Impact investing adds a third dimension to the traditional “risk-return” financial couple: It is a new way of investing, an opportunity to harness the power of capital while contributing to the improvement of our environment and society. To become an impact investor, it is essential to define your financial and impact objectives. To do so, several elements must be taken into account, including the time and resources available, the desired impact, one’s risk aversion and one’s investment thesis. And to avoid “greenwashing“, it is key to understand the differences between so-called responsible finance, sustainable finance and impact finance.
To become an impact investor, start by targeting your investments
This is an approach used by investors to avoid controversial sectors that they do not want their money to be associated with and is the first step to responsible finance, which often looks beyond financial risk and return. This method eliminates sectors that are contrary to the investor’s values. Typically, these sectors are weapons, drugs, tobacco, alcohol, pornography or gambling. Avoiding these sectors automatically guides the investor towards the territory of so-called responsible finance.
The integration of ESG criteria:
Taking environmental, social and governance (ESG) considerations into account when deciding on investments follows this reasoning: the extra-financial performance is correlated with the financial performance. If a company’s ESG management practices leave something to be desired, its performance risks weakening in the future because it will not have prepared itself to be a responsible company. Taking into account these extra-financial criteria allows one, among other things, to obtain the SRI label – socially responsible investment. This means the investor enters the world of sustainable finance through its sustainable business activities.
Contributing to solutions:
This complements sectoral exclusion and ESG integration, in order to not only minimize harmful effects but to reconcile a competitive financial return with a positive social and environmental impact. These practices fit perfectly with the nomenclature of the Impact Management Project, as negative screening aims to avoid doing harm, the ESG criteria intends to benefit stakeholders and impact investing to contribute to solutions. Although the first two levels are essential steps, only impact investing has the ability to respond to social and environmental issues.
Embrace a specific investor mindset
Regardless of asset allocation, creating a theory of change is one of the major steps in defining an impact investing strategy. Whether you choose to dedicate some or all of your assets to impact investing, it is critical to define the issues you want to contribute to and how this will be achieved. The theory of change involves mapping the steps necessary to accomplish the desired impact. To begin, a specific problem is defined. It may be a local or global problem, a serious or less serious one, but it is a situation or difficulty for which change is desired.
The investment equation:
Let’s take an example of an issue: Many homes are energy-intensive and are costly for their inhabitants and emit a high amount of greenhouse gases. Then we look at the inputs that will affect this problem. These are mostly financial investments and the provision of human capital. Now imagine investing in a company that renovates buildings by improving their energy performance. The inputs will then be financial – investment in the company– as well as human, considering the work provided by the employees of this renovation company. These inputs will lead to tangible products. In this case, the renovations will result in better-insulated homes and less energy consumed per surface.
Then we can measure the results obtained with these products. In the above example, a hypothetical study would show an average saving of hundreds of euros per home that could be achieved by avoiding energy drains. Moreover, the thermal comfort of the inhabitants will also be increased.
Navigating the way towards impact
By deciphering responsible from sustainable finance, and defining impact objectives, one starts to pave the way to becoming an impact investor who can make a real improvement in the long term. Whatever approach is chosen, it is necessary to define a theory of change, to invest in a targeted way, to be able to contribute meaningfully to the solutions of global issues.