Investor appetite for impact investment can reach US$26 trillion

Impact investment must overcome key challenges like transparency and measurement and perception of low returns, according to extensive IFC report

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The global appetite for impact investment can reach as high as US$26 trillion in both public markets and private sources, states the International Finance Corporation (IFC) in a recently released study.

Titled “Creating Impact: The Promise of Impact Investing”, the report also said that as much as US$269 trillion being held by institutions and households is potentially available for investment and channeling 10% of this to impact investments can significantly help in the efforts to achieve the Sustainable Development Goals.

To achieve this, impact investment must overcome challenges such as proving that commercial returns are possible, bringing transparency to investment management, and improving the measurement of impact.

Impact investments aim to achieve measurable positive social and environmental impact along with financial returns. Impact investments are not defined by specific asset classes or risk and return characteristics, but more by the approach and intent of the investor.

According to the report, the private market has US$71 billion in AUM, while public markets include US$8.365 trillion in corporate engagement and shareholder action investment (mostly public equities) and US$456 billion in green and social bonds. The potential appetite for impact investment is “as high as US$26 trillion - US$21 trillion in publicly traded stocks and bonds and US$5 trillion in private markets including private equity, non-sovereign private debt, and venture capital,” said Philippe Le Houerou, IFC CEO.

But before this can become a reality, the industry must overcome four key challenges which the report highlighted.

First, there is continued uncertainty over whether impact investment can provide financial returns that are in line with non-impact investments. This perception of impact investment providing smaller returns still deters many potential investors. However, there is evidence that impact investment can provide commercial returns with the report citing IFC’s realized equity investments delivering returns in line with or better than the MCSI Emerging Market Index from 1988-2016 and competitive debt returns on JP Morgan Corporate Emerging Market Bond Index.

Second, there is a lack of clarity about how impact investments are managed which has given rise to concerns about “impact washing”, which affects the industry’s credibility. As such, standards should include investment strategies that link intent to asset selection, and an impact measurement system that ensures accountability by establishing targets, monitoring performance, and reporting impact results.

Third, there is limited comparability of measured impact since common approaches, metrics and conventions are not widely accepted. Several promising initiatives are emerging with three measurement frameworks being presented in the report.

Fourth, regulatory frameworks do not support investment managers who are seeking impact alongside financial returns. Fiduciary duty is often narrowly defined as only concerned with maximizing financial returns, so asset managers are often discouraged from pursuing additional objectives in their investment strategies.

The report provides several solutions to tackle these challenges. The IFC has developed the Operating Principles for Impact Management in concert with other development finance institutions (DFIs), asset managers and asset allocators in an effort to bring more clarity and discipline to managing impact investments. “Just as the Green Bond Principles helped avoid “greenwashing” – or deceptive environmental claims – the Operating Principles for Impact Management will help avoid “impact washing” and strengthen the development of this new market,” said Houerou.

Uniform standards for impact measurement frameworks would improve transparency and allow for better comparability of the effectiveness of impact investments. The IFC has identified three dominant frameworks such as impact rating, impact target and impact monetization. Initiatives are also being undertaken by firms like the Global Reporting Initiative to strengthen reporting so that investors can be provided with more information.

As scaling impact investment in private markets means unlocking institutional capital such as funds from asset owners, the IFC also urges regulators to reduce barriers faced by institutional investors interested in impact investment. This involves making changes relating to investment policy and disclosure and reporting. Fiduciaries should be allowed to include impact considerations in their fiduciary, reporting, and disclosure mandates.

The report is one of the most detailed assessments of the current state of impact investment and provides a good blueprint on how the industry can proceed.         

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Date

6 May 2019

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