Impact Investing and Its Motivations
The concept of investing for impact has been around for a long time, but impact has gained a wider audience recently as challenging global issues have reinforced the urgent need for effective solutions. Regulators, the public, shareholders, the media, and other stakeholders are calling for action on pressing issues like the climate crisis, inequality, biodiversity loss, and human rights abuses, and they are demanding investors be transparent about the impacts of their investment portfolios. As the calls grow louder, as the claims of greenwashing increase, and as impact-related regulations advance, investors are paying attention.
Asset owners, asset managers and wealth managers may be motivated by a number of factors to consider impact in their investment processes. Some may respond to external factors like market expectations for transparency, regulatory requirements, and client preferences. Others will consider impact in response to internal factors, such as aligning with the firm’s and employees’ values and building a brand around sustainability.
In either case, investors can consider impact in their investment processes to meet several new challenges and achieve a range of key goals, including offering impact-themed products, monitoring sustainable investments, meeting client preferences, meeting regulatory disclosure requirements, or aligning with frameworks.
In this blog post, we discuss what impact is, two approaches to impact investing, how impact relates to ESG, and why it’s important for asset managers, asset owners, and wealth managers to integrate it into their investment processes.
What Do Investors Mean by Impact?
Generally, with respect to investments, impact refers to the effects that a business has on the environment and society.
Businesses produce goods and services that are purchased by consumers or other companies, they generate revenues and taxes for governments, and they provide profits to owners or shareholders. This closed circle is a common way to think about business activities. But the impact of a company’s activities extends beyond this circle.
A company affects not just its customers, suppliers, and shareholders, but also the climate, ecosystems, natural resources, human development, and basic social needs. These social and environmental impacts can be positive (e.g., bringing wealth or jobs to communities) or negative (e.g., environmental degradation), and intentional or unintentional. A company’s impact can be positive in some areas and negative in others.
What Impact Investing Is: Two Approaches to Consider
The term “impact investing” usually refers to an investment approach by investors who want to make specific real-world changes a key objective of their investment process and will prioritize impacts above other factors. With this approach, the investor wants their investment to contribute to and achieve a particular impact outcome that would not be achieved otherwise. For example, by providing access to seed capital to a private company or investing in a project-based green bond where the proceeds of the investment are explicitly allocated for positive environmental outcomes. This approach is traditionally focused on private markets where it is possible to direct investment capital to achieve specific outcomes.
With advances in disclosures and increased urgency, another approach has surfaced, which Morningstar Sustainalytics refers to as “impact-focused investing.” The impact-focused investor considers the positive or negative impacts on the environment or society that result from a company’s activities and makes investment decisions based on this dimension. In this approach, investors are intentionally seeking companies that create a positive impact or align with defined impact objectives.
Impact-focused investors are not looking to link their investment capital to specific impact outcomes, rather they look to channel capital towards positively impacting companies and away from negatively impacting companies. This approach can be integrated into existing responsible investing strategies.
How Impact Investing Relates to ESG
Investors commonly use the term “ESG” to refer to risk and financial materiality. That means the material risks that ESG issues pose to companies — think extreme weather events, supply chain scandals, cybersecurity breaches, workplace health and safety incidents and so on. These are ESG issues that can cause significant financial harm to a company (and their investors) if not managed properly.
On the other hand, the term “impact” captures and expresses the social and environmental externalities that result from a company’s activities. Some common negative examples include greenhouse gas emissions, pollution, deforestation, displacement of vulnerable communities, etc. This may be what many people imagine when they think of ESG, but it is important to recognize that impact and ESG risk are distinct concepts.
Investors are recognizing that addressing ESG risk may mitigate potential harms to their investments, but without considering impact (e.g., by solely focusing on managing financially material ESG risks), investors may not have a complete picture of how their investments contribute toward global sustainability goals. From this perspective, ESG risk and impact are complementary approaches. Both are crucial to building a holistic, credible, and transparent responsible investment strategy that has measurable positive real-world impacts, manages material ESG issues, and responds to stakeholders.
Source: Morningstar Sustainalytics
Why Impact-Focused Investing Is Important for Investors
There are several major factors driving investors to consider impact in investments. The most important of these are new market standards, market discourse on ESG and greenwashing, global standards, regulations, and evolving investor preferences.
How Impact-Focused Investing Helps Address Greenwashing Risk
The mainstream view is that any investments with sustainability-related objectives should take impact into consideration, and investors are responding by taking steps to demonstrate the effect of their responsible investing strategies. Moreover, market supervisors, regulators, the media, and other stakeholders are paying close attention to the impact of ESG products to detect greenwashing practices. Broadly, greenwashing refers to making exaggerated, misleading, or unsubstantiated sustainability-related claims for investment products.1
As a result of this increased scrutiny, there have recently been some high-profile greenwashing cases resulting in costly penalties. In addition, a number of ESG investors have faced criticism in the media for making sustainability claims while investing in companies with negative impact such as those in the tobacco industry or fossil fuel extractors. To address this, asset managers, asset owners and wealth managers need to make holistic assessments of impact for the companies they invest in, linked to a robust framework covering all potential company impacts.
