Important Considerations Before Replacing Philanthropic Contributions with Impact Investing

Impact investing, an investment approach that aims to generate specific positive social and/or environmental impacts, while seeking some level of financial return, has been a hot topic and is not a new subject for family offices which play an important role in its growth. Additionally, impact investing has significant appeal among younger generations, such as Millennials, who have an increased desire  to push for environmental improvements or social changes that align with their personal values. This momentum is likely to increase as Millennial investors gain market influence. This article takes a look at what impact investors do, takes a deep dive into impact investing and discusses important considerations when thinking about replacing philanthropic contributions with impact investing.

What Do Impact Investors Do?

Impact investors set goals and deploy capital at financially viable businesses that have clear, defined and measurable social and/or environmental benefits, while expecting their contribution to also result in financial returns alongside largely non-quantitative outcome targets.

A Deep Dive Into Impact Investing

As wealthy individuals are increasingly drawn to the excitement of impact investing, outlined below are some challenges of this investment approach to take into consideration:

1. It can be difficult for an impact investor to distinguish each potential investment’s social and/or environmental merits. While quantitative data can and does provide information for environmental issues, social issues are harder to quantify, and progress measurement is difficult.
2. For the same reason as above, though benchmarks for measuring the performance of impact investing have improved, coordinating an industry standard is difficult due to subjectivity. Independent investment analysis continues to be heavily subjective and dependent on who is doing the assessment of a given investment.
3. Impact investors may face trade-offs in decision making between socio-environmental and financial return for a particular investment. Of course, while investing is about risk-adjusted returns, impact investing takes on a different lens, and the investor should already be willing to forego, if needed, some amount of financial return in order to promote a specific social and/or environmental goal. The point is that discretion is again solely up to the impact investor to allocate between impact and market returns, hence a risk of capital misallocation for impact if impact investors prioritize market returns in order to satisfy return goals.
4. Lastly, impact investors need to be wary of putting money into investments that claim to generate social and/or environmental benefits, when in fact it is purely a branding exercise to attract funds, as ultimately companies have the responsibility to maximize profits for shareholders.

In brief, impact investing is still a powerful tool to effect meaningful change in key social-environmental matters, including the climate crisis, economic inequality, gender disparity, racial injustice and more. Nevertheless, from having appropriate investment options across the risk spectrum to standardizing regulatory views and impact indicators, impact investing continues to face challenges today.

Given its challenges, it may be best to consider a combination of impact investing and philanthropic contributions.  Impact investing can help to drive companies to positively evolve by influencing their investment decisions.  Philanthropic contributions, on the other hand, can perhaps better align with investors’ overall financial plans by making direct donations using their investment income while supporting specific causes that are in alignment with their personal values. Both impact investing and philanthropic contributions share the same goal of attempting to make the world a better place.

This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.