Rethinking impact investment: the third dimension

Rethinking impact investment: the third dimension

Rethinking impact investment: uses capital as a force for good as much as a source of financial returns.

One of the key defining characteristics of human beings is compassion – the ability to see the suffering of others and work to improve their situation. The large quantities donated to charity on a global scale every year, a number that continues to rise, stands testament to the willingness to build a more inclusive society, which has seen almost a third of the world’s population give money to charity¹.

Yet, charitable donations remain negligible in the context of the total amount of money invested on a daily basis through savings and investment plans. The global value of assets under management reached $71.4 trillion in 2015 , all of which could potentially be used to generate positive social change. So why isn’t it doing just that?

Historically, investment has been founded on two key dimensions: return and risk. As a consequence, our understanding of the value created by investment has been limited to these two factors. Today, however, the Millennial generation is recognising how powerful capital can be as a tool to address some of the most pressing issues in the global society. This adds a third ‘impact’ dimension to our understanding of what makes a good investment.

Impact investment, as it has become known, is designed to mobilise capital to create positive social change through sustainable investment strategies that improve lives, create entrepreneurs and deliver returns to savers. This typically involves investing in for-profit businesses, particularly small and mid-sized companies in developing economies, where companies have a clear mission for social improvement, such as providing low-income populations with access to finance and essential services in order to reduce poverty.

In Africa, for example, solar power generation companies have developed leasing programs to supply electricity to remote areas that are not connected to the main power ‘grid’ where low-income populations cannot afford to purchase solar panels outright. The panels are provided at a cost, which ensures both investor and end-user benefit from the program.

Initiatives like these have a huge impact on local communities. By providing access to basic services and finance, they create the opportunity for entrepreneurs to increase their income, which, in turn is shown to improve the situation for the wider local community. There is a strong link, for example, between electricity consumption per capita and education levels. Better electrification is shown to reduce illiteracy and improve educational achievement . Solar power is also a cheaper, healthier and more renewable power source than kerosene.

Unlike philanthropy, impact investment doesn’t mean savers have to compromise on their return potential. In fact, including the social impact dimension into investment decisions looks increasingly compelling. A growing body of evidence suggests there is a strong relationship between all three investment dimensions - return, risk and impact. It stands to reason that a company with a strongly negative impact would struggle to survive long-term and the opposite is also true. If the business model of a company is sound and they are genuinely creating a meaningful impact, their future revenues should be well supported, especially where they are providing essential services or finance in high-growth economies. By providing financing, such as loans, to these companies, investors globally are able to achieve their goals in relation to all three investment dimensions.

The SMX microfinance index provided average returns of 3.7% per annum between the start of 2004 and the end of March 2016, and has proven to be consistently more stable than bonds or equities over that time. Investment advisory firm Cambridge Associates also found the financial performance of private impact investment funds was in line with similar funds with no social objective.

Being able to profit equally well from doing good as through two-dimensional investment strategies makes impact investment an increasingly attractive way to deploy capital. It also makes it more sustainable, both as an investment philosophy and as a force for positive societal change.

1 Charities Aid foundation, World Giving Index: 
2 The World Bank, Mutual Funds in Developing Markets, 2015:
3 Undesa, Electricity and Education: The benefits, barriers, and recommendations for achieving the electrification of primary and secondary schools, December 2014 (p8): 

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