Impact investing usually refers to investments made by the private
sector to generate measurable social and environmental impact alongside a
financial return. Usman Hayat, a Director of Islamic Finance and ESG at CFA
Institute, explores this fast growing investment theme.
Impact investments are made to
create jobs or affordable housing in low income urban areas or to provide clean
drinking water or accelerate agricultural growth in rural areas. Similarly, they
may seek to improve access to education, or health services, and financial
services. Some investors may expect a competitive return while making a
positive impact. Other investors may be willing to accept lower expected return
or higher risk compared to a comparable investment not seeking to make a social
impact. So impact investing lies somewhere between giving money away in charity
and investing solely for one’s own economic interest. Estimates of market size
vary significantly with one estimate suggesting that impact investing can
attract up to US $1 trillion in 10 years.
How does impact investing differ from socially
responsible investing?
Traditional socially responsible
investing is about avoiding investments that are inconsistent with the values
of the investors, whether it is products, such as tobacco, or norms, such as
labour standards. Some investment opportunities may be preferred over others
because of positive attributes, such as efficiencies in managing energy and
waste, and investors may also try to influence corporate behaviour by voting
and entering into a dialogue with the companies. But these investments tend not
to actively pursue a positive impact.
The more recent shades of responsible investment tend to focus on long
term risks and opportunities arising out of environmental, social, and
governance issues but also without directly seeking a positive impact. Impact
investing can be viewed as an evolution of socially responsible investing and
it is the declared intention at the outset and the relative emphasis on making
an impact that differentiates it.
Impact investments are diverse. Investors include philanthropic
entities, commercial financial institutions, and high net worth individuals.
Impact Base, a database of impact investments, which is an initiative of the
not-for-profit Global Impact Investing Network (GIIN), lists about 200 impact
investing funds. According to Impact Base, these funds invest across regions
and about half of these funds are in North America and Africa. Access to
finance, access to basic services, employment generation, and green
technologies are the major impact themes. More than half the funds are
classified as private equity or venture capital. Many impact funds are
relatively small, with less than $100 million in terms of assets under
management.
The 2011 report, Impact Investing
in Emerging Market, by Responsible Research lists Souk Tel in Palestine and
Souk el Tayeb in Lebanon as two examples of impact investments in the region.
The former develops mobile phone services to improve access of communities to
relief services while the latter helps improve market the produce of small
scale farmers. Examples of impact investors that have a presence in the MENA
region include Synergos and Willow Tree Impact Investors. Because youth
unemployment is a huge challenge in MENA, job creations through small and
medium sized enterprises (SMEs) is an area of interest. Industry reports
suggest that in terms of volume and value of impact investments, MENA region
ranks low compared to other regions.
How does Islamic finance relate to impact investing?
Like traditional socially responsible investing, Islamic
finance has tended to focus on excluding ‘sin’ businesses rather than making a
positive impact. Because lending money on interest and sale of risk are widely
considered to be prohibited in Islamic finance, it is concerned with the
structure and not just the purpose of financing. Academic literature and news
reports suggest growing interest in Islamic finance in making and measuring
positive impact, such as through micro finance and this rapidly growing sector
is also a possible source of growth for impact investing.
Social impact bonds are a
relatively new innovation within impact investing. They are a contract between
a private and public entity in which the public entity commits to pay for
improved social outcomes. Although they are called bonds, they are in fact
public-private partnerships, with risk-return profiles that are likely to be
closer to private equity than fixed income. The public sector is motivated to
pay the private sector for the positive social benefits and corresponding
savings. The first-ever social impact bond was issued in the UK to reduce recidivism
among offenders through counseling services for prisoners serving a short
sentence at Peterborough Prison.
Impact investing faces the same risks that would be found
in commercial investments. One risk that is likely to be found to a greater
degree in impact investments is reputational risk. They may face criticism for over-promising
or even profiting by exploiting the poor. Microfinance, a prominent shade of
impact investing, has faced just such a criticism.
According to a 2011 report by J.P. Morgan, lack of track
record of successful investments is seen as the most important challenge for
growth of impact investing. Because it is a relatively new field, a nascent institutional
framework is emerging, such as the Impact Reporting and Investment Standards
(IRIS) which seeks to facilitate comparisons and performance benchmarking.
Overall reports suggest we can expect strong growth in impact investing in the
future.
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