Global Standards for Impact Investing
As the demand for environmentally and socially beneficial investments has soared, a number of global standards have emerged to support investors in measuring impact.
UN Sustainable Development Goals (SDGs) and Principles for Responsible Investment (PRI)
Though not originally intended for capital markets, the UN SDGs provide investors with a broad framework for pursuing positive impacts, such as ending poverty and taking climate action.
Since the adoption of the SDGs in 2016, the UN Principles for Responsible Investment (PRI) organization has increasingly emphasized that signatories need to align their investments to these sustainable outcomes by 2030. It has integrated the SDGs into its activities, including incorporating them into the PRI Reporting Framework.
Global Impact Investing Network (GIIN)
The GIIN has encapsulated the four core characteristics of impact investing: 1) Intentionality, 2) Use Evidence and Impact Data in Investment Design, 3) Manage Impact Performance, and 4) Contribute to the Growth of the Industry.
International Sustainability Standards Board (ISSB)
The ISSB’s proposed standards focus on ESG risk disclosure with the specific information needs of investors in mind. Formed in 2021 by the International Financial Reporting Standards Foundation, the ISSB aims to provide a global baseline of sustainability disclosures.
Regulations Relating to Investing for Impact
Regulators increasingly require investors to consider impacts at the product and entity level, regardless of the investors’ materiality lenses and objectives. Key regulations are now firmly established or in development both in Europe and North America. These include:
- The European Union Action Plan on Sustainable Finance: The EU’s strategy for sustainable finance which contains regulations requiring specific impact disclosures.
- The UK Green Finance Roadmap: The U.K.’s green finance strategy which proposes to regulate asset managers’ sustainability claims and includes impact requirements.
- The U.S. Securities and Exchange Commission’s Proposed Climate Disclosure Rules: These new U.S. rules aim to enhance disclosures concerning investment funds using ESG investing strategies, including greenhouse gas emissions.
Impact-Focused Investing and Evolving Investor Preferences
Younger investors, especially millennials and post-millennial generations, are increasingly looking to align their investment holdings with their values. And over the next decades, they are set to inherit trillions of dollars from their baby-boomer parents (US$30 trillion estimated in the United States).2 A recent study found that 61% of millennials are investing based on their values and, among investors who currently do not apply impact to their investments, 40% are considering it in the near term.3
Asset managers, asset owners and wealth managers looking to engage this group of end-investors will need to demonstrate how their investments contribute to measurable real-world impacts. An impact-focused approach provides investors with an opportunity to differentiate and strengthen their offerings, to meet growing customer demand for investment products focused on impact.
Responsible Investing Includes Impact and ESG Risk
There is growing recognition that in a truly robust and credible responsible investing strategy, investment processes should consider the impacts of investee companies as well as their ESG risks. Several key factors are driving this change. Global standards have increased market expectations for credibility and transparency, stakeholders of all types are scrutinizing financial products for signs of greenwashing, investor preferences are changing, and impact-related regulations are advancing around the world.
Considering impact as one dimension in investment processes — or integrating it as a strategic focus — helps investors address these factors in unique ways. Whether investors plan to use impact as one factor among others or make it the core focus of their investment approach, integrating impact can help deliver more robust and holistic responsible investment strategies for all.
To learn more about impact and how impact-focused investing can support asset managers, asset owners and wealth managers in meeting their diverse goals, download our ebook, Why Impact Matters: Seven Essential Considerations for Investors.
- Financial Conduct Authority. 2022. “CP22/20: Sustainability Disclosure Requirements (SDR) and Investment Labels.” October 2022. https://www.fca.org.uk/publication/consultation/cp22-20.pdf
- Hall, M. 2019. “The Greatest Wealth Transfer In History: What’s Happening And What Are The Implications.” November 11, 2019. Forbes. https://www.forbes.com/sites/markhall/2019/11/11/the-greatest-wealth-transfer-in-history-whats-happening-and-what-are-the-implications/
- Fidelity Charitable. 2022. “Using Dollars for Change: Seven Key Insights Into Impact Investing.” https://www.fidelitycharitable.org/content/dam/fc-public/docs/insights/impact-investing-using-dollars-for-change.pdf
Portfolio Screening as Due Diligence: How Investors Can Implement Responsible Business Conduct
This blog outlines how investors with access to screening options that follow the criteria of the OECD MNE Guidelines and the UNGPs can better assess investee companies’ risk of causing actual and potential adverse impacts. It shows what these research modules can look like and provides some examples outcomes on the effect of applying certain thresholds.