social impact investment | Growth Economics

The appetite for impact investing is rapidly growing globally, gaining prominence as a serious investment approach that achieves both financial returns and social or environmental goals.

Impact investment is defined as investments made in companies or organisations with the intent to contribute measurable positive social or environmental impact, alongside a financial return.

The rapid growth of the impact market is being driven by changing consumer demands. Over the next few decades, wealth will transfer from Baby Boomers to Generation X and Millennials who are becoming more aware and concerned by agendas such as climate change and social disadvantage. As a result, they are making more conscious investment, purchasing and employment decisions. While companies are being forced to respond to protect their shareholder value, brand and social and ethical accountability.

Since 2016, the impact investment market has doubled each year. In 2017, the global impact investment market was worth $US 230 billion; in 2018, it was worth $US 502 billion; and is now heading towards the first $US1 trillion (Mudaliar & Dithrich, 2019). The World Bank’s International Finance Corporation (IFC) estimates that investor demand now amounts to no less than $US 26 trillion, 50 times the actual size of the 2018 market (Volk, 2019).

Western Australia’s (WA) unique natural resources and social and environmental challenges are elements that impact investors seek to invest in. WA already has a small impact network with a few investment sources, demonstrating the demand for local investments. This includes a $20 million Impact Fund backed by WA Super, intermediaries (Impact Seed), corporate funding (e.g. Rio Tinto) and philanthropy (Minderoo Foundation).

However, more work is required to harness the unmet demand for impact investments by developing more sophisticated investment opportunities and vehicles that enable investors to pursue impact and financial returns in WA.

What is impact investment?

All investments have impact – positive, neutral or negative outcome of people and the planet, and can be classified upon a spectrum.

Impact Investing Spectrum by Sonen Capital

Impact investment is a rising investment class that goes beyond minimising harmful outcomes (responsible investment and Environmental, social, and governance (ESG)) to actively creating positive results that also contribute to social and environmental solutions. Unlike philanthropy, impact investment is an investment, as investors seek to achieve a financial return that is at commercial or sometimes sub-commercial rates.

Impact investors actively seek to place capital in assets, businesses and not-for-profits (such as stocks, micro-finance, private equity, venture capital and impact bonds). They fund industries (such as renewable energy, sustainable agriculture, manufacturing and technology), infrastructure (such as ports, housing, connectivity and utilities) and services such as (healthcare and education).

State of the Australian Market

In Australia, the market has grown exponentially from $1.2 billion in 2015 to over $20 billion today. It is projected that demand for Australian impact investment products will continue to grow and disrupt traditional markets, reaching $100 billion over the next five years (RIAA, 2020).

Investor activity is broadening and deepening in the Australian impact market, with more investors becoming active in impact investing and investors already active in increasing their allocations to impact investing in terms of both dollar amount and number of investments.

This growth trajectory looks set to continue in the medium to long term as investor awareness and interest increases, establishing impact investment as a significant investment class within the next five years. In addition, recent evidence suggests that investors are able to earn higher levels of financial returns achieved on impact investments targeting environmental outcomes – which is clearly a factor in attracting mainstream and larger-scale investment interest (Cohen, 2020).

RIAA’s (2020) analysis and survey of the Australian Impact sector found the following:

The total value of impact investment products as of 31 December 2019 was $19.9 billion (including $8 billion in foreign products). Equating to a rise of 249% from $5.7 billion in 2017;
Australian investors advise they wish to increase their proportional allocation towards impact investments. Accordingly, the market is estimated to grow fivefold to $100 billion over the next five years;
There are 111 Impact investment products widely on offer to Australian investors as of 31 December 2019;
Green bonds and environmentally-focused impact investments represent 87% of the total Australian impact investing pool;
Social impact investments are valued at $2.5 billion and have increased tenfold from $242 million in 2018. Representing only represent 13% of the total market;
Australian impact investors surveyed are neutral on whether they support environmental or social impact projects. However, social impact investments are harder to develop and often work with less sophisticated project proponents;
Australia has ten social impact bonds (SIBs), none in Western Australia; and
There is a lack of Australian intermediaries who can advise on and create impact investing to stimulate market growth.

