Morningstar - Q3 2021 - 42

Spotlight: Integrating ESG
Financing Solutions
How impact investing aims to drive better
outcomes for people and the planet.
Megan Wallingford
IMPACT
Investing for the purposes of generating positive
social and environmental impact has long been an
important motivation for responsible investors.
Once regarded as a niche investment approach
mainly employed by philanthropists, governments,
and community-focused organizations, impact
investing has grown in significance over the
past decade-both as an investment strategy and
as a way to finance solutions to social and
environmental challenges.
A recent study conducted by the Global Impact
Investing Network found that assets in impact
investing grew to $715 billion globally in 2020 from
$502 billion in 2019. As the awareness of global
challenges such as climate change and access to
basic services increases and as more countries
adopt global initiatives such as the United Nations'
2030 Sustainable Development Goals and the Paris
Agreement, we anticipate this steep growth in
assets will continue. Impact investing is a vital tool
for closing the financing gap, which the U.N.
estimates to be $2.5 trillion annually on average,
to achieve global sustainability goals.
What Is Meant by Impact?
Every company offers goods or services that have
tangible benefits-whether economic, social,
or environmental-for consumers, governments,
other businesses, or society. In addition to
generating benefits, companies also create social
and environmental costs. In economics, these
benefits and costs are referred to as externalities-
they are created by one entity but internalized
or imposed on another. Take, for example, a
factory that releases pollutants into the air during
42
Morningstar Q3 2021
its manufacturing process; these pollutants
reduce air quality and may have a detrimental
impact on the health of a local population,
raising the rate of respiratory illnesses. This
detrimental health impact is a negative externality
created by the company but imposed on
the local community. In sustainable investing,
externalities are referred to as impacts.
What Is Impact Investing?
An impact-focused investment approach is a
strategy that seeks to drive positive social and
environmental impacts while generating financial
returns. Impact investors hold positive impact
as a primary investment objective, seeking
out investments that create measurable, real-world
social or environmental outcomes. At the core
of an impact investing approach is the capacity
of investors to not only commit to or signal
their intent to generate impact but also to
measure, monitor, and communicate how their
investments contribute to a positive outcome.
ESG Impact-Focused Investor
What is the impact of my investments
on the environment or society?
most investors engage in impact investing because
they see an opportunity to generate meaningful
financial returns alongside positive impact.
In fact, in its 2020 annual survey, the Global Impact
Investing Network found that 67% of impact
investors seek risk-adjusted market-rate returns,
and 88% of these investors reported meeting or
exceeding their expectations.
Myth 2: Impact Investing Is Limited to Certain
Asset Classes, Such as Private Equity
Impact investment strategies can be employed
across a wide range of asset classes. While
traditionally, development finance and private
funds have dominated the impact market,
impact investors are increasingly also investing
in public markets. According to a 2020
International Finance report, public market impact
strategies are dominated by investments
in green, social, and sustainability bonds (where
bond proceeds are dedicated to achieving
certain sustainability outcomes) and by
public equities with shareholder-engagement
strategies that target impact outcomes.
Myth 3: Impact Investing Is Subjective, and
Impact Claims Can't Be Substantiated
Credible impact investors not only develop and
communicate a core thesis for how their
investments contribute to impact goals, but they
also measure and monitor their investments'
impact performance just as they would financial
performance. A core tenet of impact investing
ESG Risk-Focused Investor
What is the impact of the environment
or society on my investments?
There are three common myths about impact
investors and their strategies:
Myth 1: Impact Investors Are Willing to Forgo
Financial Return
While return expectations may vary from
below-market to risk-adjusted market-rate returns,
is that investors must be transparent about their
objectives and have a measurement system
in place to connect their intentions with real-world
outcomes. Although impact measurement is a
rapidly developing field that faces some challenges,
credible impact investors use evidence and
data to drive their decisions.

Morningstar - Q3 2021

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Contents
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