In a world where businesses are driven by profits, it is hard to think of a company generating meaningful social impact alongside financial returns. While environmental concerns have been present subconsciously, the exacerbating impact of the Covid-19 pandemic has highlighted the grim reality of social sectors and led to a significant increase in companies with a social or environmental mission at their core.
In India, impact investing had always been an underrated opportunity until many investors realized the paradigm shift toward social sectors. Socio-environmental issues are now being acknowledged by companies and investors alike, making them central to mainstream businesses. Indian impact investment landscape India is well conversant in social businesses and entrepreneurship.
Impact investment as a sector in the country has evolved dramatically, growing annually by 26 percent over the past decade to reach USD 10.8 billion in December 2021. The market addresses the capital needs for combating the country’s most pressing challenges in environmental sustainability, renewable energy, microfinance, and increasing accessibility and affordability of services in the highly diverse country with a scattered population.
For a long time, investors overlooked the social sectors of India, including agriculture, clean energy, and education for the underprivileged, and financial inclusion of the underserved. With the concept of philanthropic deals, many progressive investors adopted impact investing to ensure their investments make an impact, not just profits.
Having said that, finding a balance between generating decent returns and making a positive social impact is challenging. The challenges in the impact investment ecosystem yet remain to be tackled. Lack of structure the foremost challenge India’s impact investing industry struggles with is the lack of a standardized structure. From the beginning itself, the sector riddles with a high cost of registration, tax concessions, exemptions, and a favorable environment for doing business due to the lack of a homogenized process.
As a result, it deters private investors from deploying capital to socio-environmental startups. Furthermore, the Venture Capital model in impact investing proves to be unsuitable. Unlike conventional business sectors, impact-driven businesses need to focus on visible impact and drive realistic returns. In addition, these investments cannot dress up as usual business funding.
For strategic impact investing, the investor must explore more opportunities. Simply focusing on low-income geographies or only expanding the reach of fintech, edtech, agritech, and the like will eventually dilute the idea of impact investing. A standardized structure can ensure accurate assessment for identifying potential investment areas with higher socio-economic and environmental welfare benefits. Furthermore, VC investors expect an exit period of 4-5 years, which is unrealistic for impact investments.
It requires a minimum of 7 years to generate a meaningful impact, aid the company’s financial growth, and exit with good returns. India is still in its development stage, and it needs patient capital to reflect the change. One of the major factors that deter investors from entering the impact investing sector is the measurability of impact.
Despite businesses bringing positive changes, the criteria for measuring the impact is highly complex and challenging. The lack of common frameworks demonstrating the sector’s ability to measure results makes greenwashing a genuine concern. Impact investors sincerely want to know the impact made by their investments, but the lack of groundwork in designing testing tools makes the sector rely on bad science.
Addressing this challenge will help investors rigorously test the promising commitments that can help them mitigate risks with exponential financial growth.
Risk, return, and balance in the two-dimensional world of risk versus return, investment opportunities are grouped across the range of where they fall on this risk-return trade-off. Impact investing adds the third dimension of social and environmental impact, creating a new understanding of the overall risk and return profile which is not bifurcated but whole andcomplete.
Many investors still believe that impact investing comes with a trade-off between impact and risk adjusted financial return. The pre-conceived notion is that the more significant the impact focus is, the lower the return on investment. This perception holds good for the early days of impact investing when negative screening was the only technique used in due diligence.
However, over the past years, impact investing has come up with many risk management approaches, allowing investors to consider environmental, social, and governance in their investment process without giving up on financial return. To be precise, analyzing the investments with a holistic approach, above and beyond risk and return, and including social and environmental factors, can enhance the deal selection and decrease portfolio mortality, leading to a stronger investment portfolio that will deliver financial returns in the long term.
Additionally, as reported by several studies, ESG-compliant companies also aid in lowering the risk of business failure by providing downside protection, especially during the social or economic crisis. Hence, impact investors do not have to choose between generating social impact and financial returns. While we can agree that there are a few challenges, but if the gaps in the present impact investing ecosystem are duly bridged, the sector can overcome the failure of charming the investors.
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