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Impact investing paradigm asks the right questions

Business Line
By Professor  
Jeremy Wade

Look at an average investment fact-sheet, and you’ll see the usual profit, risk and return profiles. Depending on these, you are supposed to make an informed investment decision. But imagine if there was an additional section that measured impact. ‘How much does this investment affect the lives of the local communities?’, ‘Are wages being paid fairly?’ or ‘What is the company’s carbon footprint?’.

This new paradigm is called impact investing, and it is asking some deeper questions about the nature of investing, and about capitalism and philanthropy in the 21st century.

An alternative

Pioneering investors, business leaders and philanthropists are scrutinising their motivations behind investing, how it’s different from giving, and in turn, reflecting on the fundamental purpose of capital in business and society. Many are coming to the conclusion that making money shouldn’t be the only purpose of investing. At the same time, just giving money away through charity doesn’t seem to solve our increasing global social and environmental ills. Impact investing, on the other hand, allows us to transcend outdated notions on capital, and move into a new future.

Looking deeper, impact investments are investments made into companies, organisations, and funds with the intention to generate positive social and environmental impact alongside a financial return. Instead of relying on government funds and philanthropy, investment instruments previously reserved for profit-oriented ventures are being used to effectively fund social enterprises.

Impact investing is about achieving both financial return and transforming economies to take into account the larger factors that affect our collective future.

Changing the norm

A growing body of research in this field suggests that there can be gains on both sides from this approach. As awareness of these benefits increases, we are seeing a global shift in investing practices. Increasingly, commercial players like Goldman Sachs, TPG, Bain Capital, and BlackRock are entering the impact investing field.

In the future, this may not be a separate category but rather the new norm for all forms of finance.

Around the world, this form of investing is a part of a larger trend toward socially responsible business practices. However, it is qualitatively distinct from other such practices, like Corporate Social Responsibility or Socially Responsible Investing. The former refers to distribution of business profits through an essentially philanthropic model. In the latter, investors reject potential investments likely to cause social and environmental harm.

By contrast, social impact is not an exclusion criterion but a core focus in impact investing. And, as a result, social impact is treated not as a charitable benefit but as a measurable outcome of the investee organisation’s activity.

At this critical point, India is an ideal environment in which to test, innovate, and expand impact investing. India has a young and growing population, and enjoys a relatively stable financial market, but faces significant challenges within sustainable socio-economic development. Some investors have already joined the trend, as a recent report by McKinsey & Company identified 50 active impact investors and total impact investments of $5.2 billion in India. These investments have averaged an 11 per cent internal rate of return over five years.

In order for impact investment to gain traction as a new and potentially paradigm-changing finance model in India, education and training opportunities are imperative to expose policy-makers, investors, social enterprises, and corporate houses to the potential of social finance. In India, in particular, where Corporate Social Responsibility has gained great currency due to recent legislation, additional promotion and awareness would help translate the possibilities of this alternative model into effective action.

Practical application

In a recent global research report, the Beeck Center for Social Impact & Innovation at Georgetown University documented some of the current needs in the impact investing education field. The report called for adaptable and iterative models that can adjust to rapid developments in the field, an emphasis on cross-sector collaboration, and the promotion of systems thinking in a disrupted global system.

One gap in existing training programmes is a lack of emphasis on the required skills for impact measurement. There is an additional need for more sector-specific guidance and different funding strategies, tailored to investors and organisations in education or health care, for instance.

Education and training content should thus include practical tool kits and analytic frameworks derived from research. Programmes must be open and accessible to a diverse range of stakeholders. This point is especially crucial in India, where many innovations occur at the grassroots level, often far removed from the world of finance.

Looking broadly, the world is currently working towards a set of ambitious targets for addressing global challenges — the Sustainable Development Goals (SDGs). Over the next decade, the UN estimates that implementing SDGs will cost between $50 trillion and $70 trillion. How will we pay for it all? The answer is the $200 trillion in private capital invested in global financial markets. The impact investing paradigm has the potential to help unlock portions of this capital and ensure that it is deployed effectively towards development efforts. It has already proven you can do well by doing good; the next challenge is how to do that at a global scale.