Impact investing: key considerations for new investors

Traditional investment ventures, which prioritise profits and have limited regard for social outcomes, have driven the investment landscape and shaped Australian regulatory frameworks and business culture. 

In contrast, impact investments aim to address specific environmental or social problems, with impact investors often having regard to the 17 Sustainable Development Goals adopted by the United Nations Member States when formulating their strategies.

A recent trend towards impact investments globally has seen more investors becoming active and increasing their impact investment allocations in terms of dollar amount and number of investments.[1]

While impact investment options have traditionally only been available to wholesale or sophisticated investors in Australia, this is expected to change as the market widens to offer options for participation by a broader range of investors to achieve various impact objectives.

Below, we outline some of the key issues those exploring impact investments need to consider, including navigating increasing media and government focus on impact investing, the competing objectives of investment participants, measuring impact and identifying key risks.

Market snapshot

In 2018, the global impact investment market was only worth approximately 0.5% of total global financial stock. However, in response to increasing investor demand and societal challenges, it is expected to be worth an estimated US$1 trillion by 2024.

Globally, 56% of investors target both social and environmental outcomes, 36% target only social objectives and 7% target only environmental objectives. This contrasts with the small range of social impact investment products available in Australia, and highlights the opportunity for growth in the Australian social investment space.

Globally, two thirds of impact investment products are managed by specialist impact intermediaries. As the impact investment market grows in Australia, so too does the emergence of specialist impact fund managers and other intermediaries.

The Australian impact investment market has similarly undergone significant recent growth. In 2018 and 2019, the total value of impact investment products widely offered to Australian investors rose 249% to $19.9 billion, and the total number of impact investment products rose 118%.

Some recent examples of impact investments in Australia include:

• the Newpin Social Benefit Bond, a partnership between the New South Wales Government and UnitingCare Burnside and Social Ventures Australia, which aims to restore children in out-of-home care to the care of their parents by creating and supporting safe family environments;
  
  
• the funding and marketisation of specialist disability housing under the National Disability Insurance Scheme; and
  
  
• the Australian Farmlands Fund, an investment fund established by Kilter Rural to purchase and develop farmland and water assets in the southern Murray-Darling Basin with the aim of delivering more sustainable and resilient crops.

Of the total value of Australian impact investments, 87% comprise products targeting environmental outcomes, while the remaining 13% comprise products targeting social outcomes.

Although this is a significant increase from the social impact investments reported in 2018, there remains an under-representation of investment products targeting social outcomes.

Impact investing in sharp focus

Against this backdrop, the events of recent years including the COVID-19 pandemic and the 2019/20 Australian bushfires have left many reflecting on and seeking opportunities to align their values with their daily decisions and activities.

While interest in impact investments has already been steadily increasing, these recent events may accelerate interest in these investments as a means by which investors can express their values and drive social change and public policy outputs.

Media trends and investor expectations have also put into sharp focus the need for corporate boards to protect their down-side exposure in an uncertain and impact-focused business environment. Shareholders are increasingly interested in understanding the societal impact of their investment decisions in addition to focusing on risks and returns.

Governments, who often seek to target social issues that concern voters, are also contributing to the focus on social impacts by prioritising positive social outcomes in the course of their procurement and stimulus processes.

Measuring impact  

Impact investors often seek authenticity and a focus on impact at each stage of the investment process to ensure that the investment sustainably targets specific issues and changes the status quo.

The ultimate impact of the investment may only be evident and measureable years after the investment decision is made. However, investors often spend time identifying their objectives at the outset of an investment, including:

• the issue the investment is seeking to address;
  
  
• what is to change because of the investment activity;
  
  
• priority outcomes; and
  
  
• what success looks like and how it can be measured.

Once objectives are identified, an investment team can be briefed to ensure continuity in the investment process. Any additional impact ‘value-adds’ available through the investment process can then be identified.

Lawyers acting on an impact investment must ensure that all legal documentation and processes are consistent with the identified objectives. If the objectives involve social inclusion, this may include ensuring that the legal documentation:

• contains non-binary language;
  
  
• is consistent with the objective of social inclusion; and
  
  
• allows for data to be collected in order to track progress during the course of the investment and measure its ultimate impact.

A different view on risk

Impact investments often require a different approach to risk compared to traditional investments. This is because:

• it may be difficult to value aspects of the transaction risk (e.g. the value of failing to meet impact objectives);
  
  
• the success of one transaction party may be linked to the success of other parties or may impact the investment objective more broadly;
  
  
• some impact investments are exposed to valuation and pricing risks due to their new or unique attributes; and
  
  
• the provision of financial security in relation to key contractual risks may not be satisfactory where a failure to comply could impact the impact objectives.

Framing key risks in the context of the broader impact investment objectives can assist in developing robust mitigation strategies to avoid negative impacts on those objectives and the financial viability of the venture.

It may also be appropriate to discuss risk mitigation strategies openly with the relevant transacting parties. A coordinated risk mitigation strategy can help to ensure that impact and financial risks are identified and managed by the appropriate parties. Further, the emergence of bespoke investment intermediaries with limited experience is expected to require a focus on targeted due diligence and risk mitigation strategies.  

Competing objectives

Those exploring impact investments should consider the differing objectives of all investment participants, as these may not always align, leading to tensions that need to be managed in the design and operation of impact investment ventures. Some participants will be required to maximise investment returns, while others – such as benevolent organisations and governments – may be more focused on impact outcomes.