Impact Investing: How Socially Responsible Investing Has Evolved

There is a growing realization that, along with government aid and charitable philanthropy, financial institutions can help solve some of the world’s social problems. Over the past decade, there has been significant growth in socially responsible investing. Just as the formation of the venture capital industry ushered a new approach to funding the private sector, impact investing is attempted to harness the finance industry to bring social improvements.

Ideally, impact investments delivers something good for humanity while generating a financial return with limited downside risk. As socially responsible investing continues to grow, investors have flocked to companies and assets that hold similar values to themselves. This can include investments towards climate change, alleviating poverty, increasing education or anything which makes progressive social strides. Traditionally, responsible investing avoided stocks which promoted vices such as tobacco and alcohol. However, as the industry has evolved, financial institutions have created funds which now actively promote and track sustainable practices.

Socially Responsible Investing

In general, socially responsible investing creates quantifiable social change while also generating modest financial returns. These investments positively impact a variety of sectors by providing access to critical goods and services to develop impoverished areas. In particular, millennials are more attracted to impact investing and consider social responsibility an important factor when investing their money.

While a return on capital is important, responsible investing typically incorporates three major components: intent on achieving measurable change, shareholder activism, and participating in community investing. Investments can often replicate traditional asset classes, including mutual funds, ETFs, and bonds. As investors have become more socially conscious, trillions of dollars have been poured into ethically aware funds.

ETFs & Mutual Funds

As an innovative financial instrument, impact investing not only provides an alternative and uncorrelated means to traditional securities, but also offers measurable solutions to critical social challenges. Over the past few years, an increasing amount of ETFs and mutual funds have been created that specifically target socially responsible companies.

This approach doesn’t directly fund development projects, but changes value as any other asset would. In particular, mutual funds have become one of the most dynamic segments within sustainable investing and have collectively grown to over $2 trillion in assets. To ensure a fund completely adheres to a specific goal or values, stocks are chosen that hold high moral standards and good corporate citizenship. Many mutual funds will partition a portion of the fund towards community investing, which allows for direct investments into community based organizations.

Social Impact Bonds

While socially responsible investments tend to come in the form ETFs and mutual funds, fixed income has begun to embrace this trend in the form of social impact bonds. Like a normal bond, social impact bonds are a mechanism the government or public sector can use to fund critical social programs. In the social impact model, the private sector works with governments and philanthropies to develop programs with measurable social benefits.

In this relationship, investors only attain financial returns if and when improved social outcomes are achieved. At the moment, many large foundations and banks have supported impact investing, including The Rockefeller Foundation, J.P. Morgan Chase (JPM) and Goldman Sachs (GS).

In 2012, the United States launched the nation’s first social impact bond in an effort to reduce recidivism in penitentiaries on Rikers Island. The program combined the efforts of several organizations, including Goldman Sach’s Urban Investment Group. In order for investors to receive payments, recidivism must have fallen by at least 10 percent, and subsequently in the two years of the program’s existence re-incarceration rates fell 17 percent.

Diaspora Bonds

Some investors may find it difficult to invest in a country which they have no connection to. For that very reason investment vehicles exist in which expatriates can help support their home countries develop infrastructure or manage debt. Many developing countries rely heavily on remittances and foreign direct investment as sources of funding.

When this isn’t readily available, it can be difficult for developing countries to raise capital due to minimal financial credibility or political instability. Given the circumstances, countries can issue diaspora bonds as a means to raise low cost capital through patriotism. Expatriates are more likely to purchase long term and low yield securities in an effort to help their home countries succeed. In the past, India and Israel have successfully issued diaspora bonds as a means to reconcile balance payment deficits and provide assistance following disasters.

While India and Israel have been successful in reaching their diaspora, Ethiopia has been unable to utilize its expatriates as a financial resource. Nevertheless, tapping the patriotic nature of expatriates may prove to be an important introduction for countries into the foreign debt market.

In this day and age, the old adage “Greed is Good” doesn’t reign supreme as it once did. Young investors are no longer driven by profits, but rather creating impactful social and environmental change. Through socially responsible investing, investments in the form of ETFs and mutual funds can be made in companies which address social change. Fixed income has also embraced the trend with the emergence of social impact bonds and diaspora bonds. As millennials age and come into more money, the future of sustainable investing will prove to have a greater impact on society.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Trevir Nath

Trevir Nath graduated in 2011 from Rutgers University with a Bachelors in Economics & Psychology. His Psychology and Economics degrees increased his understanding of financial markets from a human behavior perspective. Looking to further his understanding of financial markets, he went on to obtain his Masters in Economics from the New School graduating in May 2014. He currently writes about personal finance, investing and its interaction with technology. His work also appears for numerous financial websites including Investopedia.

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