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Evolution of socially responsible investing

Investors expect a competitive return while making a positive impact

  • By Usman Hayat, Special to Gulf News
  • Published: 12:27 November 25, 2012
  • Gulf News

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.

What is impact investing?

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.

What type of investors, asset classes, and regions are associated with impact investing?

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.

What are some of the examples of impact investing and investors in Middle East and North African (Mena) region?

The 2011 report, Impact Investing in Emerging Market, by Responsible Research lists Souk Tel in Palestine and Souk Al 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 Menaregion 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.

How do social impact bonds relate to 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 counselling services for prisoners serving a short sentence at Peterborough Prison.

What are some of the challenges and opportunities facing impact investing?

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.

—Usman Hayat is CFA, Director of Islamic Finance and ESG at CFA Institute.

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