Impact investing: a white knight from the financial industry?
Author: Valentin Held, Esade Entrepreneurship Institute
The Financial Times dedicates a special issue to impact investing, El País reports that it is reaching Spain, and the Süddeutsche Zeitung headlines that it is becoming increasingly popular among professional investors. Recently, impact investing has moved from the circles of finance-savvy audiences to enter European mainstream media. So, what is behind impact investing, and is it going to change the world?
Those of us who have entertained the idea of working for money, and letting money work for humanity, may have heard of financial products that do not invest in harmful assets such as weapon or tobacco stocks. In finance parlance, such a strategy is called exclusionary screening. It is one of many so-called sustainable investment practices, but it is not exactly what impact investors are doing. Impact investors are leveraging money to finance aquaculture businesses that use insects for feed instead of soy products, or wild-caught fish.
Others aim at scaling up forestation projects that ensure a supply of wood and clean water, while maintaining a healthy habitat for plants and animals. Yet others deploy their resources to support the creation of small local businesses in rural communities, or propel the development of medicine and prevention for infectious tropical diseases.
Impact investors intend to create some measurable environmental or social good
These examples illustrate that impact investors do not only want to make money, but importantly intend to create some measurable environmental or social good. Measurement is crucial, but we will come back to that later.
Impact investment has been around for some ten years, which raises the question of why it is gaining traction and attention just recently.
Both in and outside of business, there is increasing awareness of the negative consequences that modern production and consumption have on the planet. During an international forum on impact investing, Gonzalo Gortázar, the CEO of CaixaBank, recalls that when he started, investors did not care about sustainability issues. However, social and environmental considerations have since become a ‘real thing’ in the investment industry.
On the political parquet, the European Commission publicly encourages the aspiration to be carbon-neutral by 2050, and promises to provide €100bn until 2027 for those most affected by the transition. It is against this backdrop that the Global Impact Investing Network estimates the worldwide impact investing market to have grown within one year from $502bn to $715bn in 2020. To put these figures in context: the estimated impact investment market equals 60% of Spain’s GNP.
Despite this growth – whether or not impact investing will have large-scale effects in the long run depends on how the impact community advances on its most pressing challenges.
A key issue is the measurement of and accounting for the aspired environmental and social goods. For an investor who is only concerned with making money, it is relatively easy to tell whether an investment was successful or not: simply speaking, is there more money at the end of the day than before (net transaction costs and inflation)? For an impact investor, it is not that easy.
Coming back to the example of sustainable forestation, one may think of counting trees, but which indicators guarantee that the cycle of plantation and use of trees is ecologically sustainable? Or how can an investor who wishes to support rural development by financing small local enterprises, account for improvements in the community’s quality of living? And to begin with, how can we compare impact investors with such diverse objectives as forestation and rural development?
Global networks of practitioners and scholars are working on solving these issues of measurement and accountability. Firms follow commonly recognised financial accounting standards to provide investors and the public with transparency regarding the economic situation. Some experts seek to craft and establish similar impact accounting standards, so that firms report the social and environmental effects of their operations in a transparent and standardised way.
A firm that is profitable by conventional standards, may turn out to be loss making as the environmental damage it causes is expressed as financial costs
Others try to translate environmental effects into monetary values, so they can be integrated into the balance sheets and profit and loss statements around the globe. This would imply that a firm that is profitable by conventional standards, may turn out to be loss making as the environmental damage it causes is expressed as financial costs. Standardised accounting and measurement of social and environmental effects would help impact investors allocate their resources and show that they are achieving real progress.
However, the challenge of measuring and accounting social and environmental effects is relevant beyond impact investing. While investors traditionally used to decide whether to invest in a firm based on an assessment of risk and return, they are now increasingly incorporating environmental issues into their decision rationale. A firm with ‘dirty’ production might simply no longer be an attractive target because it runs a risk of facing a variety of issues, such as regulatory constraints or reputational damage.
Moreover, as the public becomes more aware of environmental concerns, pressure on businesses to exhibit greater transparency surges.
To return to impact investing, it is perhaps not the white knight that is going to save the world. But as social and environmental topics turn into a real thing for businesses in general, impact investing may contribute to a large-scale change by pushing the accounting and measurement of the non-financial effects of production and consumption.