Impact investments can be exerted through a variety of vehicles, reflecting the different needs of investors. Understanding these vehicles and how they are structured is crucial for deciding which is the adequate one.
What is the adequate impact investing vehicle?
Impact investments can be made in the form of direct investments into selected companies or projects. Direct investments ensure the closest alignment with an investor’s impact and returns goals. However, with a view to private debt, private equity, and infrastructure, such investments require substantial expertise and resources with regards to sourcing, executing, and monitoring. The minimum level of investment required is typically high.
Impact funds enable investors to outsource the sourcing, execution, and monitoring of the investment. Such vehicles pool the capital of multiple investors and make direct investments. Impact funds are being managed by specialised impact investment managers with ample experience in sourcing potential investees and aligning a fund’s impact with its risk-return strategy. In particular for investments in developing countries, impact funds are usually the preferred investment vehicle.
Fund of funds
Fund of funds invest in multiple funds related to different impact strategies and themes across asset classes. They offer greater diversification benefits for portfolio construction, but might not always align with an investor’s impact goals and tend to have lower returns due to multiple fee levels.
Blended finance refers to funding by development finance institutions, multilateral development banks, bilateral governments, and foundations in de-risking instruments (e. g., guarantees, first loss or risk-sharing capital, technical assistance, and capacity building) to crowd in private capital in frontier and emerging markets in order to generate a social and/or environmental impact. Blended finance products offer multiple unique features to investors where financial and social returns, risk, and protection against capital loss are adjusted to meet each investor’s suitable risk-return positioning.
Furthermore, blended finance structured products are often equipped with a so-called technical assistance facility (TAF). Customised to the objectives of each product, TAFs play an important role in improving portfolio quality by strengthening a fund’s investees and thus improving their risk profile.
Passively managed product
Passive investing vehicles such as mutual funds or exchange traded funds (ETFs), which often track
an underlying index, are gaining ground. Since the investment process can be largely automated, the costs of passive investing products are generally lower than with actively managed products. In addition, passive investing vehicles like ETFs can make impact investments more accessible to retail investors.
However, passive investing strategies hold the risk of poor outcomes as they offer only limited opportunities to select investments based on an independent assessment of both impact and return.