Impact investing very simply defined as investing that generates a financial and a social return. Global Impact Investing Network (GIIN), one of several trade associations serving the impact investing sector, defines impact investments as:
“Investments made into companies, organizations, and funds with the intention to generate measurable social and environmental impact alongside a financial return. Impact investments can be made in both emerging and developed markets, and target a range of returns from below market to market rate, depending upon the circumstances. Impact investors actively seek to place capital in businesses and funds that can harness the positive power of enterprise.”
No matter how it is defined, impact investing refers to investments that address social problems. In reality, all investments have a social impact: negative, neutral, or positive. Impact investors, in keeping with the principles of sustainable and responsible investing, seek to do no harm and to affirmatively make investments that benefit society, creating measurable and positive social outcomes.
Access to capital is a fundamental prerequisite for improving people’s lives and enabling communities to thrive. Individuals and families use credit to buy homes, educate their children, and grow businesses and community facilities. Viable communities must invest in accessible and high quality housing for their citizens along with education, health care, and transportation. For underserved populations like communities of color, credit is often more expensive and harder to get. By creating investment opportunities that target underserved communities and provide both financial and social returns, impact investing empowers both investors and communities to change the world for the better.
There are those who incorrectly believe that impact investing is inconsistent with SRI (sustainable and responsible investing) or ESG (environment, social and governance) investing. In their early days, SRI and ESG funds focused heavily, and in rare instances exclusively, on negative screens (i.e., choosing not to invest in certain types of companies, such as tobacco or weapons manufacturers) and disinvestment. [For more history see also: Nun Funds—The Original Impact Investors.] The industry has evolved over time however, and many SRI and ESG mutual funds and asset managers now consider proactive impact investing (also referred to frequently as community investing) as an important, albeit modest, component of their portfolio activity.
Some argue that too broad a definition for impact investing means that, as Geeta Goel, director of mission driven investing at the Michael and Susan Dell Foundation, writes, “it is possible to make a case for classifying almost any financial investment as an impact investment.” While it is true that we may dilute the power of impact investing by allowing the tent to be too big, it is also true that the mainstreaming of impact investing will create opportunities to finance activity in the social sector beyond pure philanthropy and public funds.
Potential of Impact Investing
Over the past two decades, Calvert Foundation, where I work, has watched the sustainable and responsible investing industry mature. Today, according the U.S. Social Investment Forum, nearly one in every nine dollars is invested according to a set of social or environmental factors. Sustainable investing seems likely to continue to grow, especially in light of the upcoming estimated $41 trillion wealth transfer from the Baby Boomer generation to the Millennial generation, widely characterized by their affinity for environmental sustainability and social justice. [This generational transfer affects the fate of family businesses as well.] The desire of individuals to make a difference in the lives of others appears to be on the rise. Particularly among young people, there is an earnest and passionate commitment to use the power of money to effect social change.
Over the next several years, the realities of dwindling resources and growing needs are likely to result in continued stagnation in our underserved communities. Both government spending and corporate philanthropy are decreasing, at the same time as needs for quality affordable housing, health care, and education are growing. Traditional sources of capital for community development, including lending from banks motivated by CRA and private foundations, are also increasingly scarce. In an era of shrinking resources, it is more important than ever to think beyond these traditional sources of capital. We are confronting the limits of our existing financial system at a time of enormous creativity, connectivity, and possibility.
Impact investing can help address this challenge, by bringing significantly more capital to the table for financing domestic social goods, including community and economic development.
In 2012, Calvert Foundation, along with several partners, completed a research study of 1065 financial advisors entitled Gateways to Impact, which demonstrated a near-term $650 billion market opportunity for sustainable and impact investing. Capitalizing on that potential $650 billion impact investing market could greatly reduce the social sector’s reliance on unpredictable funding sources. Building the infrastructure now for access to private capital at scale in years to come will mitigate the long-term risks posed to historically underserved communities by financial uncertainty and market volatility.
Meeting this investor demand will require fresh thinking and flexibility in financing, but with a continued level of rigor. Just like traditional capital markets, impact investing markets require professional asset management, due diligence, and monitoring. The sector will also need more intermediaries to provide these services and to act as a bridge between the supply of capital from investors — both retail and institutional — and the demand for capital from social enterprises, affordable housing developers, community facilities, and other types of organizations that generate social and environmental returns.