Why governments should be interested in impact investment

In addition, the broader rationale for a coordinated impact investment approach, includes the following:

The government does not have the budget or resources to undertake the necessary investment required to address regional and environmental challenges. While the current model of grants has limitations;
Impact investment will help to share financial and performance risk with investors and service providers – allowing better risk management for governments and seeking knowledge and technical assistance from investors and service providers to improve outcomes;
Impact investment encourages innovative, entrepreneurial and scalable outcomes to change the status quo;
Returns on impact investment will be at least as good as traditional investments, and in the future most likely better (Cohen, 2020; RIAA,2020);
Increasing market disruption as young consumers, entrepreneurs and employees seek impact opportunities and influencing the behaviour of investors;
Investors are increasingly looking for impact projects, and there is now a substantial unmet market demand that is not being capitalised and therefore unrealised;
Impact measurement supports an outcomes-based management approach, a WA Government requirement, and a growing determinant for investors and business accountability; and
The impact revolution has the ability to drive sustainable and development change in WA, improving equality, living standards and environmental outcomes to targeted investment tied to social and environmental outcomes (Cohen, 2020).

References

Cohen, Ronald (2020) Reshaping Capitalism to Drive Real Change. Ebury Press: London

Deloite (2019) The Deloitte Global Millennial Survey 2019 Societal discord and technological transformation create a “generation disrupted.” Retrieved from: https://www2.deloitte.com/content/dam/Deloitte/global/Documents/About-Deloitte/deloitte-2019-millennial-survey.pdf

Global Impact Investing Network (GIIN). (2020) Retrieved from: https://thegiin.org/

Landrum, Sarah (2016) Why Millennials Care About Social Impact Investing. Forbes. Retrieved from: ttps://www.forbes.com/sites/sarahlandrum/2016/11/04/why-millennials-care-about-social-impact-investing/?sh=2a44297c59c0

Mudaliar, Abhilash, and Dithrich, Hannah (2019) Sizing the Impact Investing Market. Global Impact Investing Network. Retrieved from: https://thegiin.org/assets/Sizing%20the%20Impact%20Investing%20Market_webfile.pdf

Responsible Investment Association Australia (RIAA), (2020) Benchmarking Impact Australian Impact Investor Insights, Activity and Performance Report 2020. Retrieved from: https://responsibleinvestment.org/wp-content/uploads/2020/06/Benchmarking-Impact-2020-full-report.pdf

Volk, Ariane (2019) Creating Impact: The Promise of Impact Investing. First edition ed., Washington, International Finance Corporation. Retrieved from: https://www.ifc.org/wps/wcm/connect/publications_ext_content/ifc_external_publication_site/publications_listing_page/promise-of-impact-investing

With budget short falls and the need to create jobs, investment attraction has become a top priority for governments. The private sector is increasingly being called upon to pay for and lead investments into a whole range of assets; as well as solve social and environmental problems. However, finding the right investor and structuring the investment can be a challenging task. Understanding investment asset classes and the investor’s requirements in each category is a critical first step.

Investors

It is important to note that an investor that that works in one class/sub-class may not work in another and each investor’s preferences will differ. As Chen (2019) notes, investors “are not a uniform bunch”.

Investor is any individual or entity “(such as a firm or mutual fund) who commits capital with the expectation of receiving financial returns” through income or capital appreciation (Business Dictionary, N.D; Chen, 2019).

Investors use their capital for long-term gain and therefore are different to traders who seeks to generate short-term profits by repeatedly buying and selling stocks (Chen, 2019). In addition, some investors will also try to address a social or environmental need as well as make a financial return. This is an exponentially growing[1] field called impact investment.

Impact investment is investment that aims to achieve positive and measurable social or environmental impact, as well as financial return (Impact Investing Australia, N.D; OECD, 2015).

In order to select and commence negotiations with potential investors, investment opportunities need to be analysed and matched with investors based on asset class, risk, capital requirements, involvement and timeframes amongst many other factors (Chen, 2019; Nerd Wallet, 2012). Thus, before designing investments or approaching investors, it is critical to understand the major groupings of investments.

What is an Asset Class?

Asset classes provide a framework to categorise and analyse an investment opportunity, structure the investment and match it with interested investors. Asset classes perform either a growth or defensive strategy in an investment portfolio, depending on the underlying economic conditions at any given time. Most investors will have a mix of investments but will not invest across the spectrum of assets or sub-asset classes (Citi, 2016; Chen, 2018).

