Social finance, impact investing, blended finance…the endless industry jargon and terminology in this emerging asset class can be confusing. In this series, our industry leading global Social Impact Finance group looks to demystify the social finance market and its growing importance for financial institutions and investors.
Greed is no longer good. The next generation of investors increasingly demand that their investments do more than just generate a financial return. Demand for social investment products is driven, in part, by millennials who prefer to invest in alignment with personal values. In response to this growing demand, chatter in financial markets is awash with talk of the ‘spectrum of capital’ – a map of the broad range of risk and return strategies that exist within impact investing markets, and how those relate to wider capital market strategies. The 2014 report from the G8 Social Impact Investment Taskforce, Asset Allocation Working Group, illustrated the landscape based on both investor financial objectives and impact (see diagram below).
“The financial services sector has a fundamental role to play in advancing sustainable investment, but recognising that financial and non-financial incentives and metrics will work in tandem will be critical. The sustainable investment landscape will no doubt evolve as negative externalities eventually start to become priced in to financial models. In the meantime, any typology that helps delineate the range and characteristics of different sustainable and impact investments will be helpful for investors.” – Anjalika Bardalai, Chief Economist & Head of Research, TheCityUK
At one extreme, we have the ‘finance-only’ approach – investments targeted for risk-adjusted financial returns, having limited or no regard for either impact or environmental, social and governance (ESG) practices. Variations of this strategy, but ones in keeping with the growing expectation that money must do good as well as generate returns, are ‘responsible’ or ‘sustainable’ investments. ‘Responsible’ investments target mitigating ESG risks and avoiding harm to society. Better still, ‘sustainable’ investments actively pursue positive ESG outcomes for society. Key to both types of investment strategies, however, is still an overriding concern to deliver competitive financial returns.
At the other extreme, we have the philanthropic approach – capital allocation motivated by delivering impact solutions addressing the United Nations’ 2030 Agenda for Sustainable Development, seventeen sustainable development goals (SDGs) identified by the United Nations providing a common pathway for a better and more sustainable future. While philanthropic investors are not expecting a financial return, it would be wrong to assume that they are not rigorous in their due diligence of their ‘investments’. Given the well-documented problems of the sector in the past with wastefulness, today’s philanthropist is motivated by both the impact that any potential grant will have as well as the efficiency with which their money will be used. They demand the maximum ‘bang for their buck’.
However, at the cross section of both the extremes is impact investing, which borrows elements from both strategies. Impact investments allocate capital towards measurable impact solutions addressing ESG and SDG challenges while also generating a commercial financial return. Impact investments range from ‘finance-first’, delivering competitive financial returns, to ‘impact-first’, which tolerate higher risk projects or below-market financial returns.
These categories are not mutually exclusive and are often interdependent, with investments stretching across categories. Nevertheless, the spectrum of capital provides a useful frame of reference for investors, social finance professionals and businesses navigating the greater choice available in terms of investment and impact profile.