Impact investing represents a continuation of Canada’s ongoing commitment to social finance, an “approach to mobilizing private capital that delivers a social dividend and an economic return to achieve social and environmental goals”, as defined by the Government of Canada. The rapid growth of impact investing is driven largely by investor demand for addressing the social and environmental impact across various asset classes, according to a report released by the Responsible Investment Association (RIA) earlier this year (RIA Report).
The term “impact investing” was first coined in 2007 by The Rockefeller Foundation and is often described as “investments intended to create positive impact beyond financial returns”, as defined in a research note published by J.P. Morgan Global Research.
The recent popularity and traction of impact investing is driven by factors including an increase in customers and other stakeholders of public and private companies demanding sustainable business practices from businesses; the diversification of non-profits and charities’ revenue sources away from traditional sources such as donations and grants; and an increasing number of investors seeking to align their personal values with their approaches to investing.
According to RBC’s social finance white paper (RBC White Paper), impact investing is often explained as being situated across a continuum of investment approaches, with traditional investing on one end and venture philanthropy on the other end. Impact investing is distinguishable from socially responsible investing (SRI) and responsible investing (RI), investment approaches that generally seek to minimize the negative social and environmental impacts of investments by incorporating an analysis of a business or an asset’s environmental, social and governance (ESG) performance into the investment decision-making process rather than proactively investing in businesses and assets that create positive social and environmental benefit.
The most important distinction between impact investing and other investment approaches such as traditional investing, RI, SRI and/or venture philanthropy is the intention and expectation of investors to seek both a measurable social and environmental impact and a financial return. Due to the myriad of investors who engage in impact investing, the expectations of financial return from investors also range from return of capital to market-competitive to market-beating returns. Beyond providing financial statements to investors, it is common for asset managers and advisers to measure and report the social and/or environmental performance to ensure accountability to investors.
The RIA Report revealed that the impact investing industry grew from $8.15 billion to $14.75 billion in Canada between 2015 and 2017. This significant growth has been attributed to increasing awareness and interest in social and environmental impact from asset managers and retail investors. In particular, public equity has captured considerable engagement, and at the end of 2017, represented 41% of reported impact assets under management (AUM). This is a departure from the concentration of impact investing in private equity and private debt historically. Respondents to the RIA Report, being predominantly asset managers and asset owners, believe that the increase in public equity carries with it the opportunity to “democratize” impact investing, making it more accessible to a wide array of Canadian investors.
More than ever, investors are prioritizing intentionality and magnitude of impact above asset class allocation. Similarly, investors and asset managers are moving past integrating ESG factors in their decision-making toward specifically targeting assets that have positive social and environmental outcomes at their core. The RIA Report notes that although a part of the increase in impact AUM may be attributable to the appreciation in the valuation of the underlying assets, it is safe to assume that significant inflows of net new capital contributed to impact investing strategies.
As impact investing continues to be a relatively young and immature industry, the top barrier to growth is the lack of high quality investment opportunities with operating history. Investors identified business model execution and management as a primary source of risk to their impact investment portfolios. Another challenge is the measurements and reporting frameworks of impact investment being too fragmented, complex and non-standardized.
Notwithstanding its stage of development and current challenges facing the industry, 98% of investors reported that their impact investments met or outperformed their expectations and expect impact investments to continue to grow. As the impact investing market continues to grow and reach maturity, investors are likely to adopt existing impact measurement metrics such as Impact Reporting and Investment Standards (IRIS) or UN Sustainable Development Goals (SDGs) as an agreed upon common language to measure impact, service providers and intermediaries are likely to continue to hone their expertise and qualifications, and asset managers will likely continue to increase the depth of their service offerings and related products.
Kelly Gauthier, board member of RIA and the Managing Director of Impact Advisory at Rally Assets, noted that retail and institutional investors increasingly want to drive positive social and environmental change with their investments regardless of whether it is coined “impact”, “responsible”, “sustainable” or otherwise. The investors’ objective remains that they demand investment opportunities that deliver financial returns and social and/or environmental impact.
Impact investing is experiencing rapid growth in Canada and is an up-and-coming investment approach which Canadian investors and asset managers would do well to understand.
The author would like to thank Lila Yaacoub, summer student, for her assistance in preparing this legal update.
Stay informed on M&A developments and subscribe to our blog today.