been stronger. While traditional investment strategies focus on quickly maximizing returns, impact investing “seeks to generate financial returns while also creating a positive social or environmental impact.”
Beyond a moral imperative to preserve a liveable climate for future generations and move towards more equitable and just societies, impact investing has already proven to achieve market-rate returns in the last decade of activity. Over the past five years, the space has gained traction as more investors are choosing to put their capital into the fight against environmental and societal devastation.
This post offers a short overview of why impact investing is an important vehicle driving both climate and social action. It works to provide capital for investments into a better future, creating a strategic feedback loop and acting as a formidable financial vehicle that focuses on the triple bottom line of people, planet, and profit.
Why is impact investing important?
As entrepreneurs and investors both know, innovation requires investment. An idea, no matter how great, cannot be successful without someone taking a risk to fund its fruition. Current economic systems around the world rely on capital to flow from established individuals or institutions to emerging ideas, projects, and companies that offer solutions to problems through their services or products. Whether from public coffers or private capital, the vast majority of entrepreneurial endeavours require some initial funding to achieve great success.
Supporting climate and social innovators
In exchange for upfront funding that helps seed, start, or scale up a solution, investors buy into the promise of future returns that multiply their initial investment and deliver positive impact. Entrepreneurs take this capital to create, maintain, or expand their offerings which, in turn, provide jobs for employees and profits for shareholders.
With an impact investment strategy, investors carefully select problems to distribute capital with purpose to. This directly helps enterprises develop, and indirectly affects social and environmental issues at local and global levels. Without this critical capital, innovative solutions may never reach the market on their own.
Funding for a better future
Impact investment is especially necessary when looking at particular themes or clusters such as climate, water, clean energy, and sustainable agriculture technologies. Many of these involve complex natural and mechanical systems, requiring a number of years of research and development and field testing before mass adoption and an annual recurring revenue that would move the more traditional investment needle.
As an example, the massive undertaking of industrial transformation is using innovations from these clusters to make progress towards optimized operations, increased efficiency, and a decrease in wasted or underutilized resources. Due to the complexity of this work and the often long sales cycles associated with new solutions for entrenched systems and infrastructure, companies in these spaces often cannot survive without investment.
Social ventures that focus on affordable costs of living, health and well-being, or providing microfinancing to support developing communities also produce value, albeit in less easily quantifiable metrics and over longer timelines than investors usually expect. This is why impact investment approaches are so important for environmentally- and socially-oriented businesses, but it’s not just C-suite executives and shareholders that benefit.
What are the benefits of impact investing?
Studies are consistently showing that impact investments perform at least on par with conventional private equity deals. In some clusters, they have shown to even perform better. Beyond the monetary return, however, there is the impact that these investments have on accelerating climate action and addressing systemic social issues. The benefits gained through sustainable business practices and products are the key to impact investing’s raison d’être.
An emerging positive feedback loop
Although it’s still relatively early days, a shift in investment strategies and capital deployment is already occurring because of impact investors. As more money is funneled into companies that take environmental and social sustainability into account as they develop, the ecosystems and culture supporting businesses are shifting in step. This knock-on effect attracts further investments into sustainable business practices, creating a positive feedback loop in which businesses that are doing good also do well, with the investors that support them multiplying impact alongside their profits.
Increasing transparency and accountability
A by-product of this thoughtful investment approach is improved transparency and accountability for companies and funds of all sizes due to regular monitoring, management, and reporting structures. While methodological development is still in flux and results can vary depending on which criteria is being used, we are seeing consolidation around standards like the Global Reporting Initiative and the International Sustainability Standards Board’s recently released IFRS disclosure standards, frameworks like the United Nations’ Sustainable Development Goals, and metrics based on the pillars of environmental, social, and governance (ESG). While nuances separate these from impact investing itself, they are intertwined and influential in the process of selecting which investments have the potential for high impact.
How effective is impact investing?
While quantifying impact remains a challenge, in part due to the maturity of the space, the breadth of impact focuses and nuances within them, as well as its fragmented regulatory requirements, there are strong signs that investing in this way is making a difference. Many impact investors and funds have seen market-rate returns, an expansion of dealflow, and interest from across sectors, all while the space continues to evolve and grow year over year.
A formidable financial vehicle
The Global Impact Investing Network (GIIN) showed a 17% compound annual growth rate of aggregate impact assets under management in their 2020 Annual Impact Investor Survey. The same survey indicated that “Since inception, 99% of investors in the full sample have met their impact performance expectations. Even more impressively, […] 88% of respondents also met their financial return expectations.”
Last year’s Market Sizing Report illustrates the market’s sustained growth. In 2022, GIIN’s analysis saw $USD 1.164 trillion in assets under management, up from $USD 98 billion in 2020 and breaking the trillion dollar mark for the first time. This surge, even throughout the uncertainty of the COVID-19 pandemic, is proof that impact investments are effective. Otherwise, why would investors keep buying in? In fact, a major inflow of capital into sustainable funds has been seen over the past five years, with some signs of slowing in 2022. This influx has positioned the impact investment space for outflows in the years to come.
Investing in climate solutions
Although the first quarter of 2023 saw a 40% drop in venture capital funding towards climate technologies specifically, according to Climate Tech Venture Capital (CTVC), an 8% increase in overall deal activity indicates that interest remains strong. “Since the start of 2020, ~2,500 climate tech companies have raised $117B of venture funding across 3,332 deals, with cumulative industry growth averaging ~30% each quarter. The relative slowdown brought the cumulative industry growth rate to 6% over the past two quarters—indicating a flattening of the curve rather than an all-out retreat.”
CTVC suggests that this slowdown could be due to a pause in the initial frenzy of funding deployed in 2021 and 2022, with investors wanting to see how those technologies evolve before entering or doubling down on late stage and growth deals. Nevertheless, investment in innovation has sustained, with early stage deals up by 23% compared to the first half of 2022. Anticipation for Q3 of this year is high to tell if the funding trend ticks back up or if the slowdown continues.
Even at a slower pace, impact investors are taking calculated risks to help build the emerging climate technologies and solutions for social systems that will play a crucial role in humanity’s next steps. Intense growth over the past four years especially has seen three times more private capital raised for funds related to climate. “The global volume of climate-oriented equity transactions in private markets—equity investments, from pre-seed to buyout, in energy transition technologies and other climate solutions—increased more than 2.5 times, from about $75 billion in 2019 to about $196 billion in 2022 […],” representing an average annual growth rate of around 40%. Power generation, transportation, and hydrogen and carbon management have stood out as prominent investment fields, aiming to alleviate energy crises worldwide.
Despite the global economic downturn driven by high inflation, interest rates, labour shortages, and supply chain challenges, impact investment is just getting started. McKinsey estimates that $9.2 trillion in annual capital spending on physical assets for energy and land use systems will be required to achieve the world’s net-zero emissions goals by 2050, (around $3.5 trillion more than what is being spent today). As more governments commit to these goals and stricter regulations are put in place to support decarbonization, increasing demand for climate technologies will continue to drive the growth of impact investment.
Adopting an impact investing strategy means institutional, family office, and individual investors can support urgent, much-needed change. With sustainability at the forefront, this strategy reconciles value ethics with economics to provide positive impact and profits for people and the planet.
Join us in moving this agenda forward for a sustainable future. Our vision for impact with the best business practices and outcomes will help investors to reach their impact and business targets. We are here to guide and support investors to find the best answers to their questions. Send us an email or visit our pages to invest with us.