Impact Investing Explained

Impact investors intentionally seek to achieve positive, measurable, social and/or environmental impact alongside a financial return. In the UK, it is one of the fastest growing investment approaches.

Creating positive environmental and social impact can positively incentivise management teams to make strategic moves to grow or reposition existing business models to maximise growth and achieve simultaneous financial return.

Many more large and mid-sized managers are launching impact funds compared to a decade ago. Even five years ago, only relatively few existed, mostly US-based and growth equity-oriented impact funds, with capital large enough to accommodate large LPs.

Today, more GPs at the higher end of the market are launching impact products across private market asset classes and strategies, including infrastructure, buyouts, venture capital, private credit, and other real assets. This means more, larger-scale investments are being made in impact-focused businesses, focused on resolving the environmental and social challenges we face to date.

Recognition is growing among market players that impact investing in private markets presents unique benefits, with differentiated fund features that allow for a longer-term view compared to public markets. The increasing industry alignment on key impact investment standards, management, and measurement practices is leading to a better idea of best practice looks like. In some cases, these best practices are being adopted appropriately for use across GPs’ broader fund platform. The broader range of impact products means more opportunities for large LPs to deploy impact capital on a wider scale, across diverse asset class allocations that can generate market rate returns. An increasing number of allocators are understanding the secular tailwinds and long-term economic trends that feed market growth in the impact and energy transition sphere. In addition, more LPs are creating different types of dedicated impact, energy transition, or sustainable investment sleeves/mandates. This trend shows no sign of slowing down, and the demand for these scaled products still outstrips supply. This supply–demand imbalance is likely to persist for some time. The momentum and growth of scaled impact and energy transition investing has been noticeable and meaningful. Due to these dynamics, this evolution and virtuous circle are expected to continue. The Impact Investment Institute found that impact investing accounts for less than 1% of total AUM in the UK. However, the market is growing.

There are several drivers behind the continuing growth in impact investment:

1. Market awareness

As part of their 2022, Estimating and describing the UK impact investing market report, the III reported an increasing awareness of investors looking for investments that are focused on addressing domestic and global social and environmental challenges.

The Good Economy have stated ‘Investors can tap into this rising demand for mission-aligned capital by financing progressive companies who, in turn, can tap into the growing consumer demand for products that make a positive difference in the world’.

2. Viable impact investment opportunities

The rise of environmental and social challenges, has in turn, increased the availability of investable opportunities. A new generation of ambitious entrepreneurs, many of whom are based in the UK, believe that commercial business can play a part in solving environmental and social crises. Small, innovative businesses are key for providing environmental and social solutions and provide a myriad of opportunities for private capital to invest in a better future, whilst creating financial returns.

3. Government policy & regulation

The introduction of regulation, requiring reporting on climate and sustainability related disclosures, has already prompted a change in behaviours, and has the ability to stimulate market growth. Industry best practice and guidelines have also motivated investors and management teams to integrate impact into their investment strategy and reporting. Impact reporting and measurement helps investors demonstrate the positive outcomes achieved by impact investing, demonstrate performance, and build trust.

4. Financial and impact returns

The GIIN 2023 Impact Investing Allocations, Activity & Performance Report reported that impact investors can achieve market-rate returns, with nearly all investors meeting or exceeding their financial and impact performance expectations. As more impact investors present their data which show impact returns are at market rate (or higher), confidence in impact investing should grow and lead to larger allocations.

5. Liquidity and exits

Ensuring well-defined processes for exits, impact extraction, and re-investment opportunities and aligning time horizons from both the investor and the impact beneficiaries will give investors more certainty in their impact investments.

6. Customer Demand

The emergence of a new wave of customers (particularly among the millennial generation) who are more likely to align their purchases and consumerism with their personal values and are keen to support ‘profit with purpose’ businesses – creating a sizeable market opportunity.

7. The number of impact investors & the scale of capital under their control

Championing new allocations and encouraging ‘impact aligned’ investments to adopt intentionality and impact measurement would bring more investors and capital into the impact asset class.

Investment policies and frameworks, such as the Investment Policy Statements (IPS) would help to increase the percentage of capital allocated to impact investing.

It is because of these powerful long-term trends that an increasing number of General Partners (GPs) and Limited Partners (LPs) are integrating ‘impact’ into their core investment fund strategy.

Impact Investor Knowledge Hub

Our interactive knowledge hub examines the current landscape in the UK and the role private capital plays, in addition to outlining how impact investing works and sign posting tools for best practice approaches to measuring, managing, and disclosing impact.

Find out more