What You Need to Know About Impact Investing

What it means

Impact investing involves supporting positive social or environmental initiatives while earning financial returns. Impact investors select their securities carefully to support causes that benefit the greater good. The selection criteria are often personal -- you decide what causes to support and the financial goals you want to achieve.

You can define those criteria in terms of what you will or won't accept. For example, you might choose to invest only in renewable energy companies. Or, you could actively avoid investing in potentially harmful industries, such as oil and gas or tobacco. By this rule, you wouldn't own oil and gas securities directly or within a mutual fund or ETF.

Elements of impact investing

According to the Global Impact Investing Network (GIIN), a structured impact investing program has four key elements. While these apply more directly to professional managers of impact portfolios, you can use them in your own investing practice.

1. Intentionality: Intentionality refers to your targeted goal to help solve society's most pressing problems. This conscious pursuit of societal good differentiates impact investing from other investing practices that consider corporate behavior. With impact investing, positive social impact is not a bonus; it is a primary outcome you demand from your investments.
2. Evidence-based investing: Many companies report on their social and environmental initiatives, but some of this reporting is vague. Your job as an impact investor is to base your investing decisions on verifiable data that shows the company is achieving its social objectives. The data can come from the company directly or from a reliable third party.
3. Impact management: Plan on monitoring your impact investments for performance. Investments that do not make the desired impact may no longer have a place in your portfolio.
4. Contribute to industry growth: True impact investors willingly share their practices with other investors to encourage the growth of the impact investing community. Greater change is only possible if more investors align on their standards for positive social impact.

Four types of impact investments

Impact investments can be categorized by the type of change they pursue, such as:

1. Educational: Within the education realm, impact investments may work to reduce inequities in teaching and learning outcomes.
2. Agricultural: Agriculture-focused investments include companies seeking to enhance food security, provide clean water to hard-to-reach areas, or increase food production in climate-affected regions. Agricultural technology can also play an important role in delivering societal and environmental benefits.
3. Healthcare: Socially responsible healthcare companies may focus on pandemic readiness, medication and treatment delivery, and emerging disease research.
4. Infrastructure: Infrastructure-focused investments typically involve companies that support a broad transition to renewable energy.

Impact, socially responsible, and ESG investing

Socially responsible investing (SRI) and ESG investing (environmental, social, and corporate governance investing) are similar to impact investing, but there are subtle differences.

Impact investing focuses specifically on the relationship between your investing capital and the positive, measurable impact that certain investments may have. Impact might be measured by a reduction in disease, an increase in sustainable food production, or an attempt to correct societal ills. Profits may be your secondary priority.

SRI involves excluding investments that conflict with your values. For example, if you are motivated to preserve the environment, you would not invest in any company that profits from fossil fuel consumption.

You can also implement SRI by investing only in companies that match your values, such as renewable energy companies.

ESG investing balances investment returns with positive social impact. ESG investors typically incorporate a review of the company's sustainability practices alongside a technical financial analysis.

Note that ESG stands for "environmental, social, and governance." These are three categories of corporate sustainability initiatives that ESG investors analyze. Environmental includes things like waste management and greenhouse gas emissions. Social involves hiring and development practices, as well as local community impact. And governance includes board diversity, executive compensation, and corporate ethics.

Three examples of impact investing

Triodos Investment Management: Triodos is a Netherlands-based hedge fund that makes impact investments across four key themes: energy and climate, financial inclusion, sustainable food and agriculture, and impact equities and bonds. Triodos is a founding member of GIIN.

Gates Foundation: Not all impact investors are investment managers -- some are non-profit foundations. The Gates Foundation invests to fulfill the mission of ensuring "every person has the opportunity to live a healthy, productive life."

Foundations don't seek to earn a profit, but they do attempt to tackle the world's most entrenched issues by putting each dollar to work in the most effective way. Poverty, health, and education are primary areas of focus for the Gates Foundation.

Ford Foundation: Created by the family of renowned automaker Henry Ford, the Ford Foundation operates as a separate entity from the better-known Ford Motor Co. (F -0.93%). The Ford Foundation seeks to advance human welfare by sharing capital and resources with social justice organizations.

In 2020, the Ford Foundation made history by offering the first social bonds for sale by a foundation in the U.S. taxable bond market. The foundation used the bond proceeds to support organizations fighting inequality.