Impact Investing
/Impact investing is a broad term that means different things in different sectors. However, in philanthropy, it is most commonly used to describe ways of using investable assets — not grantmaking* — in ways that advance the social or environmental goals of the donor or foundation while still generating a financial return on those investments.
Impact investing can take many forms, from putting your money in a socially responsible mutual fund to directly investing in businesses that you believe will positively impact communities or the planet. Some forms of impact investing are easy and accessible, and some require sophisticated investment savvy along with considerable advice from legal, financial and program advisors. Impact investing is not new to philanthropists, but it is increasingly popular as a strategy to put more money into the service of philanthropic goals.
Big foundations sitting on huge endowments can make a major impact when they choose to invest their endowments in ways consistent with their charitable missions. But you don’t have to have a massive endowment to make an impact through your investments. Just as it is true that many small donors can collectively make a big impact with their giving, investors of all sizes shifting their assets into impact investing could be transformative.
What are the main types of impact investing?
Impact investing is sometimes described as a continuum, mostly from least labor-intensive to most complicated. But all of the general areas below can be more or less complicated. They can overlap with one another or have complimentary or coordinated features. Or they can be pursued discreetly with different sets of assets.
Loans to nonprofits. One of the most common forms of impact investing involves providing loans to nonprofits — usually at below-market rates. This can allow the nonprofit you may already support in your grantmaking to expand its services, build new facilities, or simply make it through a short-term period as it awaits funds from a government contract, and to do so at a reduced cost to the nonprofit while still providing the funder a low-risk and reliable return on investment.
Some lending initiatives have the potential to do a lot of good for society, but they are too risky for conventional investors, or they are in areas where capital does not tend to flow as voluminously. The MacArthur Foundation has been impact investing since 1983, and one of its strategies is below-market loans to increase capital for initiatives that align with their philanthropic priorities, such as creative placemaking in their home base of Chicago or innovative climate solutions in India and the U.S. The California Endowment, a foundation focused on health and healthcare, makes program-related investments in the form of long-term loans to community-based nonprofits working on things like access to health services and healthy food.
Direct investments in Socially Beneficial Businesses. Investing in small or new enterprises that are making — or have the potential to make — a positive impact on the issues at the core of your social change concerns are becoming more common among foundations and funding intermediaries. You can find opportunities to invest directly in companies that are doing good work in an area you care about, from solar companies to builders of affordable housing. If social justice and equity are priorities for you, you might directly invest in BIPOC- or women-led companies. You don’t have to be an ultra-high-net-worth angel investor to do this. Some companies — especially smaller or newer ones — offer investment opportunities at a range of levels.
Loans to nonprofits and direct investments in socially beneficial businesses are the strategies that most donors talk about when discussing impact investing. But many donors also consider invest/divest strategies in traditional financial markets as a core component of their impact investment portfolio.
Divestment. Screening out investments in industries or businesses that have a deleterious effect on the social or environmental conditions of concern to the donor comprise one of the easiest impact investing strategies for funders to wrap their heads around. For instance, many institutions are divesting from fossil fuels — or facing pressure from students or other stakeholders to do so. Others are removing from their investment portfolios any companies profiting from the “prison industrial complex.” By divesting from things you don’t want to support and investing in things you do, you can align more of your money with your values. Recent news coverage of the politicization of “ESG” — investing that takes into account the environmental, social and governance challenges facing corporations — shows the growing attention to this approach.
Socially Responsible Investing (SRI). On the positive side, most impact investing involves putting resources into industries or companies that are doing good, such as companies working in renewable energy or companies that have a demonstrably strong track record of diversity, equity and inclusion, labor standards, gender advancement, LGBTQ-welcoming workplaces, etc. SRI generally refers to the usual investing practices in financial markets, but with a screening-in process to invest in companies doing positive things. You can align how these funds are invested with your philanthropic vision or mission, also known as mission-aligned investing. Socially responsible investing is an umbrella term that also covers loans to nonprofits and direct investments in socially beneficial businesses described above, but because those terms describe more complex impact investing practices and are more specific, SRI usually refers to investments within traditional financial markets.
Pros and Cons
Risk/Return. Like any investment, all impact investing involves some degree of risk and variable rates of return. Of the types discussed above, making loans to nonprofits is at the lower end of the risk spectrum, but also relatively low on return (and arguably, impact).
For a long time, there was a general perception that impact investments would surely produce a lower-percentage return on investments than conventional investing, which led to concerns that pursuing impact investing might violate foundation leaders’ presumed mandate to continuously grow assets. Those concerns have abated somewhat because (1) the IRS ruled that foundation stewards can reasonably act to advance mission over preserving asset growth and (2) many studies have shown that impact investments can produce respectable, sometimes even winning returns.
According to the Global Impact Investing Network, more than 88% of impact investors reported that their investments met or exceeded their expectations. According to recent Barron’s coverage of the solid returns of impact investing, “Private-equity impact investments, for instance, can deliver high returns, outperforming the S&P 500 index by 15%, according to a study by the International Finance Corp., although a University of California study found the median impact fund had an internal rate of return (IRR) of 6.4% compared with 7.4% for the median ‘impact-agnostic’ fund.”
