Understanding impact investing: its history, rise, and evolution

Impact investing lies at the intersection of philanthropy and traditional investing, offering a dynamic approach to achieving both economic return and measurable social and environmental impact. It’s not just about making a profit. It’s about making a difference.

Core principles of impact investing

The core of impact investing is based on a few key principles.

• intentionality Impact investing is done with the explicit intention of producing measurable social and environmental impact alongside financial return.

• Expectations for returns Unlike philanthropy, impact investing can expect financial returns ranging from below-market rates to market rates, depending on the investor’s goals.

• wide range of asset classes Impact investing spans a variety of asset classes, including but not limited to private equity, debt, and real assets.

• Impact measurement Impact investing is characterized by a commitment to measuring and reporting the social and environmental performance of investments. This accountability is essential to understanding the effectiveness and scope of impact.

• additionality Additionality is a fundamental principle of impact investing and emphasizes the need for investments to create real, measurable, positive change that would not otherwise occur. Impact investing should be more than business as usual and is characterized by the ability to create new solutions, address social or environmental challenges, or accelerate progress towards desired outcomes. Must be something.

While traditional investing focuses primarily on financial returns, environmental, social, and governance (ESG) investing essentially aims to achieve both profit and profit, thereby achieving double returns. I am. This approach was inspired by the United Nations Principles for Responsible Investment, launched in 2005. However, while ESG investing incorporates ethical considerations into investment decisions, the focus is not necessarily on creating additional impact. ESG investing may avoid harm or support general good practice, but it does not necessarily target or measure specific additional impacts.

Source: Lucidity Insights

Terrence Keeley is a former executive at BlackRock Inc. Sustainable: Beyond ESG to impact investing, makes important points about the effectiveness of ESG investing. He argues that only a minimal portion of these investments truly yield double returns. Keeley went a step further, highlighting that the roughly $40 trillion in investments originally intended to generate these dual benefits has failed to do so. He classifies this amount as “the largest misallocation of financial assets in history.”

Here the concept of additionality set influences investments separately from ESG by emphasizing the direct and tangible impact of investments. This allows impact investing to go beyond passive screening and risk mitigation to actively contribute to positive change. Professor Barbara Scheck of New York University Abu Dhabi says, “Impact investors need to boldly fund businesses where other investors are not venturing and ensure there is true additionality to their investments.” Says.

The opposite of private capital is philanthropy. Philanthropy remains an important and active element within the impact investing ecosystem, particularly in areas where return on investment is not immediately obvious or measurable. Unlike the start-up and venture capital sectors, which have developed multi-tiered funding structures from angel investors and incubators to various stages of venture capital firms, philanthropy has not seen a similar evolution. explains Scheck.

This gap has created a situation where many promising initiatives initially supported by philanthropic foundations struggle or go out of business due to the lack of sustainable follow-on funding mechanisms. Therefore, while philanthropy is not becoming obsolete, there is a clear and urgent need for innovation and restructuring in this area to ensure continuity and greater impact for philanthropy.

Related: 5 must-see charts about impact investing

History and evolution of impact investing

Brian Trellstad of Bridges Ventures navigates the complex evolution of impact investing in his seminal book, Impact Investing: A Brief History. His 2016 publication delves into the transformation from traditional investment approaches to more socially and environmentally conscious methodologies. As Trelstad articulates, this transformation spans a diverse “spectrum of capital” and represents a deep dive into how investment strategies have matured in line with the evolving ethos of society and the planet. It highlights the story.

Historically, the investment environment has been dominated by two main types. One is a fiduciary investor focused solely on maximizing financial return, and the other is a philanthropic donor whose sole purpose is to improve society or the environment without financial gain. This dualistic situation began to evolve in his late 1960s and early 1970s, setting the stage for a more nuanced approach to investing.

The advent of socially responsible investing (SRI) marked a major shift beyond the simple dichotomy of fiduciary and philanthropic capital. SRI introduces a middle path, where investments are examined not only for their economic viability but also for their social impact. During this period, investors began to shy away from companies and practices deemed harmful, such as tobacco and weapons manufacturing, reflecting a growing awareness of corporate responsibility and ethical investing.

