With the world facing numerous challenges, such as environmental impact, climate degradation, etc., the private sector has been looking for ways to address these challenges. Financial markets have sought investments that create a lasting and positive social and environmental impact. Impact investing is a new investment that prioritizes bringing positive social or environmental change and generating good returns. This market-based approach hugely depends on the requirement of private capital to create impact.
Since impact investing is a new market in its nascent stages, it is important to study and learn more about it. We must understand its risks and challenges, how to mitigate these risks, and how to manage the challenges of impact investing. Here is everything you need to know about impact investing.
What is Impact Investing?
There has been increasing interest from different investors, like foundations and pension funds, individual investors, etc., towards the new ‘impact investing‘. Every investment impact society and the environment in a certain way. Today, we live in an era where investment strategies do not solely focus on maximizing returns. Investors look for funding products that can promise sustainability. With shifting needs, new investment approaches are being developed that can generate returns and create value, too.
Impact investing involves investing funds in companies with clear and measurable social or environmental goals. The performance report must include financial and non-financial metrics. While some types of impact investments focus on generating positive social or environmental impact, others have great financial returns and positive social or environmental impact.
The Risks and Challenges of Impact Investing
Since impact investing is a growing field, many things have yet to be explored and considered. There is no denying that it has its own set of challenges and risks for both investors and investees.
Let us underline the main risks and challenges here:
Not Creating Impact
One of the main risks of impact investing is that it may or may not achieve the expected impact. Many investors believe that these investments may not have the power to bring the desired positive impact on society and the environment. This could be due to insufficient information about this new form of investment or the investors’ incapacity to design or execute a foolproof plan. Sometimes, it may be because of any underlying complex issue.
Financial Loss
Another major risk associated with impact investing is the ambiguity of the financial returns. In this kind of investment, there is always a risk that the invested money may not be recovered. This could happen due to various reasons, such as the investment’s inability to create the desired impact, incapable design, weak market conditions, etc.
Regulatory Requirements
Another risk associated with impact investing is that sometimes a political or regulatory change in the investment banking industry can also pose a challenge for impact investors, leading to a financial dent for the investors. Sometimes, the government makes a law that makes it difficult for organizations to operate and yield returns. Also, some environmental regulations can make the company’s products and services less required.
Unable To Deliver Results
When the impact investments do not deliver promised results and are unable to create positive social and environmental change, the same could backfire. It can create negative publicity. Many investee companies cannot fulfill their social or environmental promises, even after trying a lot. This can stir negative public sentiments, bringing reputational damage and financial losses for investors.
Shift Towards Financial Priority
While initially, a company might prioritize creating social or environmental impact, it may slowly shift its focus on maximizing financial returns. This mainly happens when another corporation buys the company and may have financial priorities. When the company’s top-line management changes, they can also prioritize financial profit over non-financial impact.
How to Overcome the Challenges and Risks?
One of the best ways to deal with these challenges is to adopt common standards and principles of impact investing. These will provide clarity and transparency. They also promise consistency and comparability of best practices and desired outcomes.
Using techniques like ratings, indicators, platforms, etc., can provide identification and assessment of sustainable finance opportunities.
One can also invest in building capacity and partnerships to enhance knowledge, resources, and skills. You can work and move ahead with mutual learning and the exchange of best practices. This will also give you confidence in creating new strategies and synergies to leverage the strengths of impact investment.
Wrapping Up
Despite various risks and challenges, investors continue to be attracted to impact investing due to its potential to generate financial returns and positive social and environmental impact. Start impact investing by conducting deep research and due diligence to mitigate the risks.
