Traditionally, when high net-worth individuals (HNWIs) want to make a difference in the world, they put their money into philanthropic endeavours. But philanthropy has limits. While philanthropically-funded organisations do good work, they often battle when it comes to scale and efficiency.
As a result, a younger generation of HNWIs is flocking to impact investment instead. That is, projects that will ultimately sustain themselves, providing long-term, scalable benefits to the communities they serve. Impact investing intends to generate measurable social and environmental benefits alongside the traditional financial returns, though the latter is not the investor’s primary concern.
Rather than creating a legacy, they want to invest according to their goals, objectives and vision in the present, an aim that philanthropy as the mere donation of money to promote a good cause, doesn’t necessarily achieve.
And unlike the once-popular Social Responsibility Investment (SRI), which merely excludes the instruments that cause specific ethical concerns, and which is now completely misaligned with the needs of the savvy investors, Environmental Social Governance (ESG) investments target companies that already have high ESG standards. Here the investment opportunity is based on the potential these companies have to make an impact in the ESG space.
One of the main features of impact investing is that it considers the ESG impact above the potential financial returns. As well as the frustration with traditional philanthropy, there are several other factors driving the shift towards impact investing.
The growth of impact investing
One of the biggest factors is a growing belief that investment is a viable way of bringing about positive change in the world. The excitement around impact investing is most palpable in younger people inspired by activists such as Greta Thunberg. According to research from US Trust, part of Bank of America’s Private Bank, 93% of millennials believe social or environmental impact is important to investment decisions.
Another report by US Trust, meanwhile, found that 66% of high net worth millennials work for or own a company that integrates environmental and social good values into its products, services and policies, compared with just 52% of all high net worth individuals (HNWIs).
Young HNWIs are also realising that investing for impact doesn’t have to come at the expense of good returns. Research from the Global Impact Investing Network (GIIN) shows that, in general, private debt funds seeking positive impact can offer very stable returns across various private debt risk-return strategies, sectors, impact themes, and geographies.
A global research report from BofA Merrill Lynch showed that a strategy of buying stocks that rank well on environmental, social, and governance (ESG) metrics would have outperformed the S&P 500 every year for the last five years, for example. Another factor worth taking into account is that young HNWIs are taking a much more strategic approach to wealth. This is largely due to the fact that their wealth is often not linked to a single operating business, but a diverse portfolio of bankable assets
Wealthy families and individuals therefore have to define their vision and shape their profile. If they no longer stand for the brand of their operating business, they have to create a new brand reflecting their family’s values. Interestingly, female investors tend to have a more positive attitude towards impact investing, with some 65% of wealthy women believing social, political and environmental impact to be important, compared to just 52% of men, according to this Maximpact Ecosystems article.
It’s also worth bearing in mind that investing for impact means that investors are more likely to look beyond financial data. By taking a more holistic view of the companies they invest in (Are they well run? Do they treat workers fairly? Do they have an environmental focus?), they make themselves less susceptible to the kind of practices that were at the heart of the 2008 financial crisis.
Companies with better governance and compliance are less likely to end up in a litigation case and potential fines, ultimately resulting in better returns for their investors. Finally, it’s becoming much easier for investors to make impact-led choices. More and more fund management companies are offering sustainable investment choices and are starting to incorporate ESG factors into their core investment processes, alongside more traditional financial measures. With the options available, an increasing number of investors will use them.
Due diligence is vital
That said, as with all investments, it is vital that anyone looking to invest for impact do their due diligence. Over the years, there’s been debate around what impact investing actually entails. But gradually consensus is emerging around a definition which suggests that impact considerations must be purposefully integrated throughout the investment lifecycle. It must also be understood that investors will not necessarily achieve the same return with these investments, although they may have the desired impact that the investor hopes to achieve.
While investors should ensure that any project they invest in meets those requirements, they should also look out for regulatory markers. Impact investing, just like any other type of investing, has to be subject to AML, KYC compliance and overall regulation. This needs to be strictly adhered to if impact investing is to make the mark on the world it promises to.
While impact investing still accounts for a relatively small proportion of total investments, that will change, especially as more and more millennials and younger generations gain control of family wealth. Far from being a niche form of investment, it will increasingly become the norm. Investors can invest for impact without compromising on returns or missing out on portfolio diversity and the world will be a better place for it.
Kerstin Engler and Timm Reutter are Senior Wealth Managers for the Geneva Management Group.