Parallel to the rise of SRI, the Ford Foundation pioneered program-related investing (PRI). This is a concept that further blurs the line between philanthropy and investment. PRI is a low-interest loan intended to fund initiatives such as urban renewal, and has effectively leveraged philanthropic funds to create an income-generating model. This approach has allowed us to recycle and utilize philanthropic capital more effectively, and has allowed us to move certain initiatives into more traditional investments.

The rise of impact investing

As the new millennium began, investors began to wonder whether they could achieve equal or better returns by intentionally selecting investments based on their positive social or environmental impact. This way of thinking gave birth to sustainable investing, and later impact investing. Leaders in sustainable investing, such as Generation Investment Management, co-founded by David Blood and Al Gore, say capital allocation has the potential to generate more substantial social or environmental benefits. supported the idea.

Driven by the belief that investing in business models that address critical challenges such as climate change and public health can generate competitive financial returns with measurable social and environmental impact. From this intersection, impact investing was born. This belief is now increasingly supported by empirical evidence, suggesting that private fund strategies based on impact investing can deliver returns comparable to traditional investment strategies.

Source: Impact Investing Institute

Over the past two decades, impact investing has undergone a remarkable evolution driven by a convergence of social, economic, and technological factors.

1. Government finance constraints: Pressure on private capital A key driver of the growth of impact investing is the evolving role of governments around the world. Struggling with increasing debt and economic pressures, many governments find it increasingly impossible to shoulder the entire burden of social welfare and environmental protection. This constraint has created space for private capital to enter to address social needs that have traditionally been the domain of public funds. In this context, impact investing has emerged as an important mechanism, allowing private investors to meaningfully contribute to areas that were once primarily funded by governments.

2. Demographic changes: Challenges of an aging population Another important factor is the challenge posed by demographic change, particularly an aging population. As large portions of society reach retirement, governments face increased healthcare and pension costs, leaving fewer funds available for other social needs. This demographic shift has highlighted the need for alternative funding sources for social initiatives, in which impact investing is playing an increasingly important role.

3. Gen Z: Seeking purposeful employment The rise of Generation Z has brought a new perspective to the workforce. Now more than ever, this generation is looking for employment that aligns with their values ​​and gives them a sense of purpose. Their inclination toward careers that actively contribute to society is also influencing the investment landscape, with more funds being directed to companies and projects that reflect these values.

4. The Power of Social Media: Expanding Awareness The advent and proliferation of social media has revolutionized access to information. Today, we are more connected and informed about global events and issues than ever before. The immediacy of this knowledge has increased awareness of large-scale disasters, social injustice, and environmental issues, and a collective desire to contribute to meaningful change. Impact investing provides a platform for this, allowing investors to directly address pressing global challenges.

5. Rise of social capitalists An interesting development in the financial world is the emergence of social capitalists. These people, often high net worth young adults (HNWIs), primarily from the technology industry, are redefining philanthropy. They use their wealth to create foundations and impact investment funds, blending traditional philanthropy with a more investment-driven approach to social good.

6. “Profits with a Purpose” Movement Finally, the “profit with purpose” movement encapsulates the ethos of impact investing. This is a philosophy that challenges the traditional notion that economic success and social/environmental impact are mutually exclusive. The movement advocates a business and investment model that achieves both profit and purpose, and represents the essence of impact investing.

The impact investing market has shown impressive growth, achieving a compound annual growth rate (CAGR) of 29% over the past four years, reaching a total value of $1.164 trillion in 2022. According to research by the Global Impact Investing Network (GIIN), 92% of impact assets under management (AUM) are allocated by organizations headquartered in developed markets, while organizations in emerging markets account for just 8%.

Explore how impact investing connects capital with positive social and environmental outcomes. Read our special report on impact investing here.

This article was originally published on Lucidity Insights, Entrepreneur Middle East’s partner in developing special reports on the technology and entrepreneurial ecosystems of the Middle East and Africa.

Related: Paradigm shift: the world can no longer afford unsustainable investments