What Does an Impact Investment Look Like?
Although it is sometimes referred to as its own asset class, impact investing can encompass all asset classes: cash, fixed-income, private equity, and, yes, real assets, such as investments in affordable housing. In fact, affordable housing is a classic example of impact investing: the underlying revenue model generates a social benefit and can support the repayment of debt through rental payments and predictable subsidy streams. There are some that would draw a distinction between CRA-motivated lending and impact investing, but I consider affordable housing and community development to be part of the broad impact investing ecosystem.
There is also a range of returns within impact investing. Different investors have different return expectations and risk appetites. Many in the sector refer to impact investments as being either financial-first or impact-first, while others are emphatic that investors should seek a blended value of returns. In some cases subsidy is required to create market-rate returns or first-loss risk capital is required to attract market-rate investment. These types of structures have been used frequently internationally in microfinance and domestically in affordable housing finance. While underlying returns are sometimes lower than market rates, enough subsidy based on the social impact being delivered can leverage private investment with market returns. There are many examples, such as investments in Low Income Housing Tax Credits and New Markets Tax Credits, where government plays an important role in generating investors who receive market-rate financial returns while generating social returns as well. [Read more on the role of government.]
Similarly, there are varying degrees of volatility depending on asset class and the type of social impact returns desired. An investment in workforce housing where investors may be willing to take on some market risk would just as easily fit my definition of impact investing as would a highly subsidized affordable housing project where loan repayments are practically guaranteed based on the rental revenue and public subsidy. Each investor, often in consultation with their financial advisor, must determine their respective tolerance for risk and their objectives for return, conducting the necessary due diligence to determine whether an investment is suitable and appropriate from a financial and social standpoint.
Impact investments come from a range of investor types, and through a range of vehicles. Foundations, for example, have been making impact investments for many years and they are critical players in the impact investing sector. Philanthropic institutions like the Ford, Rockefeller, and MacArthur foundations have made investments totaling more than $1 billion in impact investments through their program-related and mission-related or mission-driven investment portfolios, much of which has been allocated to affordable housing and commercial, office, and industrial development. Real change will, however, come when more foundations follow the examples of the F. B. Heron and Kellogg foundations and dedicate endowment dollars to impact investing. Mission Investors Exchange has been a real leader in educating endowed foundations about the merits of aligning the 95 percent of their assets set aside for investment with the overall program objectives of their institutions. [Corporations—or corporate philanthropy at least—are getting into the field as well.]
Crowdfunding is yet another new opportunity for impact investing where we have just begun to discover the tip of the iceberg. In Northeast Washington, D.C., an organization called Fundrise is working to revitalize communities by attracting local people to invest in projects that will affect them. Fundrise seeks to bring businesses into communities that need them by engaging residents who have a stake in their outcome. Fundrise raised $325,000 from 175 investors who invested amounts sometimes as low as $100 to finance a commercial development in an underserved neighborhood. These investors will go on to observe Fundrise’s development process in their neighborhood and they will likely patronize the new businesses that move in, ultimately collecting a forecasted 7 percent return on their investment, plus a share of the rent proceeds. Fundrise has taken a simple concept — targeting lenders who are not only financially but also emotionally and culturally invested in the outcome of a project — and made it a reality.
Calvert Foundation’s Community Investment Note, a fully tradeable investment product, is yet another an example of how individuals can be part of the solution to pressing social needs like affordable housing. Calvert Foundation plans to launch several new initiatives to specifically target investor interest in particular social impact areas. One such initiative is our Revitalizing Cities effort, which plans to catalyze economic development in iconic American cities suffering from decades of underinvestment through a long-term Community Investment Note targeted to classic cities seeking to fight urban blight and decline. The money raised from investors will provide the patient capital needed to make urban redevelopment efforts work in depressed urban neighborhoods. This initiative will empower citizens, investors, and institutions that are passionate about rebuilding America’s historic older urban centers and provide a unique source of long-term capital that is currently missing in the development market. It is a classic illustration of how impact investing can help support affordable housing and other community development efforts.
While private capital will never be a perfect substitute for public funding or philanthropy, the prospect of a mature impact investing industry is transformative—for investors, for the social sector, for government, and, most importantly, for communities. I dream of the day when every investor is an impact investor, contributing to a financial system that is characterized by mutuality, opportunity, dignity, and justice.