Impact investing, a form of investment designed to generate both financial returns and positive social or environmental outcomes, has become an increasingly significant part of the global financial landscape.
However, one of the challenges that both new and experienced impact investors face is accurately evaluating the effectiveness of their investments.
Understanding this is crucial, not only to ensure the financial viability of their portfolios but also to measure the social and environmental impacts that their funds are creating. Let’s delve deeper into this complex, yet rewarding area.
What are Impact Investments?
Before we can evaluate effectiveness, we need to understand what we’re measuring. Impact investments are investments made into companies, organisations, and funds with the express intent to generate social and environmental impact alongside a financial return. They can be made across multiple sectors, like renewable energy, education, healthcare, and affordable housing, and can be targeted at various regions, from developed economies to emerging markets.
The Dual Goals of Impact Investments
Impact investments have dual goals – financial returns and impact outcomes. The balance between these goals can vary. Some impact investors seek market-rate returns, while others are willing to accept slightly lower returns for higher impact. Regardless of the balance, these two goals provide a framework for evaluating the effectiveness of impact investments.
Measuring Financial Returns
Measuring the financial return of impact investments is similar to measuring the return on a traditional investment. Investors look at metrics like the internal rate of return (IRR), return on investment (ROI), and payback period. More comprehensive evaluations might also include a review of the company’s financial health, like profitability, revenue growth, and debt levels.
Measuring Impact Outcomes
Measuring impact outcomes is more complex because it requires evaluating qualitative factors, which can be subjective and vary widely based on the investment’s goal. However, numerous standards and frameworks have been developed to provide consistency and objectivity.
One of the most recognised frameworks is the Impact Reporting and Investment Standards (IRIS), developed by the Global Impact Investing Network (GIIN). IRIS provides a set of standard metrics to measure social, environmental, and financial success. For instance, an investment in a renewable energy project might measure its impact by the amount of carbon emissions reduced, while an investment in an educational programme might measure the increase in graduation rates or improvement in test scores.
Another popular framework is the Sustainability Accounting Standards Board (SASB), which offers industry-specific sustainability metrics. It aims to measure the sustainability impact of an investment, considering the environmental, social, and governance (ESG) factors relevant to financial performance.
Tools for Evaluation
Advanced tools and platforms are now available that aid in tracking and reporting the impact of investments. Impact management platforms help investors gather, analyse, and report impact data, aligning with global standards. They provide comprehensive dashboards to track both financial and impact metrics, facilitating an integrated approach to investment evaluation.
The Importance of Impact Evaluation
Evaluating the effectiveness of impact investments is more than just a tool for investors to maximise their returns and impact. It’s also a vital step in moving the broader financial system towards sustainability. Detailed evaluations that include both financial returns and impact outcomes can encourage more investors to enter the field, accelerating the flow of capital to companies and projects that are helping to build a more sustainable and inclusive world.
The Role of Impact Investment in South Africa
In the complex financial landscape of South Africa, where public ends often intersect with private capital, impact investing is emerging as an appealing alternative to conventional financial policies. One aspect of the ongoing political debate is the controversial concept of prescribed assets – a policy where institutional investors are compelled to invest in designated instruments, usually government bonds. Such a policy, which was utilised under the Apartheid state, tends to distort markets and suppresses the disciplinary effect that investors could exert through their investment choices.
As an alternative, impact investment holds a more promising potential. Impact investments, which actively pursue defined public benefit objectives such as education or healthcare, offer a more flexible and beneficial investment approach. In a country where public policy allows tax deductions for donations to organisations that support public benefit activities, the model of impact investing aligns well with established practices.
Similarly to how individual choice dictates the specific organisations receiving support, impact investments offer the same level of selectivity. Public policy could encourage impact investment by allowing institutional funds to dedicate a portion to it, akin to the current practice with hedge funds. It can also provide a favourable tax treatment by permitting impact funds to be included in tax-free savings accounts for individuals.
However, it’s important to note that impact investing, while promising, isn’t a cure-all solution. Addressing complex, deeply rooted issues such as unemployment and inequality requires broad economic development that stretches beyond what impact investing alone can achieve. Yet, impact investments can make a critical difference in specific areas that are challenging to address through traditional investment or public spending.
In South Africa, impact investing offers a potential tool to resolve complex societal issues while also providing financial returns. By striking the right balance between profit and impact, these investments could offer a new path to sustainable development, fostering a more inclusive and equitable society. Therefore, it’s essential for public policy to support and encourage impact investing as part of a broader strategy to tackle the nation’s economic and social challenges.
The world of impact investment is complex but rewarding. To truly understand the effectiveness of impact investments, one must employ comprehensive, robust, and globally recognised tools and strategies. By effectively evaluating these investments, we can ensure that capital is not just creating wealth, but also contributing to a more sustainable and equitable world.