How to take ethics to the next level

Impact investing is making waves off the back of broad acceptance of ESG principles, but the strategy has a long history and bright future.

Over the past year, impact investing has gone from being a relatively obscure strategy pursued mostly by international NGOs to being adopted by large asset managers and becoming the subject of some major research reports.

According to research by the Global Impact Investing Network, “private debt or fixed income instruments comprise the largest asset class in impact investing, accounting for 34 percent of impact investors’ reported assets under management”.

While impact investing has been around for a long time, it has often been overshadowed by environment, social and governance investment principles, with the ESG concept becoming a major part of the way many fund managers now operate.

But the impact investment community believes the two are very different. While ESG aims to “do no harm” by avoiding investments in morally questionable areas like polluting industries and weapons manufacturing, impact investing actively seeks to invest in activities that offer a social good.

Whereas ESG has become well-established and well-defined, impact investing suffers from a lack of definition, industry standards and benchmarking, which has held back its development.

“One of the challenges is defining what impact is, and we need to have reporting in place that demonstrates you have achieved your impact goals,” says William Nicoll, co-head of alternative credit at M&G.

Abhilash Mudaliar, director of research at GIIN, agrees that defining impact investment will be crucial to its growth in the future, and it is something his organisation is working on. “We currently have a project to better define impact investing, consulting with our network of impact investors to define standards and provide investors with ways they can measure the impact their investments have achieved in a standardised fashion,” he explains.

Mudaliar is also confident that the concept of impact investing will be assimilated into the investment community more rapidly than ESG was once it is precisely defined and firms are able to benchmark it.

“Impact investing can ride on the success of ESG, which has seen a shift in norms and values around the world towards more ethical investing,” he says.

Why debt?

Debt asset classes are currently the largest within the impact investing sector, partly due to historical factors.

The origins of impact investing lie in groups that invested in microfinance institutions in the developing world. One such example is BlueOrchard, originally founded in 2001 as an initiative of the United Nations to boost growth in the developing world. To date, it has disbursed more than $5 billion to 35 million people across more than 80 countries.

BlueOrchard CEO Patrick Scheurle says the focus on microfinance and links to global NGOs like the UN are key reasons debt has been a major driver in the development of impact investing. “A lot of microfinance institutions were originally structured as NGOs, so there simply was no equity to invest in,” he says. “While many have now turned into regulated banks, they are still run with a social mission.”

Marina Parashkevova, research team leader at impact investor Symbiotics, says risk is also a key factor in how investors choose to access the strategy.

“In general, private credit is the most secure way for investors to access impact investment, especially in emerging and frontier markets,” she explains. “Debt has lower associated risks than equity with more stable returns and a fairly short investment lifetime of between three and four years.”

This is borne out by the low loss rates experienced in microfinance, with Symbiotics saying its own private debt loss rate is less than 1 percent.

A final reason that private debt has become a key way to make impact investments is the connection it gives investors to the companies and projects they are backing. A loan arranged privately can be allocated to a particular project and can contain terms and covenants to ensure it is used specifically for purposes that will have a positive social or environmental impact.

By contrast, when investing in corporate public debt, investors have no control over funding uses at all, which can make it difficult to ensure that a company is meeting its impact objectives and that the capital invested is being used for good causes. Equity also poses some problems, as a sale of the company could result in it being bought by a firm with a less ethical stance than the one originally invested in.


Another key advantage of debt investment in microfinance is the relatively low correlation with more mainstream investments.

“Microfinance is not linked to the volatility seen on traditional markets and has a low correlation with bonds,” Parashkevova says. “Investments are in small entrepreneurs, which are well-monitored and have a good recovery rate and behave very differently [compared] to making investments in larger, stock exchange-listed companies in emerging or developed markets.”

Returns from impact investment are “not high octane” according to Scheurle, but they remain attractive and stable, providing a good tool for portfolio diversification. The strategy may not deliver the sort of double-digit returns that mainstream private debt has become known for, but it can make up for it in stability, low correlation and ethical benefits.

“Impact investing provides attractive returns on a standalone basis and we’ve returned 4.5 percent net of fees to investors over 20 years in a relatively low interest rate environment,” Scheurle says.

There remain some major challenges ahead for impact investing to truly establish itself as a strategy that is well-understood by investors, offers reliable financial returns and can prove it is delivering benchmarked social returns. GIIN hopes that the slow but eventual success of ESG in bringing environmental and social issues into the investment spotlight is an indication of things to come, but the impact investing industry will need to ensure that it does not take another decade for it to be embedded in the public consciousness.

M&G’s move into the impact investing space is seen as forward planning for the long term, and like specialists such as BlueOrchard and Symbiotics, it believes that over the next 10 to 20 years, impact investing will become a natural part of the investment lexicon – just as private equity has and private debt is in the process of.

With debt investing leading the way in impact investing, the private debt industry is well placed to take advantage of expected growth in this type of strategy, as well as push it forward in becoming a widely accepted feature of the investment landscape.