The allure of Impact-first investing

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As clients increasingly commit money to make a positive impact on society, “impact-first investing,” which puts social and environmental benefit ahead of financial return, is a logical next step for philanthropically inclined individuals and families looking for a way to make a difference.

But they’ll need help from financial advisors, many of whom are already helping those same clients with ESG and impact investment funds, which have soared in popularity in recent years.

It’s a trend that’s likely to continue: Campden Research predicts that private wealth-holders will increase their average portfolio allocation for impact investing from 20% in 2019 to 35% by 2025. Given this, offering impact-first options is a good opportunity for financial advisors to deepen their relationships with socially minded clients.

Impact-first clients seek to invest in enterprises with high-impact potential that are unattractive to conventional investors because those enterprises are too early-stage, risky, expect to generate only modest returns or require a longer investment time horizon, explains the Catalytic Capital Consortium. Impact first doesn’t mean, as some fear, bad investing, or that a client doesn’t care about returns, just that the returns that matter most are measured in lives changed — financial gain takes second billing.

The need has never been greater. The social and economic toll of COVID-19, plus heightened concerns about climate change, racial injustice, income inequality and gender discrimination, have injected fresh urgency into the quest to direct capital to some of society’s biggest problems. To date, however, only a tiny amount of private wealth flows to the impact-first investments. The Global Impact Investing Network pegs impact-first investing at only 7.5% of the $47 billion in new impact investments made in 2019.

While high-net-worth individuals and families are in the habit of making major donations to nonprofits, their investment mindset typically defaults to traditional practices focused on the primacy of growing wealth. For the most part, ESG and impact investing funds accommodate this goal by emphasizing market-rate returns. Impact-first investing differs by declaring social or environmental benefit paramount while accepting less than market-rate returns. Unlike grants, however, impact-first investments aim to return capital, often with at least a modest profit that can be recycled for future impact investments.

There’s no shortage of impact-driven opportunities. The Global Entrepreneurship Monitor reports that thousands of impact enterprises have taken root around the globe, led by entrepreneurs determined to find new ways to deliver social and environmental products and services, especially for low-income and marginalized communities.

For instance, impact-first investors helped launch d.light’s home solar products business in developing nations and AeroFarms’ vertical indoor agriculture operations in the United States. Both concerns needed patient, risk-taking capital in the early days when traditional investors saw more risk than reward. Both have now graduated to more traditional forms of investment.

DAF-ready
Increasingly, donor-advised funds (DAFs), the most popular charitable investment vehicle in the United States, enable both philanthropic giving and impact investing. Total DAF grants in 2019 exceeded $27 billion. Meanwhile, DAF sponsors invest unallocated money, currently exceeding $140 billion, on behalf of the donors.

It’s now easier for DAF donors to channel that money into impact-first enterprises. For example, DAF sponsors Impact Assets, RSF Social Finance, and the Tides Foundation already provide donors a relatively straightforward on-ramp to impact-first investing.

Most DAF sponsors, however, don’t have the staff or expertise to source and vet impact investing options for donors. CapShift, which teams up with DAF sponsors to identify and screen potential impact investments, saw this as a business opportunity when it launched two years ago. Currently seven of the nation’s largest DAF providers, including Fidelity Charitable, National Philanthropic Trust, Chicago Community Trust and Vanguard Charitable, partner with CapShift to provide impact-first investing options.

Wealth-holders who already support community nonprofits with their philanthropic dollars might also consider putting money into community development financial institutions (CDFIs). These organizations grew out of the civil rights era when redlining and other discriminatory practices had left many communities underserved by traditional finance.

Today, more than 1,000 CDFIs dot the United States, managing over $150 billion. They most commonly make low-interest loans, typically on concessionary terms, which may include lower interest rates than conventional loans, a longer payback period, or grace periods. Others make direct investments in businesses owned by women and people of color. Many CDFIs have begun to make it easier for individuals to invest.

If impact-first means leaving returns on the table in exchange for social or environmental benefit, it’s a tradeoff worth making — and your clients might agree. There’s never been a better or more urgent time for wealth-holders to make impact-first investing an option for putting money to work for social change.