Things like directly investing in a small renewable-energy company are typically higher-risk than choosing an SRI mutual fund for your DAF assets. Think about how much risk you can tolerate and find an impact investing strategy that matches your risk tolerance.
Time and Effort. Any of the strategies outlined above require some time and effort to manage, and the more strategic and thoughtful you are in your impact investing, the more time and effort will be required to get it right.
This is also associated with the challenges of getting the right advice on impact investing.
According to Rockefeller Philanthropy Advisors, “Many financial advisors lack expertise in the social aspects of impact investing. At the same time, many philanthropic advisors lack expertise in making financial investments. A new breed of advisors with experience in blending philanthropy and investment (as well as related legal issues), although growing, is only just emerging. Thus, it can be difficult to build a team with the requisite expertise in both impact and financial return.” And, it says, this also relates to the challenges of identifying good impact investing opportunities and the lack of “deal flow and strategies.” RPA says, “The supply of investment opportunities offering scale, impact and financial return sometimes falls short of demand. As a result, impact investors can experience frustration finding deals that fit both their investment criteria and their philanthropic orientation.”
Board Concerns about Asset Growth. Most foundation boards want their institution to continue long into the future, and many individual donors also want to see their charity-designated assets at least maintain their value to preserve maximum giving potential. Since private foundations must by law distribute 5% of assets each year and investment growth of even normal “impact-agnostic” investments average around 7.5% growth, that doesn’t leave a lot of wiggle room to maintain or grow the corpus. Because of this general concern, many boards are reluctant to experiment with investments that might not provide the maximum return. Many foundation boards view their primary responsibility as ensuring consistent levels of grantmaking, which is inextricable from asset maintenance. Still, arguments for the large societal good that can happen with impact investing, combined with convincing research that impact investments can also provide returns that maintain the corpus, are slowly making headway among many boards. You can dedicate all or a portion of your invested assets to impact investing. It doesn’t have to be all or none — you choose what’s right for you and your values and goals.
Taking Action
There is no rulebook for impact investing, but you may want to start with a few of the easiest options. You could:
Move your assets to SRI or ESG funds. One of the easiest ways to get into impact investing is to switch to SRI (socially responsible) or ESG (environmental, social and governance) mutual funds. At this point, most standard investment fund managers have an SRI or ESG option. This is usually a broad fund that screens out “sin” stocks like those of companies profiting from weapons, tobacco, alcohol and gambling. Some also positively screen for companies that are doing good, such as companies that have a strong track record on gender equity or that are working on renewable energies. You can also put your assets in bonds for things like sustainable infrastructure or community development. To move your assets into an SRI or ESG fund, a community-focused bond or the like, contact your fund manager and ask about socially responsible investment options.
Consider more tailored funds. If you want to align your investment strategy even more closely with your philanthropic mission, you can look for funds specifically designed to make a positive impact in an area you care about. There are “green” mutual funds dedicated to being fossil-fuel-free and investing in sustainable businesses. Or you might choose to invest in Black-led or women-led funds. There are lots of options out there to align your investments with your values.
Place your DAF at an institution that aligns with your philanthropic priorities. Community foundations professionally manage the investments of all assets held there, and they usually offer a few portfolios account holders can choose from. So if your philanthropic priority is to advance LGBTQ equality, you might put your DAF at an LGBTQ community foundation that has socially responsible investment options, including funds that prioritize LGBTQ equality. Not only will you have access to a professionally managed fund that has been designed to prioritize investments in an issue you care about, your investments will also be pooled with other donors’ assets, increasing your collective impact.
Beyond putting assets into SRI or ESG mutual funds and the like, there are a number of other ways to invest for positive impact. These require various degrees of investing savvy or professional support.
You can make donations to impact investing nonprofits, such as groups that invest in social enterprises or finance community development. In this case, you’re not actually doing the impact investing — you’re making a donation — but the recipient organization will use the funds to engage in impact investing, with returns being recycled by the nonprofit into new investments. There are also nonprofits working to expand and support the field of impact investing through research, scaling the impact-investing infrastructure, and more. You can make donations to these, too.
Create an impact investing strategy. If you have a foundation, you may want to create a custom impact investing strategy for your endowment. You don’t have to start from scratch. Philanthropy-serving organizations like the National Center for Family Philanthropy have templates, and many PSOs host webinars, panel discussions and the like where you can learn more about impact investing. If you are creating an investment strategy and policy, you will probably also want to work with investment professionals.
Consider working with a professional who can offer expert advice and guidance, whether that’s a consultant investment manager or the staff at the institution where your DAF is held. There are also several funder groups that have considerable expertise in this area and can help funders with specific impact investing interests connect with other funders who share those concerns. They include: Mission Investors Exchange, Confluence Philanthropy and Global Impact Investing Network.
*Funds budgeted for grantmaking may also be used by private foundations as investments that can provide a financial return — called program related investments — and must meet IRS criteria of having the primary purpose of accomplishing one or more of the foundation’s exempt purposes. This brief does not examine PRIs, but rather how the corpus of a foundation or donor’s charity-designated assets are directed to advance their charitable mission while continuing to produce a financial return.
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