Impact funds: If finance and philanthropy had a love child

How do you marry a financial return with making the world a better place? Is it even possible or is it an oxymoron? Impact funds are here to prove that it can be done.

What is impact investing?

Impact investing is an investment style that leaves no stone unturned in the quest to achieving its dual goal: a positive social or environmental impact alongside a financial return. Impact funds are still rare and according to the Investment Association, there are only nine funds in the UK that have an impact-related investment philosophy.

Investing in general is often about creating growth, not just of your savings but of the economy itself. But impact investing takes that concept to an extreme, and the closest to philanthropy as traditional investing gets. Impact funds also go further in measuring the positive impact they have on society than other ESG-flavoured funds. This can be anything from quantifying the exact amount of emissions avoided by investing in a specific renewable energy provider, to estimating how an investment in a school for low income children will help them gain jobs in the future.

Sound hard? That’s because it is. Not only is it hard to measure the real impact of the investments, but there is also the added challenge, or shall we say balance, of generating a decent return for investors while doing social good.

This is just the beginning

Whilst the impact investing space is still small, there is huge potential. At least if we are to believe the predictions of the Business & Sustainable Development Commission, which suggests that investments aligned with the UN Sustainable Development Goals (SDGs) are likely to be a source of significant growth for the economy. In 2017, it was estimated that achieving these goals could create opportunities in food & agriculture, cities, energy & materials, and health & well-being worth $12 trillion. The report claims these areas represent 60% of the real economy and could create as many as 380 million new jobs by 2030. Now, that’s worth investing in.

But to achieve this elusive dual mission, it might cost you. Impact funds tend to command higher fees than other funds, partly due to the additional complexities involved with investing this way and partly due to lacking economies of scale (at least so far). For example, the OCFs for the open-ended impact funds on the Investment Association’s list range from 0.5% to 1.5%, with many charging around 1%.

Impact fund managers = Judge, jury and executioners?

Then there is the moral challenge. Deciding what counts as an impact investment is difficult because no investment is black or white, not even coal. While divesting from coal helps reduce carbon emissions, it also means thousands of workers will lose their jobs. How do you decide what is most important when it comes to positive impact? Do you favour the environment at the expense of social mobility or do you favour social mobility at the expense of the environment?

In an ideal scenario they aren’t mutually exclusive, but when it comes to certain countries, particularly in emerging markets, sometimes a country can’t afford to prioritise the environment if it means sacrificing hundreds of thousands of jobs. It begs the question – is protecting the environment a luxury that is mostly afforded by developed countries like many in the West? And who is best qualified to make these judgement calls? What makes investment professionals like fund managers qualified to make these decisions on behalf of the rest of us?

You may have some reservations as to whether a fund manager is the right person to make these judgement calls, but to ease any concern there are certain broader standards and frameworks that tend to at least lay down the ground rules. For example, many impact funds assess potential investee companies against the framework of 17 UN SDGs, which aim to solve various world issues such as hunger, poverty and inequality. An impact fund would pick the companies that are aligned with at least one of these global goals and monitor the actions the companies take to keep themselves aligned with these goals.

Variety of shapes and sizes

Sometimes, this means looking outside the listed equity and bond markets. But regardless of whether the companies are public or private, much of the of the impact investing space is so far focused on small and medium enterprises, as well as local businesses. This is partly because impact can be easier to measure on a local scale, especially when it comes to doing social good, but there are some funds that take a different approach and invest in large global companies that are at the forefront of advancing social change.

Consequently, there is a whole range of different investment options that tap into this area, from investment trusts that allow you to finance solar power projects in Africa, to concentrated global growth funds investing in everything from tech to environmentally friendly baby products. Given this plethora of approaches to impact investing it's hard to compare impact funds like for like. However, the rigorous reporting that these funds do, together with a clear and thoughtful fund philosophy and process, can help map out which funds are aligned with your own personal goals and values.

Because impact investing is fairly new, the jury is still out on whether it really is possible to marry a decent financial return with making the world a better place. Whilst the overall mission is broadly the same across all impact funds, there are many different and exciting approaches to achieve it. Just don’t forget to keep an eye on the cost, which over time will eat into those returns. But if you want your hard-earned savings to do more than just generate a return, impact funds may be worth it, especially if you find one that has a philosophy and approach aligned with social issues you care about. And wouldn’t the world be a better place if there was a philanthropist within all of us?

Date of publication: 23rd December 2020