Capital with a conscience: the continued rise of impact investing

Increasingly, investors are adopting responsible, ethical and sustainable investment strategies as they recognise some of the potential negative impacts of "traditional" investment approaches on society and the environment. Traditional methods of investing may prioritise short-term financial gain without fully accounting for potential long-term consequences on people and the planet. In response, many investors are shifting towards strategies that intentionally generate and measure positive societal and environmental outcomes while also realising financial returns, otherwise known as impact investing.

Impact investing should be distinguished from "ESG investing", which involves responsible, ethical and sustainable investments but differs significantly from impact investing in its approach and objectives. ESG investing primarily involves integrating non-financial factors –such as environmental performance, social responsibility, and governance practices – into the investment decision-making process. While ESG investing has the intention to avoid harm, it does not necessarily contribute to solutions; rather, it generally seeks to identify companies that manage ESG risks effectively and have sustainable business practices which are expected to yield financial returns over the long term.

On the other hand, impact investing takes a more targeted approach. It specifically seeks to invest in projects that aim to address the world's most pressing challenges alongside financial returns. Impact investors are deliberate in their focus and often develop theories of change to identify the path to reach their impact objectives and monitor and manage the performance of investments against those objectives. The key distinction here is that impact investing is inherently outcome-driven – it does not just focus on avoiding harm (as ESG investing often does) but actively seeks to create tangible and measurable benefits for society and / or the environment. While both strategies are part of the responsible investing landscape, impact investing is more direct and intentional in its pursuit, with clear and measurable outcomes tied to the investment's success.

Generating positive impact to address the world's most pressing challenges is crucial for impact investors, however, they also strive to achieve financial returns to ensure the long-term sustainability of the investment and enable a continuous cycle of capital deployment to impact. Impact investors have diverse financial return expectations or "financial floors". For example, some intentionally invest for below-market-rate returns, in line with their strategic impact objectives and others pursue market competitive or leading market returns, in many cases due to fiduciary legal obligations.

According to the Global Impact Investing Network (GIIN), impact investors who were surveyed for GIIN's State of the Market 2024 report noted that impact portfolio performance overwhelmingly meets or exceeds investor expectations for both social and environmental impact and financial return, in investments spanning emerging markets, developed markets and the market as a whole.

From a global perspective, the impact investing market now exceeds USD $1.5trillion and has been the strongest in the UK and the US. The UK, by example, has led the way in terms of scale for impact investing with a market value amounting to approximately £76.8 billion as of end-2023.

In the Australian context, the impact investing sector remains nascent, but growing. The total impact investment sector in Australia jumped from $30 billion in 2021 to $78 billion in 2023, a 260% increase in two years, and it is forecast to grow to around $500 billion in 2025.

Where to from here for impact investors in Australia

The expected exponential rise of the impact investment market in Australia presents a significant opportunity for investors interested in aligning their financial goals with addressing the globe's most urgent challenges, with, in some instances, financial and policy support from the Australian Government.

Investors, investees, financiers and intermediaries looking to get involved in impact investing should consider the implications of this trend in light of their own business models, and also track how impact investing is being adopted in the market to leverage co-investments with other participants in the impact investing space, and with Government. For example, businesses and foundations looking to increase their social impact for vulnerable cohorts should be aware of the Government-supported Social Enterprise Development Initiative (SEDI) which is offering one-off grants valued at up to $120,000 to assist with impact investing.