Asset class is a group of comparable investments that are grouped together based on having a similar financial structure and are traded in the same financial markets, subject to the same rules and regulations (CFI, 2019).

Sub-asset classes are segments that are grouped by more specific characteristics factors such as similar capital allocation, risk and return ratios. For example, the asset class equity refers to an investment in a business. However, the equity ‘spectrum’ includes shares on the stock market, start-up funds (~$20,000), venture capital (~$2-5M) through to mergers and acquisitions (over $20M). In addition, risk and return and management structure of each investment are all very different (Feld and Mendelson, 2011).

Explaining Each Asset Classes

It can be hard to classify some investments into asset classes. For example, you can invest in commodities through a company on the stock market that produces commodities, purchase tangible commodities or purchase commodity derivatives such as futures or options. Another example is real estate investment trusts (REIT) that are held as equity (Equity REITS) or fixed income assets (mortgage REITs) despite both being derivative of real estate (CFI, 2019). Additionally, there are always new segments such as venture capital and crypto-currencies (Chen, 2018). However, it is typically agreed that there are five main categories: cash, equities, fixed income, infrastructure and real estate and commodities. A final sixth category, alternatives, is used to reflect non-traditional investments (Frankenfield, 2019). Thus, general asset classes are as follows:

Asset Class Framework

Cash and cash equivalents: refers to money or other liquid assets that can be a medium of exchange or mechanisms for payment. The main benefit for cash investors is safety as it is typically the safest form of investment. However, inflation and low interest rates can undermine the value of the asset (Frankenfield, 2019; Nerd Wallet, 2012).
Equities: refers to ownership into a business and includes every things from traditional shares, trust structures, angel and venture capital. It is important to look at the capitalization, growth requirements, value and management structures when designing or investing in equities (Frankenfield, 2019; Chen, 2018; Nerd Wallet, 2012).
Fixed Income: refers to lending money to a company or government for interest such as loans (debt), bonds, and certificates of deposits. While fixed income is similar to cash in that it tends to be a low risk-low return investment, it is also classified by the investment duration and credit rating (Frankenfield, 2019; Chen, 2018).
Infrastructure and Real Estate: refers to property (i.e. bricks and mortar) where a return is made on the increased value or rental income generated. Infrastructure and real-estate may also be invested in when it helps to increase the value of other asset classes along that support supply chain development such as commodities (Frankenfield, 2019; Nerd Wallet, 2012).
Commodities: are tangible natural resource commodities that have an end use. For example agricultural products such as grain or metals such as gold (Nerd Wallet, 2012).
Alternatives: are investments that do not conform to the traditional financial securities including stocks, bonds or certificates. While other asset classes such as real estate and commodities are sometimes added into this category, they should be separated as they have their own unique features. Alternative assets therefore fall into two broad categories:
- things people collect such as art and antiques that are regarded as having value to the investor. This sub-classes tends to be illiquid and value can be hard to determine; and
- high finance such as private equity or hedge funds that give investors exposure a whole range of asset classes to balance risk (Chen, 2019; Zurich, 2019).

Why is it important to understand asset classes for investment attraction?

Understanding asset and sub asset classes allows governments and businesses to become more targeted in how they design investments and investors they engage with. The following offers a list of preliminary questions to help design and attract investment opportunities:

Investment design

How does the investor exit the investment?
How is the investment structured?
What are the standard industry/regulation terms?
How is the market performing overall in the asset class?
Where is the investment located?
what markets to you want to enter/expand into?
Are there any social or environmental goals associated with the investment?
What is the time horizon for the investment?
What time frame is the investor interested in?
Are there any tax advantages to the investment?
Is there a diversification element to the investment?

Asset classification

Which asset class is the investment in?
Can it be classified into a sub asset?
What is the risk?
How liquid is the investment?
What is the reward? i.e. valuation metrics such as earnings-per-share growth (EPS) or the price-to-earnings (P/E) ratio or growth – market size?
What is the market capitalisation (how big is the firm and its tradeable stock)
Is there an income stream?

Investor classification

Who invests in this asset /sub asset class?
Is the investor local, domestic or international based?
What scale of investment do they offer?
What other benefits does the investor bring? E.g. market assess/market knowledge/ growth knowledge
What level of involvement do you want an investor to have /do they want active or passive?

[1] In 2018 impact investment was worth six billion dollars in Australia (Uribe, 2018).